Pinnacle Financial Partners, Inc. (NASDAQ:PNFP) Q4 2023 Earnings Call Transcript

Pinnacle Financial Partners, Inc. (NASDAQ:PNFP) Q4 2023 Earnings Call Transcript January 17, 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 Fourth Quarter 2023 Earnings 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 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 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. The more detailed description of these and other risks contained in Pinnacle Financial’s annual report on Form 10-K for the year ended December 31st, 2022, 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 a reconciliation of non-GAAP measures to the comparable non-GAAP measures will be available on Pinnacle Financial’s website at www.pnfp.com. With that, I’m now going to turn the presentation over to Mr. Terry Turner, Pinnacle’s President and CEO.

Terry Turner: Thank you, Matthew. Good morning. Thank you for joining us this morning for the fourth quarter 2023 earnings call. Obviously, we will focus on performance in the fourth quarter of ’23 and our outlook for 2024, both of which I think are very good. We always start with the shareholder value dashboard on a GAAP basis and then as adjusted, which is really what I focus on in trying to manage the firm. There’s no doubt 2023 presented one of the most difficult operating environments for banks since the Great Recession. I expect few, if any, banks were able to completely outrun the rate environment and its impact on revenue and earnings growth in 2023. But despite the difficult operating environment, we grew our tangible book value 14.8% in 2023 and produced a 20% total shareholder return.

Our unusual approach of investing in our business, particularly in terms of acquiring new talent even during difficult times is one of the primary reasons we’ve been able to continue to take share and grow balance sheet volumes, which of course is accounted for our rapid and reliable growth in revenue and earnings, which we believe account for our extraordinary total shareholder return over nearly 2.5 decades now. We’ve said for some time that it’s our expectation that credit metrics have to normalize. It’s impossible to operate over time at the very low level of problem loans that we’ve enjoyed over the last two years. We saw a little bit of that in the fourth quarter, but NPAs and classified assets still remain below our five-year median, which is itself very low.

And net charge-offs during the quarter were just 17 basis points. So fourth quarter of ’23 was an excellent quarter for us, particularly on those metrics that point to future shareholder value creation. And so, with that in mind, let me turn it over to Harold for more in-depth look at the quarter.

Harold Carpenter: Thanks, Terry. Good morning, everybody. We’ll again start with deposits, reporting linked-quarter annualized average growth of 4.6% in the fourth quarter, which we believe was a real positive for us. We did see some end of year deposit outflows that lowered our EOP balances and are hopeful to see those balances return this quarter. EOP deposit rates were up only seven basis points, the smallest increase in quite some time. We felt like the rate of increase for deposit rates would slow as we enter the fourth quarter. So we’re pleased with where we ended up. Deposit [indiscernible] fell down quite a bit with fluctuations in our overall rates, driven somewhat by mix shift as several larger, more expensive depositors built balances at year-end.

We will remain disciplined as to the relationship between pricing and growth of deposits. We will continue at a more deliberate pace for gathering deposits without leaning heavily on the rate component for our growth. As to loans, the fourth quarter was another strong loan growth quarter for us, as we are reporting a 10.7% linked-quarter annualized average loan growth for the fourth quarter. As we’ve mentioned over the last several quarters, we are pleased with our results on fixed-rate loan pricing, which ended the quarter with average fixed rate loan yields on newer rate originations of 7.33%. Spread maintenance on floating and variable rate loans continues to be strong with coupons in the high-7s low-8s on new loans. This slide segments our net loan growth based on several categories to help everyone better understand the source of our expansion in the DC, Atlanta, Birmingham et cetera was a source of much of our loan growth in 2023.

That’s why we’re so excited about our announced entry into Jacksonville. We hire experienced bankers on these new markets and give them the tools and resources to build a large local franchise. Much of our loan growth is not to new borrowers, showing up at Pinnacle Bank with a new idea to pitch. Our borrowers have extended relationships with relationship managers over in many cases, decades of working with each other. This is not just true for Charlotte, Nashville, Charleston and other legacy markets, but that applies to Atlanta, DC, Birmingham as well as Jacksonville. As the top chart reflects, our NIM was flat quarter-over-quarter. We had hoped to see a modest increase and continue to believe we have great opportunity to see NIM expansion in 2024.

As we entered the fourth quarter, we felt like we were fairly close to modeled our margins and have some confidence that we have. More importantly, we feel we should see a stronger net interest income as we move into 2024. Our interest rate forecast, we believe, is consistent with most rate forecasts out there. Our planning assumption is that future Fed rate decreases begin in May, and then we see three more before the end of the year. Importantly, our yield curve shift is that it will be less inverted by year-end. As for credit, we’re again presenting our traditional credit metrics. Pinnacle’s loan portfolio continued to perform very well in the fourth quarter. Our belief is that credit should continue to perform well as we move into 2024.

