Pinnacle Financial Partners, Inc.

Good morning, everyone, and welcome to the Pinnacle Financial Partners' fourth quarter 2022 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 on a listen-only mode. The floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touch-tone phone. Analysts will be given preference during the Q&A. We ask that you please pick up your handset to allow optimum sound quality. During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other facts that may cause the actual results, performance, or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many 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 annual report on Form 10-K for the year ended December 31, 2021, 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 the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com. With that, I am now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Good morning. Thank you for joining us for our fourth quarter earnings call. Looking at the performance in the fourth quarter, key success measures like net interest income growth, tangible book value accretion, core loan growth, core deposit growth, asset quality, all continue to be strong. There is a fair amount of noise in our fourth quarter numbers, so we're going to move quickly to the performance detail for the fourth quarter to try to create clarity there. Then the outlook for 2023 to help the model builders. And finally, I'll spend some time detailing why I believe we have a unique ability to continue producing outsized shareholder value. As you likely know, we believe asset quality, revenue growth, earnings per share growth, and tangible book value accretion result in long-term shareholder returns. That's why our incentives are linked to them, and that's why we show this dashboard every single quarter where you can see the relentless upward slope of those metrics, most closely tied to the shareholder returns. Gap measures first, followed by the non-gap measures, which I'm personally most focused on. And if you believe that asset quality, revenue growth, earnings per share growth, and tangible book value accretion most influence shareholder returns, which I do, then you have to appreciate the persistent, excellent performance against those variables year in and year out. As I mentioned a minute ago, there's considerable noise in our fourth quarter financials, so we're anxious to get on to those details. The most impactful of those items was BHG's election to fund roughly $500 million in originations on their balance sheet, thereby deferring the income on those loans over the life of the loans as opposed to directing them into their auction platform, which would have resulted in taking the gain on sale up front, significantly increasing their and our earnings during the fourth quarter. Nevertheless, I believe you should be able to look through to see that the core banking business continues to have great momentum. So, Harold, let's move on. Let's walk through the quarter. Thanks, Terry. Good morning, everybody.

As usual, we'll start with loans. The fourth quarter was another strong loan growth quarter for us, and we believe annualized mid-teens loan growth pointed to 2023 is reasonable for us. As we anticipated, loan yields were up in the fourth quarter and we anticipate further escalation in loan yields in the first quarter. Along with that, we are forecasting thin increases of 25 basis points in February and 25 basis points in March. Our modeling indicates that loan yields will be up 40 to 50 basis points or so in the first quarter. The talent we've added over the last several years results in extraordinary balance sheet momentum. As we've done over the past few quarters, we're again dissecting that loan growth based on the category noted on the slide to help everyone better understand the source of our growth. It's been a huge year for us as far as loan growth is concerned, and it works out that the new markets and the new hires contribute to more than half of our growth. That said, that represents more than just an annuity strain for interest income. Those are new clients with now new opportunities for our firm to buy all types of financial products. We're definitely in a broader footprint with new markets, but also a much deeper footprint given our model. Now, deposits really pleased to report the growth in deposits for the fourth quarter. Growing deposits at a reasonable price in 2023 is a key focus for our firm right now. We are actively building out deposit gathering franchises around HSA, community housing associations, nonprofits, and others, and we believe we're going to make a headway with these and other special deposit emissions. Our average deposit cost came in heavier at 74 basis point increase over the third quarter. Although we believe we remain inside our total deposit beta guidance of 40% through the end of 2022, we experienced an acceleration in deposit costs in the fourth quarter above our expectations by about 15 basis points. Competitive pressure around deposit costs are significant, so we fully anticipate that increases in the Fed rates will