Pinnacle Financial Partners Inc (PNFP) 2011 Q1 法說會逐字稿

Good morning, everyone, and welcome to the Pinnacle Financial Partners first-quarter 2011 earnings conference call. Hosting the call today 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. Please note, Pinnacle's earnings release and this morning's presentation are available on the investor relations page of their website at www.PNSP.com. Today's call is being recorded and will be available for replay on Pinnacle's website for the next 120 days.

At this time all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. (Operator instructions).

Before we begin, Pinnacle does not provide earnings guidance or forecasts. During the presentation we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other facts that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any such 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 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 to 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 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'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Thank you, operator. Good morning. Throughout 2010 and in the first quarter of 2011 we focused on two critical priorities. Number one is aggressively dealing with credit issues. Number two is building the core earnings capacity of the firm. So, as usual, we will address our progress on both of these fronts this morning after we have had a chance to thoroughly discuss our progress on both of these priorities, then I will spend a few minutes highlighting some of the opportunities that we see going forward, and finally we will conclude with Q&A, as usual.

In regard to these same two critical priorities, let me begin with priority number one, aggressively dealing with credit issues. As you can see, we've continued to make progress, reducing virtually every important problem asset category this quarter. Net charge-offs were roughly $9.7 million for the quarter; that's up slightly from the previous quarter, but well below the average quarterly run rate for 2010. OREO expenses and $4.3 million were down significantly from $7.9 million the prior quarter. And so combining those two, our total credit losses were down for the third consecutive quarter. Non-performing assets -- and that's defined as NPLs plus OREO -- were down $8.1 million during the quarter; that's just under 6%. Non-performing loan inflows continued to slow slightly during this quarter. Non-performing loans shrank by roughly $5 million during the quarter, from $81 million to $76 million, a linked-quarter reduction of 5.6%. And that's the fourth consecutive quarterly reduction there.

Criticized and classified assets shrank by roughly $38 million during the first quarter, a linked-quarter reduction of 6.5%. That's also the fourth consecutive quarterly reduction. Potential problem loans shrank nearly $53 million during the quarter. That's roughly 24%, which represents a very significant reduction to the risk in our loan portfolio. Restructured loans, which really only make up about $15 million of the loan book, were down approximately $5 million during the quarter, and we continued to reduce exposure in the construction and development portfolio that has plagued us over the last two years. Now it's just $300 million, less than half of what it was at its peak.

Now, in terms of expanding the core earnings capacity for this firm, clearly, the two most significant levers will be accelerating loan volumes, particularly C&I volumes, and expanding margin. During the first quarter we had continued momentum on both and frankly believe we should have continuing momentum throughout 2011.

For the first quarter since third quarter 2009 we were able to produce an admittedly very modest net loan growth. But importantly, our most important asset class, loans to businesses, grew roughly $50 million and has now grown for the third consecutive quarter and at an accelerating pace, 3.2% for the quarter, or roughly 13% per annum. So you can see we really are beginning to get some traction here.

Non-interest-bearing deposits grew at 3.7% on a linked-quarter basis, which was the fourth consecutive quarter of growth there. And I highlight that not only because of the impact it can have on net interest margin, but because generally DDA growth is the single best indicator of a bank's ability to gather primary clients. And as credit costs subside, in my opinion, the real winners will be those that can reliably grow primary banking relationships.

The net interest margin expanded nicely from 3.29% last quarter to 3.4% this quarter, primarily aided by decreases in cost of funds quarter to quarter. Pre-tax income grew from $0.05 to $0.06 in the first quarter. You may recall we had a tax benefit of roughly $0.02 in the fourth quarter.

So overall, we've still got lots of room to reduce problem assets. We've still got lots of room to improve earnings. But, as you can see from a very high-level, the first quarter was good quarter in terms of execution against our two primary priorities.

What I would like to do now is turn it over to Harvey White, Chief Credit Officer, to review the first priority in greater detail. He will be followed by Harold Carpenter, the CFO, who will review the second priority in greater detail. And then, at the conclusion, I will come back and talk a little further about opportunities that we see as we move through 2011. So Harvey?

Thank you, Terry. Let me start with the actual loss experience for the quarter. Charging down a loan and charging down OREO through OREO expense are essentially the same thing, so OREO expense and charge-offs should be looked at together. This bar graph shows the sum of these two numbers has been decreasing for the past few quarters.

Actually, we had hoped that the first quarter of 2011 would be better, but near the end of the quarter we determined that we needed to charge down one credit where we had been relying on what we now believe were fraudulent representations regarding our liquid collateral. Investigations continue. Without a swift remedy, it appears that litigation is likely. But we elected at this point to go ahead and book essentially a $6.1 million loss and take a recovery in the future if that becomes appropriate. So, absent what appears to be a significant fraud loss, credit losses continued to improve.

Past-due loans are a primary leading indicator of developing credit problems. I would point to three numbers on this chart. On the top line are our non-accrual loans which are past due. As an aside and not on this slide, at March 31, 61% of our non-accruing loans were in fact not past due, but were being handled in accordance with their contractual terms compared to 59% at December 31.

As noted on this slide, those non-accruals that are past due make up 1.46% of total loans. Clearly, these loans are identified as problems and are handled by workout officers. Next, about halfway down, you'll see that 28 basis points of our loans are past due but have already been identified as problems and are being handled in special assets group.

And then the final number to look at is on the bottom line, where it shows that only 8 basis points of our loans are past due 30 days or more and are still past credits handled in the line. This is extremely clean for any portfolio and indicates to me that we do not have many credits still in the past categories who are having trouble keeping current.