Absent a couple of large charge-offs in 2023, 2023 was a good year as to losses realized from our portfolio. We mentioned one non-performing credit in the press release last night, debated on whether to call it out or not as the [indiscernible] for all of our NPAs is 27 basis points, which is very respectable in comparison to prior quarters. But given the change from prior quarter, we decided to talk about that one credit. We feel that particular credit is well down the road of being rehabilitated and expect no laws currently. Similarly, there was an isolated incidence in both classified and past dues. We’ve downgraded the challenge of credit to classified late in the fourth quarter and one credit also account substantially all the net change and past dues.

For that credit, the borrower did pay interest current before year-end, but we will pass maturity and waiting on the borrower to settle a few matters before granting the renewal, which we anticipate in the next week or so. Concerning commercial real estate, again, some select information. As to the top left chart, construction originations are very selective and reserved for projects where we have a strategic reason to participate. For those that follow regulatory ratios, our 100% concentration ratio was at 84% at year-end, roughly the same as the prior quarter. Our goal is to reduce that ratio to approximately 70% over the next [Technical Difficulty] appetite for construction lending will remain limited at this time. Secondly, much discussion about renewals of commercial real estate fixed-rate loans, which is the objective of the chart on the top right.

Over the next four quarters, we will have approximately $500 million in fixed-rate commercial real estate renewals coming up for repricing, where the average rate on these loans is currently around 4.5%. Our current yield target for these loans at renewal will be in the 7.5% to 8% range. Altogether, we have about $6 billion of fixed rate loans maturing over the next two years with a weighted average yield of 4.8%. Thus, we see real opportunity from a repricing perspective for these loans. Now on the fees. And as always, I’ll speak to BHG in a few minutes. Excluding BHG and various other non-recurring [Technical Difficulty] fee revenues are up 1% to 2% linked-quarter. We are very pleased to report that our wealth management units had a strong 2023, and we fully expect the efforts of our wealth management professionals will continue into 2024.

As we noted in last night’s press release, we accomplished a significant BOLI restructuring program during the quarter, as we sought to increase yields on about $740 million in BOLI contracts with various carriers. In the end, we feel like the payback period on the approximately $16 million in charges we incurred during the quarter is around a year and a half. We believe the anticipated tax equivalent cash yield on our entire BOLI portfolio as a result of all this will approximate 4.5% in 2024 and 5.5% in 2025. This compares to approximately a 3.4% yield currently. Now expenses. Fourth quarter expenses came in about where we thought. As we noted in third quarter, we expect [Technical Difficulty] assessment from the FDIC in the fourth quarter.

A $29 million FDIC special assessment was recorded in the fourth quarter, which we will pay to the FDIC over eight quarters beginning in June of 2024. Our incentive costs for the fourth quarter include the final calculations for our 2023 cash bonus awards. The total cost for 2023 were slightly over $46 million. In comparison to our target payout plan would have required about $30 million more in costs. So our 2023 earnings include $30 million of incentive savings, which is exactly how the plan is supposed to work. If we hit our targets, participants are eligible for target awards. If we don’t, then we aren’t. I will speak more about our outlook for expenses in 2024 in a few minutes. Capital. Our tangible book value per common share increased to $51.38 at quarter-end, up 14.8% year-over-year.

Our focus on book value generation has been a big positive for our firm and has, we believe, benefitted our firm meaningfully. Growing tangible book value has been top of mind to leadership over the last several years and has impacted decisioning as management has not been willing to risk significant tangible book value dilution by perhaps building a large investment portfolio. If we had, we could have put tangible book value generation at risk. Impacting capital ratio in the fourth quarter were several matters that we discussed in the press release last night. In addition to the BOLI restructuring and the FDIC special assessment, we incurred a $35 million capital charge for our [Technical Difficulty] of BHG’s adoption of CECL on October 1st, 2023, which was consistent with our expectations for the last year or so.

Again, this amount did not impact fourth quarter earnings, but did impact our capital and our capital ratios. The chart on the bottom-left of the slide details several pro-forma capital ratios at the end of this [Technical Difficulty] and how we compare to peers on these ratios as of the end of September. Although we don’t anticipate significant changes to the capital rules, we are pleased with these results and believe they will continue to compare favourably to other banks and speaks to our efforts to manage tangible book value effectively. Now to BHG. As we look at fourth quarter originations and as we mentioned last quarter, fourth quarter origination volumes were less than the third quarter as they continue to shrink their credit box and I’d like to emphasize that point.

