Pinnacle Financial Partners, Inc.

Good morning everyone and welcome to the Pinnacle Financial Partners second quarter 2023 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 for 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 performed by Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's annual report on Form 10-K for the year ended December 31, 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 GA presentation. A presentation of the most directly comparable GAAP financial measures and a reconciliation of non-GAAP measures at the comparable non-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.

Thank you, Paul. Those of you that have followed us for a while know and expect I'm going to begin every quarterly earnings call with this dashboard of what we believe are the primary things that matter over time in terms of bank performance. Gap measures first, followed by the non-gap measures, which provide the best insight into what I focus on and consequently what we focus on at Pinnacle. My guess is that as 2Q earnings continue to roll out, we'll see some pretty wide variability in performance among the banks. But for us, 2Q was a really good quarter. On an adjusted basis, we grew revenues 11.7% linked quarter annualized, EPS 10.8% linked quarter annualized, and pre-tax, pre-provision net income 24.8% linked quarter annualized. We continued the dramatic growth in loans and deposits at 11.3% and 9.1% link quarter annualized respectively, which are generally the best predictors of our ability to continue growing revenue and earnings going forward. Tangible book value per share grew meaningfully during the quarter, aided by a sell-leaseback transaction that Harold will review in greater detail shortly. And the key asset quality metrics like NPAs, classified assets, and net charge-offs continue to hold up extremely well. So in summary, second quarter was a great quarter for us. Now I'm going to let Harold review the quarter in greater detail, and I'll come back and give some thoughts on the shares later.

Thanks, Terry. Good morning, everybody. We will again start with deposits, reporting late quarter annualized average growth of 12% in the second quarter was again a real positive for us. As we've mentioned previously, growing deposits in 2023 is a key focus, and the second quarter was another indication that obtaining deposits in an environment where competitors can be fairly unpredictable is very much doable for this franchise. Several factors contributed to increased deposit rates in the second quarter. Competitive pressures were heightened during the quarter, primarily from large regional banks offering rate specials at some fairly incredible rates and an apparent effort to achieve funding goals. We also have an important public funds client base, with much of these balances being tied to Fed funds. Lastly, the mixed shift of reduced non-interest bearing to interest bearing continued in the second quarter, albeit at a lesser pace. All of these factors contributed to average deposit costs increasing to 2.52%, with a spot rate at quarter end of 2.77%. We're optimistic about the pace of deposit rate increases as we head into the third quarter. Several factors to consider. Over the last few weeks, our costs do not appear to be moving up at the same pace as we experienced through the end of the first quarter and most of the second quarter. A contributor to this slower pace is the slowing of the mixed shift of deposits from non-interest-bearing to interest-bearing. Also, we intend to reduce the absolute size of our more expensive wholesale funding base in the third quarter by absorbing some of the added liquidity which has been acquired over the last few months. In other words, we do not believe we need to be nearly as aggressive on gathering funding as we have been over the last few months. Deposit rates will continue to increase in the second half of this year as we hopefully approach a terminal value for Fed funds. We just believe with all the liquidity noise in the first half of the year, A more deliberate stance for gathering deposits is available to us as we move into the third quarter. Lastly, in the supplemental slides is more information on uninsured deposits, which are down to 28% of total deposits at quarter end. We won't go into this on the call, but just making sure everyone knows the information is there. The second quarter was another strong long growth quarter for us. That said, our line leadership successfully managed our long growth down to the 11% linked quarter annualized rate. We are maintaining our loan guidance for 2023 at low to mid-teens growth. As we mentioned over the last several quarters, we've tightened the credit box for construction and deployed more discipline on loan pricing, which should serve to reduce our normally outsized growth. Spreads on floating and variable rate loans have continued to be very respectable. We also are seeing spreads on fixed rate lending improve given emphasis by our line leadership. Our loan data thus far is essentially the same as the deposit data, which we believe reflects a great deal of effort on the part of our relationship managers. Our aim with respect to loan pricing is to maintain our spreads on floating and variable rate loans and achieve 7% to 8% plus yields on both new and renewed fixed rate paper. As the top chart reflects, our gap NIM decreased 20 basis points, which is more than we anticipated at the start of the quarter. As we noted last quarter, out of an abundance of caution, our average liquidity increased by approximately $1.2 billion in cash during the second quarter, and our quarter-end liquidity is slightly higher, so we have a lot of cash going into the third quarter, which should help us eliminate some wholesale funding as well as provide for loan growth in the second half of the year. Contributing to the cash bill this quarter was the impact of the sale-leaseback transaction we mentioned in the press release last night. We received approximately $199 million from the sale of non-earning fixed assets. We also sold $174 million from the sale of investment securities. These two transactions allowed us to reposition