Pinnacle Financial Partners Inc (PNFP) 2010 Q3 法說會逐字稿

Good morning everyone and welcome to the Pinnacle Financial Partners' third-quarter 2010 earnings conference call. Hosting the call from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer. He is joined by Harold Carpenter, Chief Financial Officer, and Harvey White, Chief Credit Officer.

Today's call is being recorded and will be available for replay this afternoon by calling 888-203-1112 and using the passcode 14241013.

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. This webcast will be available on Pinnacle's website for the next 120 days. (Operator Instructions).

Before we begin, Pinnacle does not provide earnings guidance or forecasts. During this presentation we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other facts that may cause the actual results, 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 not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's most recent Annual Report on Form 10-K.

Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events or otherwise.

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.

Thank you, operator. Good morning. Over the last several quarters we focused on two critical priorities. Number one is aggressively dealing with credit issues. Number two, building the core earnings capacity of the firm. And so we will address our progress on both those fronts this morning.

But unlike previous conference calls we are beginning to see some signs of stabilization. I will touch on those briefly. And while it may be less important than the first three themes, it looks like that we are coming through this difficult cycle extremely well. We're well-positioned to capitalize on the vulnerabilities that most of the large regional banks, the vulnerability that they continue to have with their large commercial clients. And I want to address those topics as well.

In regard to the first two things, specifically aggressively dealing with credit issues, on a linked quarter basis net charge-offs, down 78%. NPAs -- in that category I am defining that as NPLs, OREOs and past-dues greater than 90 days -- down 5.7% on a linked quarter basis.

Very importantly, NPA inflows down 52%, linked quarter; nonperforming loans down 13% linked quarter; potential problem loans down 16% linked quarter' past-dues down 22% on a linked quarter basis. And another important thrust and measure of our movement there is the reduction in our construction, acquisition and development exposure, down 13% on a linked quarter basis.

I want to add here that even with that meaningful improvement on virtually every credit metrics, our reserve coverage remains relatively unchanged at 2.60% versus the 2.61% last quarter.

In terms of building the core earnings capacity of the firm, you can see our net interest income before provision, up 1 percentage point on a linked quarter basis. Impressively, DDA is up 10% on a linked quarter basis; core deposits up 5% on a linked quarter basis. And then really the most important measure there EPS at $0.02.

Based on giving you those numbers I don't think I will comment further on slide 5. I have really addressed most of that in slide four. What I would like to do now is move quickly to Harvey White, and ask Harvey to address the -- address more specifics here on our progress on aggressively dealing with credit issues. So Harvey, I will turn it over to you.

All right. Thank you, Terry. Addressing slide six, the first bullet point speaks to the fact that I think, as many of you know, in the third quarter we completed our routine regulatory exam with the OCC. This exam was concluded without surprises. Though it is not on this slide, our own internal loan review is on track this year to review a full 70% of our loan portfolio this year.

Between these two we have had very few risk rating downgrades which were not identified by the line account officer. We have put an awful lot of emphasis here on risk rating accuracy and feel very confident that we have accurately identified the risks in the portfolio. So that is the point of the first bullet point.

The second bullet point highlights the significant reduction in our real estate, construction, acquisition and development book in the past nine months, which has been another major focus of ours in 2010.

As one frame of reference, as of the end of last year, 12/31/09, these loans, the construction and A&D book related to risk-based capital were 112% of risk-based capital at year-end. We have worked that down and now they're below 75% of risk-based capital. So significant progress in attacking that concentration.

Third bullet point speaks to improvement we are seeing in the level of NPAs, and we will detail that a little bit more in a few minutes. Then the final bullet helps explain in part how some of this has been accomplished, and that is by aggressively allocating resources into critical areas of special assets, loan review and compliance.

On slide 7, given the fact that we believe our account officers are doing a good job of rating credits and assigning risk ratings, this slide is very powerful. Two things to look at that are at work here. The first is that there are significant and steady decrease in the volume of credits that are moving from a past risk rating to a fail, which in the fail is criticized classified or doubtful. That is represented by the blue bars in your charts, and again, you will see a good -- a significant and steady decrease in pass to fail.

Again, as many of you know, our routine OCC exam was in the third quarter, so the third-quarter results would include a small number of downgrades from that exam.

The second thing to notice is the red bars, because starting in the first quarter of 2010 and increasing for the past two quarters we are beginning to have more credits that are moving from a fail category to a pass category. This is sometimes due to improving customer results and sometimes due to structural changes that we are able to make in a credit, such as adding guarantors or co-makers, but we are glad to see that that fail to pass is starting to be more evident.

Slide eight, this we think demonstrates that our problem asset levels appear to have peaked out. Looking at them two different ways, whether you look at the total of criticized and classified assets, which is the line in absolute dollars, or whether you look at potential problem loan percentages of the loan book. And again potential problem loans are classified assets or assets with a clearly identified weakness, but that are still performing. So whichever of those two you look at we feel we see a clear peak in our numbers.