The next slide is, I think, very powerful. There are really two things at work here. The first is that there is a significant and steady decrease in the volume of credits that are moving from a pass risk rating to a fail risk rating, and failed is either criticized, classified or doubtful. That number is represented by the blue bars in your charts; and again, since the second quarter of 2009 you will see a good and very significant, steady decrease in these as they move from pass to fail.

Then, the second thing to notice is the red bars. Starting in the first quarter of 2010 and continuing since then, we began to have more credits that are moving from a fail risk rating to a pass category. This is sometimes due to improving customer results, sometimes due to structural changes we are able to negotiate. But in any event, we are glad to see more and more move from the pass to fail categories. In fact, in the first quarter of 2011 the upgrades exceeded the downgrades. For the first time since the recession began, we had a quarter with net upgrades.

The next slide demonstrates that our problem asset levels appear to have peaked out in early 2010, and there are two different ways of looking at this. First, the line represents the total criticized plus classified assets in absolute dollars and relates to scale on the right-hand side of the chart. As you see, these peaked in the first quarter of 2010 at $627 million, were down slightly in the second quarter and then have continued to come down well in the third quarter, fourth quarter and again in the first quarter, ending at $443 million.

The second way of looking at this issue in the chart is the bars, and they relate to the scale on the left, which show the potential problem loans. And those are classified assets still performing, so it's problem loans relative to total loans. This measure peaked in the second quarter of 2010 and has shown very good improvement in the third and fourth quarters and again in the first quarters of 2011.

On slide 10, we look at the 90-day past dues and non-performing loans for each of the basic loan categories. In the peer comparison, our peers are banks that are over $3 billion in assets for the most recent uniform bank performance report, which is the fourth quarter of 2010. As you see, our numbers are better than peers' in all categories, and this is true whether you look at our March 11 numbers versus the 12/10 peers or you look at our 12/10 numbers versus the 12/10 peers. In both cases, ours are better than peers' in all categories.

The top line, the worst category, of course, is construction and land development category. This 12.3% is very high for us, but it's slightly better than peers and is improving each quarter. In fact, all categories have improved each quarter, except a slight uptick in the first quarter for C&I. Even then, overall, we are noticeably better than peers.

Slide 11 shows two different but related issues. In an earlier slide, we showed where criticized and classified loans are decreasing every quarter since the first quarter of 2010. This slide demonstrates a similar issue looking at non-performing loans, which are represented by the green bars. They peaked in the first quarter of 2010 and have decreased every quarter since. In addition, line on this chart is allowance for loan losses expressed as a percentage of non-performing loans. This has been increasing or improving ever since the first quarter of 2010 and is now above 100%, which is at the high end of our peer group, which is a good thing.

The next slide is about the non-performing asset disposition activity. You may remember a high second-quarter number is in large part due to our charging off almost half of that $68.8 million in the second quarter. The good news of this slide is that in each of the last three quarters, dispositions were in the $34 million to $43 million range, but charge-offs in each of these quarters was less than $10 million. So obviously, most of the non-performing asset disposition was getting accomplished by selling the NPAs or selling off properties rather than charging them off.

We sometimes talk about the progression from NPLs to OREO to ultimate resolution, usually through a sale of the OREO. But I will point out that not all NPLs take this route. Of our NPLs, our non-performing loans right now, about 40% are expected to go through foreclosure, and about three-fourths of these have foreclosures already scheduled for the second quarter. We have already written these down based on current appraisals. 30% of our NPLs are expected to pay off or improve to the point that we can put them back on accrual status. And then, finally, we think 30% will be long-term workouts with periodic reductions, generally based on lot takedowns or unit sales and where we feel foreclosure is not the best option.

The next slide speaks to some of the detail of our other real estate owned, and the point of this slide is that OREO balances are broadly covered, 121.4%, by generally current appraisals of the OREO. You will note that the average age is a little over four months. We believe our OREO valuations are good and expect minimal losses on this disposition. We anticipate continued high levels of OREO over the next few quarters as we continue to move troubled loans through OREO to ultimate resolution. Again, the fact that 42% of our non-performing assets were OREO indicates that we are aggressive in pushing these assets through the process.

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 the movement through the process to ultimate resolution.

The next slide -- this slide is intended to convey again that we believe we had our other real estate owned written down appropriately. The last column shows, for all OREO dispositions from January of 2010 through March of 2011, shows original loan amount, the customer payments, the charge-offs, valuation losses all the way down the columns to show the final number in that column showing that for all these foreclosed properties that we disposed of during that 15 months, we ended up collecting 50.5% of the original note amount.

And then the right column shows that, of the properties we have in OREO as of March 31, goes through the same process and shows that we have already marked those down to 44.6% of the original note amount. So again, we feel that we have been aggressive and appropriate in taking our marks on the OREO and don't expect continued loss on disposition or additional loss on disposition.

Our OREO disposition strategy goes hand-in-hand with our strategy to dispose of all of our non-performing assets. We've had six consecutive quarters of NPA disposition activity, including OREO sales that range in the $30 million to $45 million per quarter. We anticipate this place of NPA disposition to continue in the future, and as we stick to our plan which calls for planned strategic disposition of these problem assets.