continue to add a tailwind for increased deposit costs in 2023. Average deposit costs weekly may approach 1.9% to 2% in the first quarter of this year. As to next, we are seeing deposits move more non-interest-bearing and lower-yielding interest accounts into higher interest products and time deposits. Our average non-interest bearing deposits were down approximately $440 million and a quarter from pre-Q averages and even more based on either period balances. Our plan would contemplate this decrease to continue at a lesser pace in the first half of 2003. About 90% of our non-interest bearing balances are commercial, with about 25% of that number being analyzed. Over the last year, analyzed commercial has dropped from around $425,000 per account to around $350,000, while non-analyzed commercial has dropped from $35,000 to $30,000. Pre-COVID levels would be around $300,000 for analyzed and a little less than $25,000 for non-analyzed. So average account size is still 10% or so higher than pre-COVID levels. Our number one objective remains developing strategies and tactics around funding our growth. We continue to lack our chances given the significant investment we've made in both relationship managers and new markets over the last few years. Hopefully, you'll not hear this bank's leadership ever talk about having too many deposits. Our belief is that we have and will fund our deposit growth effectively and prudently, maintaining the appropriate balance between profitability and growth. Now liquidity, we believe we have ample liquidity fund our near-term growth. As to investment securities, our allocation of bonds was slashed in the quarter. We don't anticipate any significant growth in bonds this year. As the top left chart reflects, our gap NIM increased by 13 basis points compared to 28 to 30 basis points in the previous two quarters. As we mentioned last time, a decrease in our NIM expansion was not unexpected, although we felt like the NIM would expand in the fourth quarter by a few more basis points than it did. Our planning assumption is that our NIM will likely be flattened down next year and likely down in the first quarter given the first quarter is burned by fewer days. That said, our growth model should provide for increases in net interest income. As we enter 2023, we believe net interest income guidance for the high-tenured percentage growth for 2023 over 2022 is reasonable at this time. As to credit, we're again presenting our traditional credit metrics. Pinnacle's own portfolio continues to perform very well. Our current ACL is 1.04%, which again compares the pre-CECL, pre-COVID reserves, to 48 basis points at the end of 2019. We did modify our CECL modeling this quarter with a more pessimistic assumption, set with a baseline at 20% speculation at 30%, and a pessimistic scenario at 50%. We continue to have conversations with borrowers about supply chains, inflation, and how it's impacting their businesses. We've been all about sustainable credit diligence efforts with the intent to actively identify any weaknesses in our borrowings. We continue to have a very limited appetite for new construction, whether it be residential or commercial. Thus, the growth of our construction portfolio is limited to funding previously approved commitments with no new projects being added at least through the first quarter of 2023. We also remain attentive to our concentration limits in all areas of our portfolio, particularly in CRE, as the table on the bottom right holds of the slide details. No changes regarding our CRE appetite from last quarter. In summary, our outlook for credit remains strong as we enter 2023 from a position of strength, so if negative trends begin to develop, we believe we're advantaged. Now on the fees, and as always, I'll speak to BHG in a few minutes. Excluding BHG, fee revenues were flashed for the third quarter. All that said, we're pleased with the effort that our pre-generating units are putting forth as several units are negatively impacted by the current operating environment in a meaningful way. Obviously, residential mortgage volumes are down this year. Mortgage does see their pipelines building back modestly in the first quarter as rates hopefully will be less volatile in the spring home buying season again. Gains on SDA loan sales are also down significantly from the third quarter as their business was impacted by the elimination of incentives from the CARES Act which drove more business to SBA lenders in previous quarters. We've gotten a few questions on earnings credit rates and the impact on deposits. So here's a stat of that. We have approximately $2.5 billion in analyzed commercial non-interfering accounts. Our current ECR is around 35 basis points, which we feel is competitive at the moment. Our run rate on analysis fees with waivers is about $4.5 million per quarter. For every 25 basis points we raise the ECR, that reduces our analysis fee by $400,000 to $500,000 each quarter. Our goal is to stay in the middle of our competition peer group on earnings credit rates, so we have to believe some lift in the ECR is coming, but