On the next slide we look at past-dues and nonperforming loans for each of the basic loan categories. And the peer comparisons are our peers that are greater than $3 billion banks for the most recent Uniform Bank Performance Report as of, I believe, it is the second quarter of 2010.

As you can see, total past-dues between 30 and 90 days are on the left-hand side of the table, and are better than peers in every category except construction and land development, and it is fairly close there. And actually, we are pleased with this overall number of 0.55%, because we feel this is a very good past-due number for this stage of the economic cycle.

Then on the right-hand side of the chart you see a similar comparison for those loans that are greater than 90 days past-dues and for nonperforming loans, again with peer comparisons. As you see, our numbers are better than peers in all categories. Up top the worst category, of course, is the construction and land development category. The 15.28% is very high for us, but as you see, is slightly better than peers.

The next slide is another cut at what we see in our past-due statistics. Since past-dues are an indicator of developing problems, we have divided our past-dues into two groups. At the top are the non-accruals and the credits that have been identified as problem loans and are which -- and typically have been moved to special assets. Then in the bottom are the past-dues for those loans which are still past credits and still handled in the line.

The point of this slide, and the point I would make here, is down at the bottom the 18 basis points or the 16 basis points -- the 18 basis points and 16 basis points is extremely low for past-dues in almost any portfolio. I interpret this to indicate once again that our line officers have done a good job of identifying our problem credits and getting them into the specialized asset area and so that we do not have a whole lot of past credits out who are still -- who are struggling to pay us.

The next slide addresses net charge-offs. This chart obviously shows that our charge-offs -- well, it shows that over the past seven quarters we are obviously above our original projections on charge-offs for the year. But you'll note that, as we said last quarter, the first quarter and second quarter were unusually high, largely because of some aggressive choices that we made relative to the speed of resolution of our problem loans.

The next slide speaks to some of the detail on our other real estate owned. The point of this slide is that the OREO balances are broadly covered 118% by generally current appraised real estate values. You'll note that the average age is overall under six months.

We anticipate continued high levels of OREO over the next few quarters as we move troubled loans through OREO to ultimate resolution. This could be and probably will be impacted somewhat by the possibility that some of our borrowers will declare bankruptcy in order to avoid foreclosure, which obviously slows down the movement into OREO and ultimate resolution of the problems.

You can see a number of bullet points down at the bottom of the slide. I won't read all of those to you, but I would want to point out one, and that is we have a little over $12 million of the $49 million of our OREO, or roughly 25% that is currently in OREO, that we currently have under contract. And based on those contract we would have no additional losses in that 25% of our OREO.

The next slide about NPA disposition activity, the high second quarter number, you remember, is in part due to our charging-off almost half of the $68.8 million. And the good news in this slide is that in the third quarter the charge-offs were about $7 million, so obviously a lot of this NPA disposition is getting accomplished by selling the NPAs or selling the properties rather than charging them off. So that is the good news in that slide.

I think with that, I will turn it over to Harold to go over some of our financials.

Thanks, Harvey. I will briefly cover capital funding and have some brief comments about our third-quarter operations. As you can see by this chart, our capital ratios remain strong as of the end of September.

As to TARP repayment our message remains the same. We continue to look for sustainable credit metric improvement and an improving economic landscape, particularly in middle and east Tennessee. We continue to monitor the regulatory landscape to anticipate regulatory requirements should we apply for redemption of the TARP preferred.

That said, we had more than three years of what we believe to be fairly inexpensive capital before the coupon increases to 9%. Additionally, we are interested in recent developments regarding the U.S. Treasury small-business lending fund. And we will be reviewing these matters to see if there is something there that can be of benefit to our shareholders.

At a minimum, should we participate, it appears it would extend and/or reduce the lower coupon rate out at least another two years to December 2015, thus making any sort of common capital raise to repay TARP in the near term much less likely. Also, at quarter end our holding company had about $63 million in cash to support the ongoing operations of our firm.

Core funding continues to be an exceptional -- continues to be exceptional, as we reposition and strengthen our funding base. We are particularly pleased in the growth of noninterest-bearing deposit and believe we will continue to have success over the next few quarters.

Before quarter end we had anticipated our margin to potentially decrease into the 3.20% range for third quarter, but due primarily to the level of absolute cash we are maintaining on our balance sheet; therefore, we are very pleased with the 3.23% margin that we are posting for the third quarter.

As I will discuss in a few slides, we are also very pleased with how our line managers have managed their relationships on both sides of the balance sheet, with emphasis on deposit accounts that have above-market funding costs.

We maintained about $270 million in low-yield funds and other investments in the third quarter compared to $150 million in the second quarter. This additional liquidity amounted to about a 7 basis point margin dilution. It will take us a few quarters to trim this liquidity to a more typical run-rate.