Our OREO dispositions strategy begins with our planned NPL migration. As I noted earlier, we anticipate approximately 30% of our NPLs to have a positive resolution in the next six to 12 months. Approximately 40% of our NPLs are contractually performing and are not delinquent. We anticipate 40% of our NPLs to be moving to foreclosure, and in fact, again, most of these are scheduled for foreclosure in the next three months. These foreclosure actions, again, could be delayed if the borrowers elect bankruptcy protection.

We continue to obtain updated independent third-party appraisals every nine months on both OREO and on non-performing loans. Assets are appropriately marked upon receipt of these valuations. As mentioned on the previous slide, our OREO is marked lower than our historic loss rate. In fact, in our most recent quarter we experienced improvement in our loss rates in OREO sales with a 6% gain on asset sales held in the first quarter of 2011.

Our current OREO book is about six months in average age. We will continue to monitor this statistic to keep the age of the book in a reasonable range. As assets increase in age, we will place more emphasis on these assets for disposition. Again, OREO comprises 42% of our NPAs, and we expect this percentage to increase as we continue to take aggressive strategic action in the procurement and sale of these problem assets.

With that, I will turn it over to Harold Carpenter.

Thanks, Harvey. We continue to focus on building core earnings capacity of our firm. We are pleased with the margin performance at 3.4% during the first quarter, along with increases in C&I and owner-occupied commercial real estate. We continue to maintain high levels of core funding, as we are particularly pleased in the growth of non-interest-bearing deposits and believe we will continue to have success with that over the next few quarters, due primarily to an increased sales effort by our relationship managers.

We remain excited with how our relationship managers have managed their clients on both sides of our balance sheet with a return to growth on the loan side and continuing emphasis on deposit account funding costs, particularly those accounts where we believe deposit rates are above market in price. Along those lines, we are pleased to report that our deposit funding costs decreased 15 basis points in the first quarter, and we expect continued decreases in the next few quarters.

As we mentioned last quarter, we anticipated our expense run rate to increase with the re-introduction of incentive accruals in our 2011 run rates. Our belief is that our expense run rate should stabilize for the remainder of this year.

This slide details the momentum we are seeing regarding growth in our loan volumes, particularly C&I and owner occupied. As the blue bars indicate, you can see that net change in aggregate loan balances are trending in the right direction, while the core of our business, C&I and owner occupied, are making positive strides with approximately $50 million in net growth in the first quarter of this year compared to $30 million in growth in the fourth quarter of last year.

We have indicated several initiatives that we are deploying to help increase our net loan balances. We are re-focusing our efforts on small business and have realigned certain personnel so they can spend 100% of their time on securing strong client relationships in this segment.

As to middle-market commercial lending, we are seeing that many of our clients have cautiously worked through the last two years and now beginning to display renewed confidence by purchasing new equipment, adding inventories or otherwise considering borrowing money again.

Additionally, our sales force is also looking to gaining new clients. Using their years of experience in our markets, they are displaying a renewed energy for sales calling in Nashville and Knoxville. We believe 2011 is a good time to capitalize on competitive vulnerabilities and continue moving market share.

This slide shows more information on the good work our relationship managers have done on growing core deposits over the last six to seven quarters. As the blue bars indicate, our core deposit balances held during the first quarter of 2011, and as the red line indicates, we have been very successful in reducing our overall deposit cost of funds from 1.6% at the third quarter of last year to 1.01% as of the first quarter of this year.

This slide details the 42% growth we are experiencing in DDA accounts since the first quarter of last year -- of 2009. We believe these green bars provide further validation of the local market acceptance of our firm and our business model. Year-over-year growth in dollars is approximately 20%. Our average DDA account is almost $16,900 currently compared to $15,500 a year ago, an increase of 8.6%, while at the same time the absolute number of accounts is up almost 9%.

Regarding margins, the chart above, the chart details the quarterly trends of our net interest margin. As noted, we finished the quarter with a 3.4% margin. Also during the quarter, we reversed $481,000 in accrued interest related to inflows from new non-performers compared to $387,000 in the fourth quarter of last year. During 2010 we recorded interest reversals of $2.6 million, which impacted our margins meaningfully throughout the year. Hopefully, as NPA inflows continue to reduce, this will also be less of a risk factor to our future margins.

The chart on the bottom is the trend of interest expense over the last five quarters. We have done a great job of reducing our cost of funds, and we anticipate continued reductions over the next several quarters. Our most liquid earning assets averaged about $186 million during the first quarter compared to $231 million in the fourth quarter of last year. We believe we can optimize our earnings as well as keep our balance sheet in a reasonable growth posture with a target threshold for liquid assets at around $100 million to $140 million in balances.

This is a slide we have shown before, as we believe this is a good reflection of the margin trends within our balance sheet. The red line represents the customer margin. This is net interest income from loans funded by customer core relationship-based non-core deposits. You can see it has ramped up nicely over the last few quarters and continues to show a positive trend. The blue line or the Treasury margin is much more volatile and has had a negative trend up until the first quarter of 2011. The Treasury margin represents primarily net interest income from the bond book that's funded by wholesale deposits. It's also impacted by the absolute level of liquidity we maintain.

Impacting our Treasury margin during the first quarter was a slowing in prepayments on our bond portfolio. As with that slowing, amortization expense for the premium on those bonds have also slowed. Obviously, by keeping both lines moving upwards, the green line should respond likewise.

As to the CD book, our consistent margin improvement opportunity continues to be within our upcoming maturities on CDs. The $233 million represents about 24% of our CD book. And as you can see, these CDs are currently priced at approximately 1.8%, and our target is to reprice into the 0.75% to 1.25% range. We will continue to emphasize money market accounts in order to enhance our ability to reduce our funding costs further as well as increase our core funding metrics.