it will come in small bites. We had anticipated 2022 to return a high single-digit growth in fees over 2021. Excluding VHG and other non-equity investments, we believe we achieved 5% growth for the year. We think mortgage should recover modestly in 2023, and we've also added some strong revenue producers and wealth management late in 2022. Excluding VHG and the impact of other equity investments, we believe that high single-digit, below-teens growth in 2023 over 2022 is reasonable. Expenses came in about where we thought for the quarter. We did see non-compensation expense decline from 4Q, in 4Q from 3Q, but attributable to the reversal of some franchise tax accruals with some of that being added to the tax line, so it was a reclassification between franchise tax expense and income tax expense. All in, we are anticipating an effective tax rate of approximately 20% in 2023. Our incentive costs also decreased in 4Q from 3Q. This was primarily the result of the impact of 4Q22 PPR results on the cash plan, which came in below target, and overall performance metrics on the performance-based equity incentive boards, which came in below our expectations. All of this is a segue into a few comments about variable cost nature of our expense base. We feel like our expense base should result in mid-teens growth for 23 over 22. As to how we can manage expenses, as I mentioned, we've reduced our 22 payouts due to the firm not achieving selective incentive targets, particularly on our quarterly PPNR targets and various other measurements when it comes to equity compensation, which is, by the way, primarily impacts senior leadership. That's how it works. Our cash incentive plan is always tied to EPS growth targets, and for 2022, it was also tied to PPNR targets for each quarter. We missed our fourth quarter PPNR target, thus incentives were reduced. Our leadership equity plans are tied to results in relation to our peers. Some are returnable tangible common equity, some are tangible book value accretions, some are PE and tangible book value models. So it's all based on ranking in relation to our peers for measures that we think are directly linked to shareholder value. The higher the peer ranking, the better we do. We believe we have a very shareholder-friendly compensation system that is objective, not subjective, which is a meaningful variable cost component. The other element that brings the variable cost attribute to our expense growth is our hiring model. We can always back down or off on recruiting and have done that a few times in our history. I can recall once during the financial crisis and the other at the start of COVID. Both times we slowed recruiting until we better understood the depth of the macro environment. Lastly, and as we mentioned in the press release, we've got the ability to modify, cancel, postpone various events and projects with the absolute woo-hoo, should our targets be in jeopardy of not being achieved. On the capital, tangible book value per common share increased to $44.74 a quarter and up slightly from the last quarter. Our capital ratios remain above well-capitalized levels. We'd like our tangible common equity ratio to stand at 8.5% currently. We are mindful of our Tier 2 capital levels, particularly at Pinnacle Bank. We'll be monitoring our capital levels as we get into 2023. We will action to take a preserved tangible book value, and our tangible capital ratio has served us well and have no plans currently to alter our PNFP Tier 1 capital stack via any sort of common or third offer. Now a few comments about VHG before we look at the outlook for the rest of the year. As the slide indicates, VHG had another great quarter on originations, second best in its history. Originations did decrease from the prior quarter with VHG's implementation of a tighter credit box so fewer of the lower credit score loans, which are typically more profitable, were funded in the fourth quarter. As a result, spreads did come in from the last quarter from 9.7% to 8.9% as the chart on the bottom-up indicates. That's more spread shrinkage than originally planned, but as the chart indicated for several quarters in 2020, current spread remained above or near historical norms. The accrual for loan substitutions and prepayments increased to 5.66% to 5.28% last quarter as a result of a more precautionary posture of VHG management. VHG's accrual for loan substitution and prepackage for our sole loan portfolio increased from $207 million in September 30 to $314 million in December 31. As the blue bars in the bottom right chart show, recourse losses fell slightly from 4% to 3.96% at year end. Additionally, given the macro environment, and as we mentioned last week, VHG also increased on-balance sheet reserve for loan losses to $147 million or $4.5 9% of its on-bound sheet homes from 3-5-3 last quarter. Of course, CECL is still on the radar for adoption on October the 1st, 2023. We continue to anticipate the CECL reserve to be 8% to 9%, but that certainly isn't an estimate at this point. The quality of BSU's borrowing base, in our opinion, remains impressive. As mentioned