BHG estimates that 25% of their borrowers in 2021 and the first half of 2022 would not qualify for a BHG loan today. We are very supportive of the efforts by our BHG partners with respect to credit discipline and client selection. We’re also very pleased to see that sales into the bank network during the fourth quarter were basically consistent with the third quarter. The banks continue to have a strong appetite for BHG credit. With original [Technical Difficulty] fourth quarter placements to institutional buyers were about $200 million less than the third quarter. BHG did increase held-for-sale inventories on its batch by $170 million in the fourth quarter, which provides a nice runway going into 2024. As to liquidity, not a lot of change here from last time.

BHG’s liquidity platform remains exceptionally strong. During the fourth quarter, and again as we mentioned at the end of the third quarter, BHG placed about $300 million in loans as a result of their second ABS transaction for 2023. BHG also successfully negotiated a $50 million private whole loan sale during the fourth quarter. Importantly, these private sale transactions are executed with no recourse to BHG, with many of these clients coming back to BHG routinely and planning on being back in 2024 as well. As to spreads, this is the usual information we’ve shown in the past detailing spread trends since the first quarter of [Technical Difficulty]. On the bottom chart, the spreads for all balance sheet loan placements have expanded, as lower coupon loans originated more than two to three years ago pay off for the borrower coupons for the on-balance sheet continue to increase.

Again, as we’ve mentioned for several quarters, the spreads on the chart for on-balance sheet loans represents the build-up of the book over the last few years. BHG believes that should the Fed begin to reduce rates in mid-year 2024, such a move would actually result [Technical Difficulty] spread for BHG for both the bank and institutional platforms. Now to BHG credit. As we’ve noticed in previous quarters, BHG has tightened its credit box over the last several quarters, particularly with respect to lower tranches of its borrowing base. Average FICO for 2023 has improved to 745 from 732 in 2022. The chart on the right details originations in 2012 through 2015 [Technical Difficulty] level out cumulative loss rates of 10% to 12%, whereas vintages after 2015 began to reflect improved performance with the lines leveling out within the 5% to 10% ranges.

On the reserves, again, the usual trends on loss reserves for both on and off balance sheet loans. As expected, the adoption of CECL on October 1st for the on-balance sheet loans resulted in about 300 basis point increase in reserves. Trailing 12-month losses for on-balance sheet amounted to 6.5% in the fourth quarter. If you just look at the fourth quarter, losses were 7.6% for on-balance sheet loans. BHG has been anticipating that credit losses will begin to trend back after the fourth quarter. Right now, BHG believes they have a great shot at seeing reduced credit losses in the first quarter and with a much greater degree of confidence for reduced losses by the second quarter of 2024. Now about BHG’s earnings and production. Last quarter, we anticipated that fourth quarter loan production [Technical Difficulty] approximate $600 million to $800 million and it came in at the high-end of that range.

Impacting earnings, and also as we mentioned last time, BHG recorded several one-time expenses that approximated $10 million in the third quarter, impacting our fourth quarter results with approximately $4 million in severance and other non-recurring costs. A lot of work has been done by BHG to get ready for 2024. With a tighter credit box, BHG anticipates flattish production comparing ’24 to ’23. That said, the bank network and institutional platform both remain very liquid for BHG. Also as the post-COVID credit issues fade into the background, along with a potentially better yield curve, all of this could add up to make 2024 a much more accommodating year for BHG than 2023. With that, I will turn it back over to Terry.

Terry Turner: All right. Thank you, Harold. Well, as Harold mentioned earlier, in the fourth quarter of 2023, we hired our leadership team for our market extension to Jacksonville, Florida. Earlier when I was discussing the 2023 performance, I highlighted the fact that we continue to invest in our business even during the difficult times, which in my judgment has been the key to the extraordinary total shareholder return we continue to produce. One of the good things about 2023 was that it showcased our enterprise-wide risk management system, which provided the necessary guardrails to protect us when a number stumbled, but more importantly, put us in a position to stay the course while many are trying to restructure their business model with major expense initiatives which may aid short-term earnings, but have a devastating impact on long-term shareholder value creation.

Our conservative approach to credit, liquidity and interest rates put us in a great position as we continue investing in our business. The risk management system not only protected us, but, again, left us a capital base and an ability to continue to grow, which is what we intend to do. Most of you know that our target market has been all the large urban markets in the southeast which are so advantaged, where Florida has been our principal [board] (ph). Most of you have heard me talk about this for a long time. The catalyst for when we decide to extend to a new market is when we have the availability of leadership that we believe can build a $3 billion bank over a five-year period of time in any of those large markets. Last quarter, I used this slide to build on the fact that, having started on a de novo basis back in 2000 in Nashville, we now dominate the Nashville market by almost any measure, including things like FDIC deposit share.