Now, concerning capital in the SBLF, as you might guess, in spite of the new information the Treasury rolled out during the first quarter, we still don't know everything we need to know to be certain that we'll ultimately avail ourselves of this option. It continues to be interesting to us. Obviously, the SBLF option has the potential to get further incorporated into the political partisanship debates such that the advantages that SBLF offers a firm like ours as well as the advantages it offers our country's local small/middle-market business segment could be minimized.

In spite of all that, all I can say is that we are hopeful we will be able to get all of our questions answered by Treasury and our regulators and finalize our path forward based on that.

With that, we will turn the presentation back over to Terry to wrap up.

Okay, thanks, Harold. Well, as you can see, in terms of executing on the two critical priorities of our firm, first quarter 2011 was a good quarter. Hopefully, we are beginning to sound like a broken record in terms of quarterly progress we're making on both those fronts. As we turn our focus to the remainder of 2011 I think you ought to expect momentum to continue building in terms of both credit issue resolution and improving our core earnings capacity.

Let me take just a few minutes to talk about some of the specific opportunities we see as we move forward. First, I'll talk about balance sheet growth opportunity just a minute. As I mentioned earlier, the two principal levers for earnings momentum for this firm will be loan growth and margin expansion. So first of all, in my view, the economy is still fragile, but it appears to me that our markets are beginning to stabilize and we are seeing a few more loan requests from existing clients. We're beginning to see a resurgence in corporate relocation activity here in Nashville, and that is what really fueled its outsized growth for over the last two decades. Some of you may have seen Kiplinger just ranked Nashville as one of 11 comeback cities, primarily based on its ability to produce jobs. So we believe that ability to produce net jobs and should enable our market to outperform the nation.

Even with that, my plan and assumption is that the economic environment is still not sufficient to provide adequate loan growth for us, or really for any bank, for that matter. So I think the only banks that are going to be successful in producing meaningful loan growth will have to be successful at taking market share.

Fortunately, I believe we are in an unusual position to do that. We we've proven our ability to move market share. 17% of businesses in middle Tennessee name us as their primary bank; that's more than any other bank in Nashville, and we've built that in just 10 years. So I think we demonstrate an ability to exploit the vulnerabilities of these large regional and national franchises.

Happily, according to Greenwich Research, 66% of small and mid-sized businesses are willing to switch banks. We expect to be the primary beneficiary of that willingness to switch. Not only did our lead market share and reputation for client satisfaction but importantly, Greenwich research also reveals that, as we are nearing the end of the credit cycle, we've preserved our reputation with both clients and prospects as being the most reliable provider of credit in this market, which over the years has been the single most important bank selection criterion for business owners. So the environment to move market share for our firm is arguably even better than the environment in which we moved from a de novo bank to a market leader.

On margin expansion, we have made significant robbers on our net interest margin from its low at 2.72% in March of 2009 to 3.40% last quarter. We expect continued margin expansion. To help you think about sizing that ongoing margin expansion opportunity, let me start with the reduction in non-performing assets. As we replace non-performing assets with performing loans, that lift in loan yield represents a significant margin expansion opportunity. Assuming that we move from the first quarter NPA to total loans and OREO ratio of 4.04% just down to 1.50% and reinvest in performing assets, that would improve the margin 3 to 8 basis points.

Harold highlighted the cost of funds reduction opportunity just a few minutes ago. Over time, we would expect that to translate to 14 to 19 basis points in margin. And over the last year or so we have chosen to maintain excess liquidity on our balance sheet. Harold went over that just a minute ago as well. As we begin to replace the liquidity with loan growth, we expect that to add another 3 to 6 basis points in net interest margin.

So you can see, over time, we believe that we still have pretty good opportunity to grow our NIM, say from the 3.40% current level to something in the range of 3.55% to 3.70%.

Now, specifically as it relates to second quarter, lending opportunities from both clients and prospects appear to be increasing at this point, so we would expect continuing momentum in net loan growth, particularly C&I. You heard Harold size the volume of CDs to be repriced in Q2 at roughly $230 million. That's 22% of the book, and the rate pickup should approximate 60 to 80 basis points there. That, in conjunction with the slowing prepayment speeds in the bond book and reinvestment in non-performing assets should lead to continued margin expansion in the quarter. As a relates to NPL and NPA resolution, we expect the pace to pick up in the second quarter. Specifically recall that we have roughly $76 million in NPLs. As Harvey said, over $30 million of those are contractually performing, leaving about $46 million in some stage of delinquency or default and we have already scheduled foreclosures for $25 million of those during the quarter. Also we expect further slowing of NPL inflows, so we expect more meaningful progress on NPL/NPA resolution during the second quarter.

We've got a major emphasis with our sales force on referrals to various fee businesses, particularly investment trusts and insurance, where actually we are making nice progress. But I think, due to the deposit in mortgage headwinds, we would expect total non-interest income to be relatively flat next quarter.

On expenses, ex-OREO expenses, we will generally hold the first quarter run rates. And I think, finally, you should expect the impact of tax expenses to be minimal until we reverse the DTA valuation reserve.

So really, I guess very much the same summary as the last several quarters. We continue to be very aggressively addressing problem credits. Specifically, we continue to pursue meaningful NPA resolutions. We are making great progress on that front. And you should expect continued reductions in problem loans and in our exposure to the construction and development lending book.