earlier, BSU has modified its credit box, particularly with respect to lower tranches of its borrowing base. This will have an impact on both production and spreads going forward. BXG refreshes its credit score monthly, always looking for indications of weakness in its borrowing pace. Credit scores were at consistent levels with previous quarters, so their borrowers have remained resilient through the cycle thus far. In comparison to other consumer lenders, we believe BXG borrowers remain well compensated, with average borrower earnings being around $293,000 annually. BHG's 12-month charge-off ratio has increased from 1.98% to 2.94%. Similarly, its delinquency ratio has increased from 1.22% to 1.78%. Although these ratios are in line with early 2021 ratios, BHG recognizes the macroenvironment could lead to further deterioration of similar credits. In an effort to keep performance near historical levels, BHG has made a number of credit cuts to both their marketing and underwriting models. We believe that BHG's management team has taken a proactive approach to managing credit as of the year 2023. Lastly, BHG had another great year in 2022. As I mentioned during our earnings calls this year, we have always believed VHG's earnings in the first half of 2022 would likely be stronger than the second half if they sent more loans to the bank auction platform in the first half of the year rather than hold loans on their balance sheet. As you know, the bank auction platform delivers immediate gain on sale income, while loans that they retain on the balance sheet and fund through various funding options deliver interest income over the life of the loan. DSG accomplished three securitizations this year, aggregating almost $1.3 billion in volume. During the last part of December, they added $550 million in new facilities with Goldman and Truist. This represents incremental funding available to DSG in 2023. A third facility for $500 million was closed in late December as well. Closing of this facility required more loans to remain on balance sheets than we otherwise had been expecting. This facility was fully funded at year-end 2022. So here's a simple example. $100 million issuance through the bank option platform could generate anywhere from $30 to $40 million in gains. Immediately, while going through the securitization platform at an 8% spread would yield approximately $7.8 million in interest income annually. In the fourth quarter, BHG sent more to the balance sheet than originally anticipated, which was both widely sold through the GMS model. Again, looking forward, some key points I'd like to reemphasize, which are basically the same comments I mentioned three months ago. BHG management is responding to the macro environment in a very real way. BHG is and will be increasing reserves based on macroeconomic data at least over the next few quarters. PSG has been modifying their credit model scores to originate less risky assets. With that, spread shrinkage may occur as we head into 2023. Production volumes are strong, and we believe they will maintain production levels going into 2023. BHG's new funding alternatives will broaden their already strong liquidity platform, which we also believe is unmatched by their peers. Lastly, a few weeks ago, BHG took steps to limit its headcount with job eliminations and eliminations of most open positions, as well as other expense reductions, which should yield a 10% reduction in its expense burden in 2023 from 2022. For all those reasons, we have great confidence in our partners at Bankers Healthcare Group to deliver strong results over the long term. Quickly, here's our final initial outlook for 2023, along with a comparison of our comments on 2022, the third quarter conference call in October. We expect mid-teens growth in loans, low to mid-teens growth in deposits. This correlates to a similar outlook for net interest income, which should result legally in high-teens growth in net interest income. Our plan for 2023 contemplates our NIM being flattened down for the year. This will obviously be a challenge, and we need to be nimble with respect to price, especially on the top. Fee revenues may be our biggest challenge, as many fee units are facing more than their fair share of economic headwinds. but we've had some key hires in several of these areas that are optimistic that we should see a lift from those new associates. We believe BSG's earnings will be flat slightly up for 2023. We've reduced our expense growth outlook to mid-teens. Our senior leaders are still committed to a strong recruiting year, especially as it pertains to revenue hires. Asset quality, we believe, is in great shape currently, and we believe we're entering the year from a position of strength, which should be a great thing should we have negative trends begin to develop. We're putting the final touches on our strategic and financial plans for 2023, with just as many unknowns now as there were last year, but our goal remains the same. Top four tolerance performance no matter what gets brought with us. With that, I will turn it back over to the chair.