And we’re actually running faster in the relatively recent start-ups in Atlanta and Washington DC than we did as we built out the Atlanta market. As you can see here, Jacksonville, Florida is on par with our other large high growth markets, extraordinarily healthy and rapidly growing. And it’s ideally suited us from the perspective of the competitive landscape. It’s dominated by the same exact competitors that we’ve been facing off with for now 23 years. I always try to help people understand this. The size and growth dynamics are really important in terms of the success in the markets that we’ve been in. But more important than the size and growth dynamics would be the competitive landscape. It’s important to have competitors from whom you can take market share.

As I’ve already said, talent availability is what controls the timing. As you can see, our leadership team in Jacksonville is uniquely prepared to build a big bank there. Scott Keith, who run that market for us is a 34-year veteran in that market. He was the former Regional President for North Florida at Truist and he led an 1,100 employee group serving 100,000 clients in that market. He’s joined by Debbie Buckland, who has 27 years of local experience and was the former Market President in Jacksonville at Truist and prior to that, SunTrust. And they are also joined by Bryan Taylor, who has 21 years’ experience in the BB&T/Truist franchise as well. He most recently led North Florida, the middle market effort and through all of North Florida.

So I think it’s evident why Jacksonville and why now. So with that I think I’ll turn it over to Harold and we’ll walk you through the 2024 outlook.

Harold Carpenter: Thanks, Terry. Quickly, we’ll go through the 2024 financial outlook. What I’d like to do is condense all the information on the slide down to five key points. First is deposits. We have to maintain consistent, reliable growth in our deposit book at a reasonable price. That’s what makes all of the initiatives that we’ve invested in to gather new deposits so critical. I believe we’ve made great headway. I think we have got great tools in place. I think we’ve hired experienced professionals to promote and lead these deposit gathering initiatives. So high-single to low double-digit growth seems reasonable. Secondly, BHG. We don’t anticipate BHG to have a great year. We do expect modest growth, mid-single, but I think that comes basically from a new firm, one that has the ability to achieve sustainable growth with an intense focus on growing core businesses.

We’ve had a great partnership with BHG and we believe that the partnership is as strong as ever. We believe the leadership at BHG is focused on the franchise and not on pushing more widgets through the pipe. If credit can get back to its usual run rate by the second half of this year, BHG could have a great year. Loans and loan pricing, primarily fixed rate loan pricing. We’ve done well to get fixed rate loans pricing to their current levels. In comparison to peers, we do quite well, but we can be better. We will continue to focus on that as I think that will be absolutely critical to our ability to grow net interest income high-single to low-double digits in 2024. Now I’d like to talk about expenses. It seems like our expense growth rates are always a topic of great discussion.

In ’23, we harvested at least $30 million out of our incentive plan to help support our EPS results for 2023. In order to support our people in 2024, we need to have a plan that accommodates upwards of $40 million to $50 million in additional incentive expense. As always, we absolutely have to hit numbers. If we don’t hit numbers, we won’t pay. We’ve averaged about 80% of targeted payout in my 23 years here at Pinnacle. We are not bashful about using the incentive pool to help support our earnings results. I do think a reasonable expense target at this point for 2024 probably is a range of between $960 million and $985 million. So as you’re putting together your models, that range seems fair for today. Lastly, earnings. This management group understands to get the share price moving up, you’ve got to grow core EPS.

We believe 2023 was a [Technical Difficulty] year, so we’re aiming north of that. We’ve looked at peers and have stacked ranked earnings growth rate projections for 2024. Our plan will be comfortably in the top quartile of earnings growth. We have to grow earnings in 2024, so our targets reflect that. To be successful, we can’t let expense growth outpace revenues. It’s that simple. Hopefully, we can achieve our planning assumptions, such that all of our associates earn their incentive, while at the same time, the share price reflects all the hard work they’ve accomplished. And with that, Matt, I’ll turn it back over to you for Q&A.

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Q&A Session

Operator: Thank you. Everyone, the floor is now open for questions. [Operator Instructions] Your first question is coming from Ben Gerlinger from Citi. Your line is live.

Ben Gerlinger: Hi. Good morning, guys.

Harold Carpenter: Hi, Ben.

Terry Turner: Good morning.