I would say that we are fortunate to serve attractive markets. Of course, job creation is critical to achieve economic stabilization. Nashville's ability to attract new jobs is beginning to show signs of life. We continue to find great opportunity in terms of competitive vulnerabilities. And I think, really, that that is the single most important point as it relates to growth profile of our firm going forward.

We are particularly focused on growing the core earnings capacity of the Company. The two principal levers for achieving that are loan growth and expanding margins, and the trend lines for both of those levers are very good. We expect further quarterly progress on both of them throughout the remainder of 2011.

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

(Operator instructions) Kevin Fitzsimmons, Sandler O'Neill.

Just two quick questions -- first, I hear what you're saying about the expense run rate being stable. But specifically, I wanted to ask about what you thought about the pace of OREO expenses. That came down quite a bit this quarter, and it sounds like you are saying, while you're going to have more progress in second quarter on NPL resolutions, OREO balances may not move down as quickly if foreclosure isn't the ultimate resolution on a lot of those, so just how we should think about that.

And then, secondly, Terry, just wondering what your thoughts are on the recoverability or the reversal of the DTA allowance. You have had three consecutive quarters now of profitability, and wondering how those conversations are going with your auditors on that front.

On the OREO question, we continue to push OREO sales. As I mentioned, we are really trying to push them out the back door. But also, as I think I mentioned a couple of times, we think we have marked them down appropriately, so we expect our loss on disposition, which is one component of those OREO expenses, would be reduced. So, again, for all of 2010, loss on disposition was in the range of 20%-some. In the first quarter in 2011 we saw a net gain in the -- when we actually disposed of them.

So we are going to continue pushing it out the back door, try to keep average age in there no greater than about six months. But again, less loss on disposition, because your normal maintenance and taxes and stuff like that will certainly be there.

I might add to that just a little bit. I think it's a reasonable assumption that the current run rate is probably as good a proxy for the go-forward run rate over the course of the year as anything. You know, I just give you this caution -- you know how that is; sometimes it will be a little spotty as you'll have a transaction move -- that you expect to close in one quarter, it will close in the next, those sorts of things. So it may be a little choppy; but I think, if you looked at it over three- or four-quarter period, I think the current run rate would be a good assumption for the average run rate going forward.

On the DTA question, we continue to have discussions with the accountants on that matter. Our posture is we are in the same place -- sustained profitability over an extended period of time, and also our ability to look forward and see that our credit costs are, in fact, moving down, I think, are two critical elements to that whole process.

We are pleased that the margin is moving in the right direction. We think expenses will be flat on all the operating expense categories this year. So we think we are making headway to build a stronger argument for that reversal here over the next few quarters.

And, Harold, correct me if I'm wrong; we haven't seen anyone yet that has reversed that, right, this cycle?

I get some information on some non-banks that have done it, but I haven't seen any financial institutions that have done that.

Okay, all right, thank you.

Jefferson Harralson, KBW.

I wanted to ask you about the -- your dispositions are certainly, I think, exceeding expectations, but I wanted to ask you about the inflows. You had about $27 million of inflows this quarter, if I'm not mistaken. Can you talk about what loans are coming in there, what type loans are coming in there, and what the expected loss content of that $27 million, if you can? And it seems like with your improving direction of past dues, that you would expect that $27 million to decline in future quarters.

All right. Now, you are talking about the movement into the OREO?

Into NPLs.

On, into the NPLs altogether.

It still seems like it's a fairly high number.

Yes, and it's across the board. We have a few large numbers in there, but it gets pretty granular in a hurry with a pretty wide variety of -- still a lot of real estate names in there, but continuing to see some increase in commercial business moving in there. But I mean, really, there really aren't any huge, significant patterns to it. I'm sort of looking at the list right now of the names, and there just are a few, about three or four large names, and then everything else is pretty granular.

Let me ask you about the -- how should we think about the $300 million left in the C&D portfolio? It's cut in half, which is good. But it sounds like you think that you are more than halfway through the losses in that portfolio. Is that a fair statement?

Yes, and there's a chart back in the charts that we give you. I think I would probably point to the chart on page 34 of the supplementary charts, and it tries to break down the construction and the land categories, which is where we believe most of the issues are. As you look at that chart, we really haven't had difficulty in the spec residential or the custom residential, the condo that we have we see movement in. The commercial construction part has not been a problem; typically, that rolls on through the construction and gets taken out.

The two numbers where we have of the $300 million, the most issues would be in that $97 million and the $99 million. And one of the points of that slide is, of that $196 million, really $91 million or essentially half of it is already in the non-performing loan column or the performing but criticized column. So our point there is, gosh, half of it has already moved into our special assets area. What's left in the past category has, from a past due point of view and those points of view, shows sign of health.

So we think we are appropriately identifying the problems, moving them to our specialized area. And we are expecting continued reduction in the construction and development portfolio. I think that about $25 million reduction in the second quarter just through foreclosures that we have scheduled. So that will continue to go down.

And just one final one, just on -- if you take those two categories, the $97.5 million and the $99.8 million, and you may push back on this, but let's just let -- if we put a 20% loss rate on that -- you may argue that's high, and it may be, so let me know -- that's $40 million, and that would keep you at this same kind of charge-off run rate the rest of the year. But it does seem like that you are seeing such improvement that you might think that's way too high.

Well, I would say it's high in as much as the half of those numbers that are already in non-performing loans or performing but criticized have been reappraised when they moved into those categories. So we are going to have marked those down. So no, I would expect that 20% would be extremely high, given that we've already marked them down.

All right, perfect, thank you guys.