under-earning assets into interest-bearing cash in order to eliminate the negative near-term impact from increased lease costs. Our rate forecast is consistent with most rate forecasts out there. We are optimistic that a July raise by the Fed is the terminal point for Fed funds, but we may be slightly more pessimistic in that we don't see rate decreases occurring until mid to late 2024. With that, our forecast for the rest of 2023 is that quarterly net interest income will likely be flat to slightly up from the second quarter results. As for credit, we again are presenting our traditional credit metrics. Pinnacle's loan portfolio continued to perform very well in the second quarter. Our belief is that credit should remain fairly consistent for the remainder of this year. We did increase the ratio of our allowance for credit losses to total loans during the quarter to 1.08%. We reworked several of our CECL models during the quarter and are implementing these changes this quarter. We don't anticipate similar increases during the second half of 2023. Any increases from this point should be fairly modest dependent we believe primarily on macro trends. As noted for the last few quarters, we continue to have a very limited, if any, appetite for new construction. Also, the CRE appetite chart on the bottom right is basically unchanged from the prior quarter, but does give you a real perspective on how we have reduced our appetite in commercial real estate over the last year or more. In summary, our outlook for our loan portfolio from a credit perspective remains strong. So if negative macro trends begin to develop, We believe we are advantaged as we enter any potential recession from a position of strength. Again, and consistent with last time, more information around credit. The top left chart deals with trends in construction originations. We began reducing, eliminating our appetite for new construction originations last summer, which is consistent with the chart. The chart would indicate that our limited appetite is largely concentrated in warehouse, multifamily, and residential. A quick note about new residential commitments. The gold bars on the chart are new lines for new homes under old guidance lines for a limited set of long-time residential builders. We continue to support our resi-builders under guidance lines that have been in place in some cases for years. As you likely know, residential builders are very busy right now given the state of the housing market and the lack of existing home inventories, which is especially relevant in our markets, which have a lot of in-migration from around the country. Secondly, the chart on the top right, we are providing updated information about the status of maturities for CRE and construction fixed rate loans. Our yield target for these loans has increased into the 7% to 8% range. Two comments regarding this chart. The absolute size of the fixed rate volumes coming up for renewal remains manageable, and that with rental increases over the last three to five years and occupancy levels remaining we believe that our borrowers will continue to be able to afford the incremental interest costs. Additionally, our underwriting for several years has required that any new commercial real estate or construction commitment be underwritten at higher rates than the contract rate, which in most cases is 200 to 300 basis points higher. Again, we believe our borrowers have the resources to afford these increased rates, both due to increased revenues on their part and based on our previous conclusions from our underwriting practices. Now on to fees, and as always, I'll speak to BSG in a few minutes. Excluding BSG, the impact of the gain on sale of fixed assets and the loss on the sale of investment securities, fee revenues were up slightly from the first quarter. That said, we're pleased with the effort of our fee-generating units during what is proving to be a challenging banking environment. We continue to anticipate that fee revenues, excluding BSG and all these other items, will come in at around a high single-digit growth rate for 2023 over 2022. Link core expenses were essentially flat as personnel costs were down and other expenses were up by similar amounts. Seasonal decreases in payroll taxes and other benefit categories from the first quarter were the cause for the reduced personnel costs, while the sale leaseback lease expense, all set in part by reduced depreciation costs, was the primary contributor to the increased occupancy costs. Additionally, we reduced our anticipated annual cash incentive payouts from 70% to approximately 67% of target awards at the end of the second quarter, so not much change quarter over quarter with respect to our outlook for incentive costs for either cash or equity incentives. Again, the reduced incentive accrual speaks to the variable cost nature of our incentives, which are all substantially performance-based. Additionally, along with deferring projects or slowing our hiring, we feel like we have enough leverage to throttle back on expenses should we need to. We have again lowered our expense growth forecast for this year and have incorporated that into our updated outlook. As it stands, our expense guidance was previously low to mid-teens growth for 2023. We have lowered to high single digits to low teens growth for 2023 over 2022. Our tangible book value per common share increased to $48.85 a quarter and up 16%. Influence of this increase was the sale leaseback transaction, which provided almost $86 million in pre-tax gains, offset in part by $10 million in securities losses. In view of the macro environment, we anticipate retaining this incremental capital at least through the end of this year. We believe the actions we've taken to preserve tangible book value and our tangible capital ratio have served us well and have no plans currently to alter our Tier 1 capital stack via any sort of common or preferred offering. The chart on the bottom left of the slide compares several capital ratios as of the end of March to our peers. Although we don't anticipate significant changes to the capital rules, we are pleased with these results