Ben Gerlinger: Curious if we just kind of touch base on the expenses. Harold, good clarity just a second ago. So when you think about just expenses overall, is this entirely going to or majority going to lenders, or is there some technology or back office spending that needs to be done? I mean, it just seems like Pinnacle getting back to legacy Pinnacle of kind of low double-digit growth is good, but it could put some pressure on PPNR over 2024. Just kind of clarity on where that expense might be going.

Harold Carpenter: Yeah, Ben. I’ll start and I’ll let Terry kind of add his comments as well on this whole topic. Our non-personnel expense base for next year is fairly reasonable. I think, you know, last night, we talked about in the press release that if you exclude incentives, growth rates probably in the low double-digit range. I think that’s pretty conservative with call it an 860 to 885 kind of target for this year. I think we’re more of a high single-digit kind of grower with respect to excluding incentives. Our IT team has gone through what they believe they’re going to need to do this year. We spent a lot of extra time on operational expenses and information technology expenses for 2024. We think we’ve got a good plan. We think we’ve got a plan that they can accomplish. And at the same time, not overboard on kind of the expense burden. With that, I’ll stop and let Terry kind of finish.

Terry Turner: Yeah, Ben, I think to your point, we continue to invest. I think it would be foolhardy not to invest in technology. I mean, you’ve got all the digital progression, AI, all those sorts of things. So, we’re not a do-nothing company. We continue to invest in technology and stay current. I think you know about our firm. We’re not trying to innovate anything. We’re not trying to do something particularly new and different. Our idea is to be a fast follower. And so to do that, we have to stay current. So certainly, there are expenditures other than incentive type expenditures. But one of the things that I guess I would offer for clarity in this company, your question was phrased around, is it all going to lenders? So in this company, 100% of our salaried employees participate in annual cash incentive plan and 100% of us earn our incentive based on hitting our revenue growth targets, our earnings growth targets and keeping asset quality strong.

So 3,400 people are aimed at that outcome. And that’s who gets paid. And so having only paid at a 62% level this year, you would expect most of our associates desire to make 100%. Therefore, we have to run fast enough to produce enough revenue and earnings growth to satisfy the shareholder returns, but get our associates paid. And I think we can do that.

Ben Gerlinger: Sure. No, that’s good color. I think just philosophically hitting commission targets and bonus payouts is a good thing because it literally means you’ve hit your upside targets. If you could kind of just parse through here a little bit. So when you think about adding additional lenders and just revenue producer, well, more lenders specifically than just revenue producers, how are they incentivized or how much flexibility do you give them on gathering deposits in this environment? I mean, given your pretty rapid pace of growth, are you giving them a little bit more slack to gather deposits? Because I’m sure that’s on their scorecard as well kind of tangentially to that. Does that kind of put a lid on the margin overall? I get the back-book repricing will produce a higher margin by the end of the year. I’m just kind of curious on how you guys are structuring their incentive on gathering deposits and any flexibility on rate they might have.

Terry Turner: Yeah, Ben, let me just reinforce the point I made earlier. You know, most people have a hard time understanding the incentive systems here at Pinnacle. Most people are used to structure plans where relationship managers get paid on one basis and, you know, branch managers might be paid on a different basis and so forth. That’s not what happens here. 100% of our salary-based associates, which would include lenders, financial advisors, office leaders, every category of salaried person, their incentive is tied to this company hitting its revenue and its earnings targets. And so that’s a really important thing that I think a lot of people don’t get that direct connection. And so, when you ask about the incentives for the lenders, if you will, to gather deposits and so forth, they have an incentive which is we’re going to have to hit the revenue and earnings growth targets.

And to get that done, we’ve got to produce the loan volumes. To get that done, we have to produce satisfactory deposit volumes. And so, that’s the mindset inside this company. 3,400 people are aimed at hitting that revenue target for the company and the earnings target for the company. It’s not an individual — individually-based incentive plan. I don’t mind to say to you, I don’t want to go get too far afield from what you’re asking, but that idea is really important. Every quarter, we meet with all the associates of the firm and we talk to them about, hey, here’s where we are on our performance on revenue and where we are on earnings and how that impacts incentives. And these are the things we need to do. But it is really easy to crystallize for every single person.

As an example, if we’re not hitting, if we’re not repricing fixed rate loans at a satisfactory margin, man, every quarter, you can stand in there and say, okay, look, here’s what the target is. Here’s what we did. Here’s what that cost us in terms of revenue and earnings. And, man, everybody can see through clearly to exactly what has happened and what needs to happen in order to hit the target. So I don’t mean to go on too much about it. I hope that’s helpful.