Obviously, there are advantages to having that liquidity during this time period. We are pursuing lower funding sources, plus time depositors that require higher rates may have to shop elsewhere. We are also seeing some thawing in local loan demand where we now can perhaps forecast stabler modest decreases in loan balances over the next few quarters.

As to perhaps leveraging the additional liquidity into the bond book, we have elected to keep the investment book fairly flat for the time being, and instead remain focused on remixing the deposit base to lower cost categories and capitalizing on slightly increasing loan demand.

As to funding sources, similar to what has been going on in our construction development book, we continue to be excited about the transition we have made in our funding base over the last six plus quarters as we continue to reduce our wholesale funding sources. Even though competition for our deposits remain intense in our markets, our salesforce has been very effective in gathering core funding.

As noted in the chart, core funding has gone from 49% at the end of the same quarter of '09 to 69% currently. Since the end of '09 core funding is up almost $340 million.

This slide details the growth we are experiencing in just DDA accounts. Year-over-year growth is approximately 15.3%. Our average DDA account is $16,900 at the end of September 2010, compared to $15,700 a year go, an increase of about 7.5%, while at the same time the number of accounts is up almost 7%.

Concerning margins, the charts detail the quarterly trends of our net interest income and our net interest margin. As you can see, our linked quarter net interest income between the second quarter and the third quarter was up slightly. 2010 has been a period of elevated nonperforming assets, and as Terry mentioned, we remain focused on reducing our nonperforming asset base in order to return those assets to performing status.

[I believe, if you look] at the chart, it is a fair reflection of the impact of NPAs on our margins, with the third quarter being -- incurring about an 18 basis point dilution. As noted, we finished the quarter with a 3.23% margin.

Also, during the quarter we reversed $575,000 in accrued interest related to inflows from new nonperformers compared to $1.1 million in the second quarter of this year. Hopefully, as NPA inflows continue to reduce this will also be less of a risk factor to our future margins.

This is a slide we have not shown before, but is a good reflection of the margin trends within our balance sheet and is a testament to the great work our relationship managers have done over the past year and a half. The red line represents the customer margin. That is net interest income from loans funded by customer core and relationship-based non-core deposits. You can see it has ramped up nicely over the last few quarters.

The blue line, or the Treasury margin, is much more volatile and has had negative trends. The Treasury margin represents net interest income from the bond book and funded by wholesale deposits. It is materially impacted by the absolute level of liquidity we maintain, as we manage liquidity through the Treasury function. As noted, we are hopeful that we can reduce liquidity over the next few quarters.

As to the blue line, a couple of things we have done this quarter should help, including restructuring some of our Federal Home Loan Bank debt. And one of our TruPs issuances went from a fixed-rate to a floating-rate right around quarter end.

Obviously, our goal is to get the blue line to reverse field and stop the descent, while we continue to grow the red line. As a result, the green line should trend upward.

As to the CD book, another margin improvement opportunity continues to be within our upcoming maturities in CDs. The $220 million represents about a 17% of our CD book. And as you can see, these CDs are currently priced in the low 2%s and are targeted to reprice into the mid 1%s. We will continue to emphasize money market accounts in order to reduce our funding cost further and thus increase our core funding metrics.

This table details our quarterly transfer fees. Regarding our run-rate on fees overall we expect fee revenues to be fairly flat for the fourth quarter. Service charges made a modest comeback this year as we enter life under the new Regulation E rules. Our opt-in program, we believe, has been very successful. Thus far with our target customers we have received responses from about 85% to 90% of these target customers with better than an 85% opt-in rate.

Investment Services is having a good year, while insurance had a strong third quarter. We believe insurance pipelines appear to be opening up somewhat.

Mortgage had one of their best quarters ever. You can see loan sales were $1.3 million for the quarter due to the refinance business that has been very strong for the last few months. At quarter end mortgage did have a strong pipeline, but not as strong as prior quarters, so we expect originations to drop off somewhat in the fourth quarter.

Now since inception of our mortgage operations, mortgage repurchases have not been an issue, and we don't believe they will be an issue for us currently. We are deliberate in our methods of delivering loans to the secondary market and intentionally have systems in place to mitigate and help eliminate mortgage repurchase risk. We believe this strategy has served our shareholders well.

As to expenses impacting our run-rate is obviously the volatility of ORE. Aside from ORE contributing to higher expenses this quarter from last quarter was a reversal of previously accrued incentives in the previous quarter, as noted in the second line of the chart, and generally reductions in various variable expense categories.

In comparison to the third quarter of '09 generally run-rates are up primarily due to increased hires. Four new branches have come online in the last year, and 39 or so new customer contact positions have been added since September of last year. We have also increased our expense base in such areas as compliance, special assets and other related areas.

We continue to have elevated ORE expenses, which will continue into the fourth quarter. Please note that we have completed our formal assessment for impairment of goodwill and concluded we did not have any impairment as of September 30.