Kevin Reynolds, Wunderlich Securities.

If you could -- a couple of my questions have already been answered. But if you could talk a little bit more about the nature of the pickup in borrower activity, specifically in the commercial and small business and middle market segment. What kinds of things are they talking about doing or actually borrowing to do? And is it in specific industries or anything like that, or is it broad-based?

It's fairly broad-based. Most quarters in the past we have said it's zero demand. I think we've started to see some activity. Recently in terms of new building activity, I've seen schools doing stuff. I've seen some commercial -- light manufacturing putting on some protective equipment. But let's don't overstate this; it isn't a resurgence of loan demand. It's still pretty anemic. But we are, relative to a quarter ago or two quarters ago when we were just saying, guys, we are not getting anything but what we are able to move in market share. But we are starting to see some new activity and people deciding to deploy capital and do new projects.

Kevin, I might just tag up onto Harvey's comment -- Harvey, you feel free to add anything you want to add to it. But my sense is that when you come out of these recessions, generally the first thing you begin to see is some equipment requests where people have deferred capital expenditures and those sorts of things. And so we are beginning to see people that are doing just that; they are now willing to refurbish equipment, add equipment, those kinds of things. I would say that we've not had anybody that wanted to build a new plant or add a new shift. So, again, just trying to be clear with you about what it is.

But it seems like typical early-stage stuff, largely capital expenditures on deferred CapEx.

And, believe it or not, some requests in the entertainment and hospitality industries.

And then I know you've had -- obviously, for several quarters now, you have had paydowns in the loan portfolio, and I think it was either last quarter or the quarter before where you all had said some very modest early-stage signs of life with C&I but to be offset by paydowns in the CRE portfolio, I believe non-owner occupied. Is that still the dynamic that's going on, and would you expect flattish loan balances? I know, if you took the gross numbers they are actually okay at this point in the cycle, but still being offset by those kinds of paydowns. Do you see those coming to an end, or is that going to continue?

I think, generally, we are going to continue working down the residential and the land, but I think that our C&I we are trying to grow and, I think, showing some success in that. And we are still in the CRE construction, commercial, both owner occupied and non-owner occupied business. And we see some life in those two segments of real estate.

And then one last question, and I'll hop off -- not to say that everything is rosy, but it sounds -- you had a pretty good quarter, at it looks like you are seeing some signs of activity there that at least can let you be somewhat cautiously optimistic. But what worries you now? I know the Japanese tsunami is not going to impact Nashville, but what worries you today? What keeps you up at night, makes you be a little more conservative than you might otherwise like to be?

Well, you know, I would, I guess, hit at two or three things. What I've tried to say here is not dissimilar to the preface to your question. While I do see some growth and some life, I guess, some opportunity for growth, and we are cautiously optimistic about it, I do think the economy is still very fragile. I think the real estate markets, in particular, are fragile and they are not coming back as quickly as most of us would hope. I think you've got possibility of very high gas prices. There are a lot of things here that I think could potentially put you in a double dip.

So just the general economic state, while I'm cautiously optimistic, I would classify it as very fragile. So that would be something that I would worry about.

I think, broadly, just in terms of the earnings growth and profile, you know the head winds as well as anybody, I think. While we believe we are going to expand our margin here, primarily on the back of cost of funds decreases, I would be very worried about pricing on loans. As you know, the industry has got too much capital and there are too many banks and there are too many banks chasing too few deals. So I think that's going to -- it will retard the growth in our margin due to the pricing competition on the asset side. I think that will be a continuing thing.

And then I think, just real quickly, you have all the other fee businesses for us. As I mentioned, we have a lot of selling energy in our trust and insurance and investment businesses. But I don't really think they're going to outrun the compression that you've got in mortgage and deposit service charges. So those would be things I would think about and worry about.

And one last follow-up; I apologize. You mentioned too much capital, too much capacity in the banking industry. We know that there's at least two or three banks in the eastern half of Tennessee that are deeply troubled right now. Do you get the sense that anything is going to improve there? Could some competitors in places like Knoxville go away or maybe get recapped? And how would that change your outlook for market share gains?

Well, I -- let's stick with it at 30,000 feet. You're going to continue to see bank failures. We will have less competitors. But I think even at the end of all that, there will still be too many competitors and too much capital in the industry.

Okay, thanks a lot.

Andy Stapp, B. Riley.

Just trying to get a handle on how quickly C&D, construction and development loans become less of a head wind for overall loan growth. Do you have a target where you would like to get that down to over time?

Well, no. The ones that are -- it's kind of like the ones that are in the wrong place and we've sort of charged down and have in either non-performing or OREO -- I'd like to go ahead and move that all out. But most of the stuff that's still performing is performing because there is some absorption or it's in the right place and is holding value pretty well. So one way of looking at it is say, gosh, half of what I have right now seems to be performing, and some absorption, and if the economy keeps improving, at least that half of the book ought to be a pretty good book of business.

And could you provide some color on what was driving the increase in the unemployment rates in Nashville and Knoxville versus year end?

We don't know a whole lot about that yet, but I do know that it's been a fairly consistent kind of post fourth-quarter kind of trend over the last few years, is that the first quarter is usually a more difficult quarter for unemployment are the numbers that we reflect, which aren't seasonally adjusted.

Okay. And Harold, you had made some comments about what you see forward regarding incentive comp accruals. I missed that.

Yes; we have made some comments before, and I think there's some information in the press release about it. We had about $1 million in incentive accruals that we put into the first-quarter expense run rate. We think over this year that number could go up as high as probably $5 million to $7 million, in aggregate for the year.