and our ability to withstand any changes to the capital rules that potentially could come our way. Now a few comments about DSG before we look at the outlook for the rest of the year. The top right chart is consistent with various calls and details that production has been consistent over the last several quarters at $1 to $1.2 billion per quarter. Placements to the bank network were less in the same quarter, while placements to institutional investors were at the highest level ever and signaled that demand for BSG paper by some of the most respected asset managers in the country is really strong. BSG has been able to penetrate a very liquid channel over the last few years, which during some of these times has proven to be somewhat fickle for some of the BSG's competitors. Over the last several years, BHG has made periodic calls to pivot between on-balance sheet investor paper and off-balance sheet bank placements. Historically, as institutional investors come to the table, their orders may receive a level of priority as to funding which BHG has to manage. That said, BHG's unique bank network, which we believe can't be replicated by any other BHG competitor, continues to grow and provide the necessary liquidity to BHG. This is a new slide where we're trying to provide additional clarity with regard to the significant funding channels available to BHG for placement of their loan production. What's new to the funding channel list is that in the second quarter, BHG successfully negotiated two private whole loan sales with $550 million of capacity. These are slightly different in that in both cases, these were large purchases structured similar to the bank network. Gain on sale treatment is afforded these sales as the investors acquire the loans with no BSG has negotiated three warehouse lines with three well-known and respected asset managers' private equity firms. Performance of BSG's loans sold to the capital markets have been such that many of the firms that have participated in the past are in constant contact to acquire more loans in the future. The bank auction platform remains very liquid and able to meet the necessary funding that BSG requires of it. All in, these funding channels can collectively provide several billion dollars in capacity and the flexibility to manage liquidity risk effectively between the various channels. This is the usual information we've shown in the past, detailing spread trends just in a slightly different format. The top chart represents the gain on sale of the off-balance sheet bank network, and the bottom chart is a blended chart of all balance sheet funding strategies, which incorporates the historical buildup of balances. As anticipated, spreads have come in with higher rates, with the bank auction rates being consistent with pre-COVID spreads. During the same quarter, the blended spreads for on-balance sheet was slightly higher than the bank network, given the balance sheet loans reflect the buildup of balances over the last three years. As it stands today, BSU expects spreads to be fairly consistent going into the second half of 2023. As we noted in the previous quarters, BSU has tightened its credit box over the last several quarters, particularly with respect to the lower tranches of its borrowing base. This will have an impact on both production and spreads. Average FICO scores in 2023 have increased to 743. As we've stated in prior quarters, BSU has been modifying their credit models to originate less risky assets. Production volumes remain strong, even with tighter credit underwriting. BSU refreshes its credit score monthly, always looking for indications of weakness in its borrowing base. Credit scores are up from previous years. Additionally, approximately 22% of BSU's production is with repeat borrowers, adding to the quality of their loan base. This slide details reserves and losses for both off-balance sheet and on-balance sheet loans. As we mentioned in previous quarters, BSU determined that loss rates in several lower tranches of their production was exceeding internal tolerances and elected to stop lending into these lower tranches. Their conclusion was that for loans written in 2021 and for most of 2022, several contained an element of grade inflation which required remediation. As a result, we believe outsized losses could occur over the next couple of quarters at a similar pace as the last two quarters. Typically for BHG, approximately 70% of the loss content is incurred within the first three years of origination, but with grade inflation, losses should come to light sooner. As a result, BHG has expended significant resources to bulk up collection activities, including hiring more lawyers, and will be instituting in-person closings for new borrowers, which was suspended during COVID. BSG had another strong quarter with approximately $1.1 billion in originations and are on track to achieve $3.8 to $4 billion in originations this year, which is slightly less than last year. Thus far, through two quarters, production is slightly more than the prior year, even with efforts to tighten the credit box. BSG has a conservative bias that production in the last half of the year will likely be lower than the first half, but should be close to what they had last year. Net earnings are being forecasted at $175 million to $190 million, which is a tighter forecast from last quarter's reduction of a 30% to 40% reduction from prior year's results. The numbers now work out to be a 35% to 40% reduction. Quickly, again, the usual slide detail on our current financial outlook for 2023. We continue to plan for a recession, but how severe it will be neither we nor anyone else really knows. Our job is to manage the risks that face this franchise every day. What we know is that our business model is relationship-based, nimble, and resilient. Our management team has significant experience and have tackled economic downturns before. We have great confidence that we will be able to manage the high-quality banking franchise that our shareholders have come to expect from us and can currently handle whatever curveballs get thrown at us. And with that, I'll turn it back over to Terry.