As to taxes, given the valuation allowance that we posted last quarter, we are reflecting no tax expense this quarter. We believe the tax line will have a minimal, if any, impact on our results in the fourth quarter of 2010. The reversal continues to be based on sustained profitability for our firm.

The next two slides are intended to reflect what we think our core earning capacity could evolve over the next several quarters. During that time we believe credit costs will remain elevated, thus negating some of the progress. As to margin opportunities reducing our NPA book will have a meaningful impact on our margin. As noted earlier, our impact on third quarter was about 18 basis points.

We also believe we have opportunities to continue to reduce our funding costs as we study various peer groups' funding costs -- as those peer groups' funding costs are higher. We continue to rate shop competitors, and have instituted various programs with our line personnel to target depositors whose rates are higher than market.

Our goal is to gradually reduce the gap that currently exists between our funding costs and that of peers. Lastly, we should be able to reduce our liquidity to more normalized on run-rates. For third quarter that was about a 7 basis point dilution factor.

As to provision expense, we believe our business model post this credit cycle will support charge-off rates of less than 30 basis points.

As to expenses, we get a lot of questions about expenses -- what we are doing, what is happening, etc. We have been and will continue to review our expense base and look for opportunities.

As to the core earnings capacity and expenses, our branch build out is substantially complete in Nashville, with only a few more branches needed in Knoxville. Eventually our special asset group will have a reduced headcount and the ancillary cost of handling troubled assets in this environment have been significant and will be reduced. We believe a sub 60% efficiency ratio for this firm is doable.

With that, I will turn it back over to Terry.

Thanks, Harold. I might expand just a little bit on Harold's comments and talk about a case for growth. I hope it is apparent to everyone that our two critical priorities really remain unchanged. Number one is aggressively dealing with credit issues. Number two is building the core earnings capacity of the firm.

That said, meaningful balance sheet growth is still probably several quarters away. With that in mind, we remain confident that as our credit metrics continue to improve and the market itself stabilizes, that we are extremely well positioned to grow the earnings of the firm.

I continue to believe Nashville and Knoxville are the two best banking markets in the state of Tennessee. And Nashville, in particular, it has been one of the hottest relocation markets in the United States for a good number of years.

Of course, during the downturn relocations and related job growth virtually halted. But we are now beginning to see some of the relocations and the job growth pick back up. There is a slide in the appendix that addresses that, so I won't really spend any time in that in this presentation.

Greenwich research reports that 66% of middle-market businesses express a willingness to switch banks. That is an important theme for us. It is roughly twice the normal volume. And as Nashville's largest locally owned bank, we would expect to get a disproportionate share of those businesses that are willing to switch.

On the flip side of that, based on Greenwich research, our clients continue to be extraordinarily loyal to us. 91% continue to recommend us. That is an amazing statistic there.

Through the tough cycle we have maintained our targeted 95% associate retention rate, which not only helps us capitalize on the vulnerabilities at the other banks, but it really minimizes any vulnerability that we might have.

I guess, as a final proof point on our ability to take marketshare, despite the fact that we are not growing our balance sheet, primarily as a result of limited loan demand and aggressive loan depletion due to our efforts on problem loans, our year-over-year core deposit growth rate is 30.5%. And maybe even more impressive is our DDA year-over-year growth rate of 15%. Harold hit at that a little earlier.

I mentioned at the outset we are beginning to see some signs of stabilization. Unemployment is one of those. As you can see on this chart going back to the second quarter of 2009, our markets actually accelerated faster than the national numbers. That is the first time I have seen that happen. But since that time you can see both Nashville and Knoxville are coming back very nicely and actually doing substantially better than the nation as a whole.

I want to, again, provide some context for our belief in our ability to maintain our clients and continue to take marketshare. As it relates to capitalizing on the vulnerabilities of large regional competitors, let me develop slides 27 and 28 very quickly.

First of all, this is Greenwich research. Secondly, it addresses middle-market businesses with sales from $100 million to $500 million in both Nashville and Knoxville. The y-axis is the marketshare or penetration, and the x-axis is client satisfaction. The crosshairs really represent the median of the top five banks in the state. And so the idea here is to get into the top-right quadrant you would be an out-performer were you in the top-right quadrant.

As you can see, really in just 10 short years we are actually challenging 100 year old franchises in terms of marketshare. And we are relatively unchallenged in terms of client satisfaction. So the marketplace does appreciate what we are offering. And, again, we have been highly successful at taking share from those large regional banks.

On slide 28, this chart is also Greenwich research. Again, it addresses middle-market client loyalty. This is for the same banks as on the previous slide., the top five banks in the state.

As you can see there, not only do we have the highest client loyalty, and that is whether you are expressing it in terms of the loyalty index, the likeliness to recommend the bank, expected to add more business to the bank, likelihood to continue using for future banking needs, any of those areas, we have by far the highest loyalty. And importantly it is actually improving year-over-year, even in the face of what has been a very difficult environment.