Okay, great, all right, thank you.

Mac Hodgson, SunTrust Robinson.

Just a question on margin, Harold, on the 5.26, where it walks through the first-quarter margin at 3.40 and then the potential range of 3.60 to 3.73. How quickly do you think you can hit those levels? And how will that be impacted by rising rates?

This is a longer-term perspective, Mac, so it's not going to happen in the second quarter. It's probably not going to happen in the third quarter. But over the next year or so, we think we can get into this range and maintain it in that range. So that's what we are trying to position with you, with respect to this slide.

And what about interest rates, rising interest rates, how would that impact this?

Well, right now we think we are pretty neutral on interest rates. We've got loan floors on our books that we would have to work through, so we need a rate pop of probably anywhere from 75 to 100 basis points. But once we get that rate pop, then we become largely asset-sensitive. So we are hoping, when rates move, they move fast.

Okay, great. Harvey, just to clarify a comment you made earlier -- I don't think I quite followed it. It sounded like there was a large charge-off that you took this quarter related to collateral values that may have been fraudulent. Could you go over that again?

Sure. I was just saying, towards the end of the first quarter we felt we needed to charge down one loan where we feel that there were some fraudulent representations relative to liquid collateral that we thought we had. We are continuing to investigate, and litigation is likely. So I can't say a whole lot about it, but that's what I mentioned.

Okay, can you say how big the charge-off was, related to it?

Yes, that was -- I'm sorry -- $6.1 million of the charge-offs were due to that one account.

And then, just in general on appraisal values, obviously over the last several quarters charge-offs have come down and OREO expenses are coming down, yet you are still seeing, obviously, some write-downs on OREO. Is there still downward pressure on reappraisals, or we're getting close to the bottom?

Well, we've seen some increases, actually. I'd say across the board, I would characterize it as having stabilized. But we've seen, even in some land categories, some increase. But I would represent it as stable.

Okay, great, thanks.

Peyton Green, Sterne Agee.

Just to clarify, I think you have answered probably all you can on the one credit. But in terms of the seasonality in disposing of credit, I think you had $8.5 million under contract to sell currently out of the OREO basket at par or better versus $5.3 million a quarter ago. Would you expect this position to pick up just from a seasonal perspective?

Yes, I think so. I think it's natural in the spring and summer, people are going to be in a buying mood more. So yes, I think so. This first quarter was kind of slow, but I expect you to see pickup there.

Okay. And then I guess, given the stabilization in values, you feel pretty good that OREO expense still should trend down from where it was, say, a year ago or even a couple quarters ago?

Yes, I think so, flat to down. But yes, I think you will.

Okay. And then on the charge-off side of things, that's a pretty big move down in charge-offs if you back out the one credit. Is that something that you think is sustainable going forward, if you continue to see the solid improvement in the potential problem loans and other criticized categories?

Well, I think that backing out that one, certainly we would have had a great first quarter. Whether the $9 million less $3 million is a sustainable number -- I would hate to predict that. But yes, we would have had a great quarter without that one.

And maybe I'll ask it another way. How much of the $6.1 million provision was related to that one credit?

I don't think -- that's a difficult way to get at that. We had -- I'd say, $4 million to $5 million of it was related to that one credit. We took the reserve down some during the quarter, so that negated provisioning. So there was -- it was a meaningful amount of money.

Okay, so this was a credit that had some reserve allocated to it previously, but the bulk of the provision expense in the first quarter was related to that?

Yes, I think so. Now, as far as -- we didn't come across this credit or didn't become aware of the various details of it until later in the first quarter. So we didn't have any reserves set aside for it at the end of December.

And then, in terms of the margin, certainly the deposit mix change has been extraordinary over the last couple of years. How good do you feel about the account growth versus the balanced growth? If you have any color there, it would be helpful.

We feel real good about what our sales force is about doing. We think they are energized. We are very pleased with their focus on operating accounts. There are numerous people or numerous teams around the firm that are out about this market area not only putting arms around our current customers but going after those new businesses that are currently being banked elsewhere.

So we think market share movement is going to be a key to our growth over the next several quarters.

I think I might just add to that -- I think Harold mentioned when he was discussing the chart that showed the growth in DDA balances -- the account growth is actually 9% year-over-year in that DDA category, which I think is very strong, given what the economic environment has been that we've been operating in. And so, as Harold mentioned, we have significantly more thrust and energy in our sales and marketing programs today than we would have had a year ago. So I think the combination of the 9% growth in a difficult landscape and a concentrated effort ought to yield a larger improvement.

Okay, so you are saying the operating customer growth was about 9%?

That's right.

Okay, and the balance --

Account growth, to be clear on that, operating account growth, which I think is a proxy for customer growth, although it might not be exactly the same.

Sure, okay, great, thank you very much.

Michael Rose, Raymond James.

Just a quick follow-up on the margin slide; I think it's slide 26. Can you just speak to if that includes potential runoff of the DDA deposits? Obviously, you guys have done a great job in improving the mix. But if the cycle picks up, should those balances decline? And how would that actually impact the margin on a go-forward basis?

I would say that we have a belief that there will be some -- as the economy improves, there will be some movement of deposits really out of all those categories, whether you are talking about DDA, money market or CDs. The banking system is clearly flush with liquidity. But our belief is the impact to the margin itself will be modest.

Okay, that's helpful, thanks guys.

Steve Moss, Janney Montgomery Scott.