So really, I guess, with much the same summary as the last several quarters, we continue to very aggressively address problem credits. We continue to pursue meaningful NPA resolution. We're making great progress on that front. And you should expect continued reductions in our exposure to construction and development.

We are fortunate to serve attractive markets. We are seeing some early signs of economic stabilization and recovery. Nashville's employment rate and ability to attract new jobs is beginning to show signs of life. And we continue to find great opportunity in terms of competitive vulnerabilities.

We are particularly focused on growing the core earnings capacity of the Company. I believe that we can achieve double-digit core funding growth through the remainder of 2010 and continue our margin expansion, as Harold developed that case earlier.

So, operator, I believe we will stop there and open for questions.

(Operator Instructions). Matt Olney, Stephens Inc.

Over the last few quarters we have seen the credit trends have been very lumpy, to say the least. Can you give us an idea of what has been driving that lumpiness? And looking forward to 2011 should we expect similar lumpiness in credit trends or will it be more of a straight line recovery from here on out?

This is Harvey. I assume by the lumpiness you are looking at like the charge-offs in the second quarter and then as low as they are in the third quarter. Is that really what you are focused on?

That's right.

I think the way I would explain it is that in the second quarter we were just real aggressive and saying, folks, we really need to identify our problem credits and deal with them and be aggressive in recognizing the problems and charging it off, cleaning the deck, so to speak.

We had several projects, as we have said before, I think going on in the first half of -- making sure we were correct on our risk ratings, making sure that we were looking at global cash flows correctly, making sure that we were looking at our real estate operators correctly. So during the first half we made every effort to identify what was out there that were developing problems and went ahead and tried to deal with them as much as we could in the second quarter.

So I would say that we are certainly hopeful that we don't see that lumpiness again, because I don't think we're going to have another one-time push or a major push to say, guys, let's get it right. Let's get to the bottom of it and flush as much stuff out as we can. So I would attribute it to that on several fronts efforts to get to the bottom of identifying the risk in our portfolio.

I would add to Harvey's comments there. I think that, as he said, we have had a number of projects over the last 12 months where we have gone in and combed the portfolio, and gone at it this way, gone at it that way, and done a number of deep dives. As you go through those projects you discover things, and it does create a lumpiness.

I will say really for the first time in quite some time we don't have any projects underway where we are trying to go back and understand some aspect. We feel like we've got a good understanding of where we are, and feel like that is really confirmed with the risk rating accuracy that Harvey highlighted earlier.

Okay, great. Thanks, guys.

Kevin Reynolds, Wunderlich Securities.

Good quarter. We have talked a lot about how we feel like things have gotten better and the trends that give you some theory of confidence. But I want to take it on the other side here, or ask it from the other side.

What could happen out there -- what are the reasonable things that could happen out there that might cause you to say, gosh, we missed that one one or that this isn't a clear turn, that this is the anomaly in the quarter, not that the prior quarter's effort was the anomaly?

Well, I think -- I will probably hit two or three things. I guess the first thing is that if you get -- if the economy doesn't stabilize, if you get into a double dip economy that would be problematic in terms of having credit trends begin to move back the other way.

I think in terms of other issues, you always run some risk of being surprised on valuations. When I say that, our policy is to have a current appraisal within nine months. As we have gone down over the last 12 months, in the early part of that cycle we saw some real meaningful degradation in valuations just year-over-year appraisal differences, and those have slowed by a great deal.

So the point I am really trying to make is that we continue to stay inside that nine-month window on appraisals, but evaluation differences are much less significant than they would have been 12 months ago. But you always run the risk of being surprised in those valuations, and so I would think that would be a second thing that might cause numbers to move around if something came in out of the way there.

We get asked a lot -- I think through the last 12 months most of our questions have really -- that we have received really had to do with the land acquisition, construction and development book. Of course, we still have a fairly large component there. And we -- I think Harvey highlighted the fact of our $49 million in OREO, you've got about $12 million of it under contract at valuations that really effectively match the book value.

But you're always nervous on liquidating land and OREO and those kinds of things. Again, we feel like we have accurately marked it, have appraisals that support it and so forth. But, again, anytime you're going to auction real estate that is a wildcard. You might miss something in there.

Kevin, I think those are the key things I would highlight.

Then a separate question. This foreclosure nonsense out of Washington and all recently that has been weighing on the overall sector, do you view that as an -- does that enhance your marketshare gaining opportunities as the larger banks out there get bogged down in that -- in that issue or does that also present a risk for you in some form out there that we haven't really factored in at this point?

My sense is that it is probably no impact to Pinnacle. As you know, our business mix is still skewed to the commercial side. We are not a heavy -- in terms of our balance sheet, as you know, we sell mortgages in the secondary market, but in terms of the balance sheet, we are not a heavy mortgage lender. So I don't look for it to have much impact on Pinnacle one way or another.

Okay, thanks. Good quarter.

Mac Hodgson, SunTrust Robinson Humphrey.

Harvey, can you give any color on the upgrades? I like the chart that shows the upgrade from fail to pass. Can you gave any color on where those upgrades are coming from? Is it just traditional commercial credits? Any color there would be helpful.

Well, it is a combination. Some of those are real estate where you have been able to shore them up. Typically in the real estate sector I would say it is where we have been able to do something structural, adding guarantors, getting guarantors to perform, those type of things rather than the underlying economic improvement.

I think in the C&I side you are probably seeing some where you are seeing improvement in the underlying numbers of the companies. Believe it or not, we are seeing -- and through this cycle we saw a number of people who turned in better results in '09 than they did in '08. People that figured in the fall of '08 when the municipal bond market went to pieces that, hey, this was real and maybe you should do something.

A lot of people were able to react and react pretty quickly, many times at the expense of employees, because the easiest thing to do was to cut expenses through layoffs and the like.

So in the C&I sector -- I guess, what I am trying to say is in the C&I sector we are seeing more where, yes, there is true improvement. And the real estate upgrades would be where we are doing something structural, adding strength to the credit and making it upgradable that way.

Okay, great. Then on the OREO costs in the quarter it has been really elevated now for several quarters. How much of that, of the OREO expenses, were related to write-downs? Do you have that? And you expect that expense to stay elevated at this level going forward?

This is Harold. A couple of comments on that. First of all, in the third quarter probably about 70% of it is related to valuation adjustments. And so we are continuing to see appraisals coming in and we are seeing adjustments to those values.

So how much it will be in the fourth quarter I can't tell you. But our planning assumption is that we will have elevated cost over the next few quarters. We are also projecting that we will see less inflows into the ORE book as well. So hopefully over time you will see that number decrease.

Okay, and just one last one. On the small business lending program or lending fund, I haven't heard a lot of banks talk about it or express interest. Maybe walk us through you all interest there and what would make you do it versus not do it.

Well, to be clear, it is hard to say whether we would want to do it or not, because the regulations haven't been published. So you would have to understand what the regulations are, what the requirements are, what the various incentives and penalties might be, before you could determine whether you would want to participate or not.

So I think that is important to begin with. But in just -- from 30,000 feet, it would seem that banks who currently have TARP funding and could utilize those funds to repay TARP, there would be an advantage from that.

In terms of the cost of capital there is an incentive for banks who are able to grow their C&I portfolio -- I'll use that term loosely, that is a technical definition. I think it is companies with sales less than $50 million and loans less than $10 million or something. But as you know, that is really the wheel house of our Company; that is what we do.

So to the extent we can leverage those funds, loan them to small businesses that meet that definition, we would have an opportunity to drive our cost of capital to as low as 1%, which would be extraordinarily attractive.

I think you have heard me say this a number of times, there was a time when it seemed critical and urgent to get out of TARP. I have said over the last several quarters it is a less urgent thing just because of the cost of capital benefits. And my sense is we care a lot -- well, not my sense, I mean, I care a lot about trying to figure out a way to avoid any shareholder dilution, common stock issuance and so forth.

So those are things that have appeal, but again, I don't want to overstate or have you draw a conclusion, hey, those guys have decided they want to do it. We don't know enough to decide whether we do or don't. But those are the things that have appeal.

Sure, that's helpful. I appreciate it. Thanks.

Steve Moss, Janney Montgomery Scott.

I guess to start off one housekeeping item there. With regard to the yield on loans for the quarter, a pretty big move. Are you repricing loans higher here, and should we expect to see more of that going forward?

I think what is influencing that number also -- I think we are getting good headway on repricing, but I think something that influenced it also was the nonaccrual impact this quarter. We had about $1.1 million in reversed interest last quarter and had only about less than half of that this quarter. So that was impactful.

But your original question was, are we getting traction on loan yields. I think so. But I would also let you know that there is intense competition for a good C&I credit. I think that is not only in Nashville, but all over the country. So our philosophy thus far has been we are not going to lose a customer on price, so we are battling that currently.

If I could, I would add to Harold's comments. I think this is an industrywide trend. It certainly is true in our market. You've got swelling core deposits and limited loan demand. What that does is create an extraordinary demand for high-quality credit. So in terms of looking forward I would not look for much widening on asset or loan yields.

Okay. And then on the asset quality frontier, with regard to your criticized assets, it looked like about 43% are construction-related. What is the composition of the remaining credits?

What are you -- which one -- let me try to figure out which one you are looking at. Are you looking at a specific slide?

I am looking at your potential problem assets of about $267 million. And then I was looking on the supplements on the past-dues, which -- I'm sorry, on the page 35, the performing criticized for Q3 at $114.6 million.

If you're asking about what are the loan categories or their criticized assets? Is that what you're asking?

Yes.