Most of my questions have been answered here. Just two things -- any thoughts on any bulk loan sales?

I guess the answer is, I don't think you ought to look for us to have bulk loan sales. When I give you that answer, I guess we've talked about that from quarter to quarter, and we always -- there are lots of people traveling around with ideas about bulk sales and so forth. And so we look at them, we consider them. But we've never felt like that was the best way for us to resolve our problem credits. We believe that we are actually producing a significantly less loss through our current mechanism than we would through a bulk sale.

So unless we come across something that's different or better than what we've seen in the past, I think you ought to not expect us to do bulk sales.

Okay. And then the second question, with regard to the construction book, what are your expectations for reductions in the second and third quarter as the selling season picks up, if you have any visibility with regard to stuff under contract and what have you?

Well, I think that certainly for the second quarter, that's roughly a $25 million number that we expect through closure to move on out. Getting beyond that, it partly depends upon how quickly this area snaps back and what this summer season is like. So I'd like it to be faster rather than slower, but some of it is going to depend a little bit on the market.

Okay, thank you very much.

Stephen, I might just add to Harold's comment, if you look at the residential sales in Nashville, I believe that they are probably down roughly 10% March over March a year ago, down 5% year-to-date over year-to-date a year ago. So, again, it's hard to say that's a strong market. It's not.

I would point out, though, that it's up about 5% if you're looking at the year-to-date numbers than 2009. So I think what you see here is that the market is generally improving if you isolate out the impact of the first-time home buyer tax credit. But it's still not strong market, by any means.

Okay, thank you.

Bryce Rowe, Robert W. Baird.

A couple questions for you guys -- if you could talk about the composition of the OREO expense, assume it sounds like you had a gain on disposition this quarter. Is the rest of that remediation cost real estate tax, etc.?

Yes, you have that right. I think that's a quarter in which you do have (inaudible) much in the way of capital expenditures. And some of them maintenance, taxes that type of thing. (Multiple speakers).

So any appraisal kind of write-downs associated in that $4 million number? Or is it -- again, is it all just kind of the remediation cost, taxes, etc.?

Probably 80% of it is in write-downs. And then, like Harvey was saying, we've got just maintenance costs making up the rest of it.

Two more topics to hit here -- Harold the average loan yield came down here in the first quarter. Wondering if you could give us some kind of outlook for what loan yields do, assuming a stable rate environment?

You know, Bryce, I'll let Terry kind of answer or follow up on my response here, but we are not expecting any large increases in loan yields for the rest of this year. We are seeing quite a bit of competition on quality credit. The LIBOR-based stuff is really competitive. So will it go -- I think, as more of these construction loans pay down, that will be a head wind on loan pricing. And then the competition for some of these quality credits is pretty intense right now.

I think there's not really a lot I can add to that, Bryce. To Kevin's question, I really worry about the overcapacity of the industry and the impact that's going to have on loan pricing. I think, when you boil it down you ought to generally assume loan yields will be flat until rates start to rise for us.

Okay, that's helpful. And then the last question -- I know you guys don't have a crystal ball with respect to the political environment, but obviously, the access to the small business lending fund is a big part of the story here. Any thoughts on timing when that could happen, if in fact it does?

Yes, Bryce, we can't give any kind of assurance as to when this is all going to transpire. We are having a dialogue with regulators to try to figure out where they are in the process, and so on and so forth. We do believe the ball is moving, but we just can't give you any kind of time line as to when all this will work through it. We've listened to all the webcasts. We know the Treasury has announced, first of all, an extension for applications. But they have also announced that everybody has to be funded by September 30 of this year. So it's between now and September 30, how about that?

Okay. And the tone of the conversation with regulators -- has that changed much over the last couple of months? I don't know if that's a good question or not.

It's hard to describe what the tone of the conversation is with regulators because there's essentially little or none of it. Honestly, it's a little bit of a black box until they start rolling stuff out and so forth, which they have not done. So I couldn't offer any change in the tone and tenor of the conversations with regulators. But that's not -- I don't think that's indicative that it's either better or worse or the same. It's just that there's not really been much conversation at all, anyway.

Okay, all right, that's helpful, thanks Terry.

Brian Martin, FIG Partners.

Just one last question on the loan fraud -- was there any industry that that was related to that's concentrated within the portfolio, or is that -- I guess it was a C&I or commercial real estate? Or did I miss that if you said it?

Ask that question one more time? I'm not sure I understood it.

Just the loan fraud that you guys talked about in the quarter, Harvey mentioned -- was there a -- what type of industry do that involve? Was it a C&I type of credit? Was it real estate or construction? What was that?

That was a C&I credit.

Okay. And as far as any other exposure, whether that was to an industry or whatnot -- there's nothing else in the portfolio that, for instance, if it was hotels, there's no other hotel exposure. In this one, it's a C&I exposure. But any other exposure? Or is it just kind of a one-off, in your mind?

I haven't seen anything that would make me believe that's indicative of other problems in industry or systems or anything, no.

Okay, all right. And then, Harvey, you talked about the resolutions of non-performing loans. I just missed what you had said on that earlier as far as what -- the pace for the second quarter.

I think that in the $30 million to $45 million NPL reduction per quarter is what we said; that has been that for the past six quarters, except for the second quarter last year, where we have a lot of charge-offs. So the $30 million to $45 million range is, I think, what we have seen and continue to believe we will see.

Okay, all right, that's all I have, thanks.

Matt Olney, Stephens Inc.

All my questions have been addressed, but thanks anyway.

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