We've got about, I think, $168 million, $170 million or so of construction and development that are being managed by our special assets group that got probably another $100 million of C&I credit and maybe $120 million in commercial real estate. That includes not only potential problem loans but the next step up, the criticized credits. Is that helpful?

That is helpful. I guess in terms of what type of CRE and C&I credits are you seeing the most stress in?

Well, quite frankly, in the C&I world we are seeing mostly C&I credits that have some relation to the real estate, quite frankly, whether it is suppliers or subcontractors were one thing and another that is classed as C&I, but really has some impact because of the real estate.

In the commercial real estate where you are seeing the stress, is that generally on the retail and office side, non-owner occupied or is it --?

Well, we really don't have much stress in our CRE, quite frankly, if you look at our past-dues and so forth. As you know, we said many times before, we don't have any of these trophy downtown, big high-rise offices and stuff like that. So we are relatively clean in our CRE. I mean, zero past-dues in what is out there in our past CRE credits.

I guess just to clarify, in terms of criticized and the potential problem on the CRE side, it is $20 million? I thought I heard $120 million.

Potential problem loans, which would be performing credits that are 8 rated?

Right.

Our substandard rated.

Yes.

We've got about $80 million.

In CRE?

In CRE. That would include owner-occupied.

Okay.

$34 million of non-owner occupied.

Okay. Then, lastly, with regard to a pretty significant move on the construction book this quarter, I guess a little more color in terms of how you were able to reduce that book. It looks like $3.5 million was charge-offs. I haven't quite figured out what was OREO this quarter, but a little color there would be helpful.

Well, it is a combination of things. Of course, since construction is in that bucket, when you have a construction loan that moves to permanent that is a reduction. There have been lot take down -- I mean, we continue to see some residential activities, so you are still having some houses getting built that absorbed some of that land. You have some that flushes out of the loan category into the other real estate owned.

I think there was probably maybe $10 million of movement out of that bucket just by reclassification of where we went in and said, okay, are we sure that these loans belong in that category. So a small part of that was due to that. So it is a combination of things.

Okay, thank you very much.

Jefferson Harralson, KBW.

I wanted to ask you about the -- I am trying to figure out impact of GSE activity and rep and warranty on smaller banks. I realize it is not a huge issue for you guys, but how do you gauge your risk on the loans that you have sold in the past? And do you think the GSEs are treating smaller banks differently? What kind of put backs have you had so far, and what kind of put backs do you expect?

This is Harold. Since the life of our program we have had less than 10 put backs. And there is always going to be that risk, so I don't know if they are treating small caps differently than large caps. I don't know the answer to that question.

But one of the things that we do is that we sell loans on a one-off basis, and so we have avoided the underwriting on most of those credits. So that if we sell them into the secondary market, the person that is buying them is doing the underwriting. We are just sending the package to them. We take less of a price by doing that kind of business model, but we also don't assume -- we don't assume the repurchase risk.

If you look at your various loan categories, it sounds like you guys are very bullish on credit, which is a good thing. Are the categories that you think that losses are getting worse or that inflows are getting higher maybe on a non-owner occupied commercial real estate, or do you think that it has seen the peak in most of the categories, and may be a little lumpy, but pretty steady improvement from here?

I guess different words mean different things to different people. To say we are bullish on credit, I would just caution that we've got a lot of heavy lifting left to do, if bullish sounds too strong. We are pleased with our progress is probably a better characterization. I think we are moving forward appropriately and have a good capacity to handle the problems in terms of having them identified, working through them in an orderly fashion and those kinds of things.

As it relates to CRE, we, I guess, tried to make this point several times. We do community bank type income producing property loans. In other words, as Harold just said, no downtown skyscrapers, no trophy retail malls, that kind of stuff. When we are doing retail space, you might to a small strip center, but more likely you might do a build-to-suit for a tractor supply or Walgreens or those kinds of things. That is just the kind of credit that we do, and so it is different, I think, than what a lot of folks would have in their portfolio.

We are cautious on office, on warehouse and on retail. The reason we are cautious on that is just what the current vacancy levels are. But as Harvey pointed out, I guess we've got zero past-dues in our income producing property. And so we are not having things that are bubbling up in terms of the maturities that we would have been coming up in say 2011. About 5%, I guess, of the portfolio would mature in 2011.

So again, I don't see things -- Jefferson, I guess, to your question, I don't see things that have us alarmed about what is remaining in the portfolio. I think we understand that risk pretty well. We are cautious about ongoing underwriting obviously in a lot of those categories, but I don't see a lot of things that are keeping us awake at night right now in terms of changing trends.

This is Harvey. I guess what I would point out is, although we have made huge progress in the land and construction -- there is a slide in there in the appendix that breaks down construction and land categories. The fact is we still have almost $250 million of land, residential and commercial land, land unspecified. And although 60% of that is already being handled by our special assets group, that is still a pretty big number for us. And getting that land flushed through, resolved, dealt with is, I guess, the issue I see that we've got to deal with over the next year.

Yes, I think that's accurate.

All right, thanks, guys. That is great color, and a great quarter.

Peyton Green, Sterne Agee.

Just to touch again on the land component of the C&D. It has dropped significantly linked quarter and it has dropped significantly year to date. I was just wondering what your guidance would be going forward on that? It certainly -- I mean, it has been a very hard environment to move those balances lower, and I was just wondering if you could comment on what has changed in the last 90 days compared to say a year ago or nine months ago?

Well, I think relative to a year ago we still feel that we would like less land, more active projects. You look at the total, and the total again includes construction, quite frankly, I would just as soon see some more construction if we can get out of the land. It is that residential land, in particular, but some commercial come in middle Tennessee, that there is just too much of it, and we have our share of it.

So, I guess, going forward we are going to continue to try to get out of just raw land lots and more into -- or hope that more of our real estate component of our book is construction or non-owner occupied or owner-occupied commercial real estate.

I might just add to that. I think, and you are probably familiar with these numbers, but you've got a nine year supply of lots, 12 month supply of single-family residences. So ultimately the path out is to convert lots to single-family construction. That is going to be slow going there. But we are very aggressive in terms of our actions on OREO. I think because of that you ought to have an expectation that we are going to continue to drive that portfolio down.

Okay. Then when would you -- in terms of the dispositions, again, you saw kind of a good dollar volume of disposition, ignoring the charge-off component, in the third quarter. Do you think you can handle that same kind of volume over the next two or three quarters or do you think that it slows down a little?

This is Harvey. I think we want to get rid of it as we can. I think that one of the balances you have to make, and one of the things I think we did several times before, is that as you have fewer and fewer coming in as problems, it gives us the luxury, if you want to call it that, of taking our time and disposing of them and dealing with them. Because we think if we take our time in those dispositions we tend to do better in terms of cents on the dollar that we recover or resolve.

So I think that you're going to see somewhat of a slowing down. We are just not going to be pushing stuff through like we did in second quarter at that kind of pace.

Right. Payton, you know, I think last quarter the average age of our OREO was 123 days, if I remember right, and this quarter it is 144 days. You might see that expand a little bit, but it won't go to 365. But to Harvey's point, the idea here is we think we can minimize actual losses by being a little slower and a little more orderly in the liquidation of that.

I think that is what you see -- Harvey made the point about $12 million of the $49 million in OREO was under contract at no loss to what we are carrying it on the books at. So again, I think that strategy will pay dividends for us.

Okay, and then on the nonperforming loans, and this would refer to slide 40 in the deck, it seems like you've got a fair amount of payoffs coming in the fourth quarter, which could seem to be more of an acceleration on that front. Would you characterize it that way, and if so, what has changed to drive that?

A lot of these are just things we have been working on for a long time. That is a simplistic answer, but some are moving to OREO and some are controlled liquidation, but I would say that you just have a lot of things that have been bubbling out there our special assets guys have been working on, and just a lot of things are coming to head between now and year end.

Okay, and I guess once you get past this group of kind of the five largest, to what degree does it become more granular?

I think these five represent about 50% of our nonperformings in that -- let's see (inaudible). Yes, so the last point down there the 220 accounts make up the remaining, so it gets real granular after these five.

Okay, all right. Excellent. Okay, and then last question is just in terms of the appraisals. Now versus six or nine months ago have you seen the appraisals start to stabilize and you're not seeing the kind of marks you would have a quarter of go on similar properties. Have you seen them move the other way at all?

Some have. I would say certainly related to a year ago we have seen more stabilization quarter to quarter. I am not sure that I would say there has been much move one way or the other, but over the past six months or so, yes, I think that's right.

Okay, great. Thank you very much.

Brian Martin, FIG Partners.

Payton just covered one of my questions. But just your improvement on the credit quality front that you guys have seen, what are your goals as far as what do you think is realistic as far as getting down the nonperformings down to -- what type of levels are you guys targeting or you think it is realistic over the next, let's say the next four to eight quarters?

This is Harold. We go through all kinds of forecasting exercises, but based on the inflows that we're getting from special assets and their forecasts and all that sort of stuff, we ought to be able to get this level -- this absolute level of $150 million down into the low hundreds and below that say by the next -- by the end of next year or the middle of next year.

Okay, that's it. Thanks, guys.

Thank you, Brian. Okay, operator, I just might try to summarize where we have been. We have really gone back and hit the same two themes that we have hit at the last four or five quarters. We made -- had a great quarter, I think, in terms of aggressively dealing with the credit issues. We have had a good quarter in terms of building the core earnings capacity of the firm.

We are also beginning to see some stabilization in our market trends. And as we begin to rid ourselves of problem assets, and begin to look out a little bit, we continue to be excited about the markets that we serve, and our ability to move marketshare from vulnerable competitors.

So that is largely what we have covered. I thank everybody for their participation. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Everyone have a great day.