Pinnacle Financial Partners Inc (PNFP) 2014 Q1 法說會逐字稿

Good morning, everyone, and welcome to the Pinnacle Financial Partners first-quarter 2014 earnings conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer; and Mr. Harold Carpenter, Chief Financial Officer.

Please note that Pinnacle's earnings release and this morning's presentation are available on the Investor Relations page of their website at www.pnfp.com.

Today's call is being recorded, and will be available for replay on Pinnacle's website for the next 90 days. (Operator Instructions).

Before we begin, Pinnacle does not provide earnings guidance or forecasts. During this presentation, we may make comments which constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other factors that may cause actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned 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 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 comparable GAAP measures, will be available on Pinnacle's website at www.pnfp.com.

With that, I would now like to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Good morning. For quite some time, we have been discussing our strategic approach to growth and profitability; essentially, that we would grow our balance sheet in the form of loans at a double-digit pace for a period of three years while containing non-interest expenses, which should result in dramatically improved profitability as a result of the operating leverage that would provide.

So, again, this morning I thought I would start with a dashboard that provides a simple snapshot of how that strategy has worked through the first quarter of 2014. As you can see on the first row of graphs, we're getting outsized balance sheet growth in the form of average loans, up 10.9% the first quarter of 2014 compared to the same quarter last year.

You can also see that we have increased average transaction accounts by 18.7% during that same timeframe. And, frankly, the thing that I am most proud of within the deposit category is the growth in low-cost core funding, with core deposits up roughly 15.5% year-over-year, all through organic growth. We have been accreting capital, most notably tangible book value per share, which, of course, is highly correlated to share price increases.

On the second row of graphs, you can see further evidence that we have been able to translate that balance sheet growth into real earnings growth. With organic revenue growth of just over 7%, we face pretty stiff volume and margin headwinds, and fully diluted EPS was up 20.5% year-over-year. I would add that net income is up 21.7% year-over-year. Our return on assets hit a 1.20%. That's a record for our firm. And return on tangible capital was 13.47%, also a record for the firm.

As you can see on the third row of graphs, the dramatic improvement in asset quality over the last several years, which continue through the first quarter, has provided meaningful credit leverage for our firm over the last few years, and we anticipate will continue throughout the remainder of 2014 as the soundness of our loan portfolio continues to improve.

As you will recall, we began publicly discussing our long-term profitability targets on our fourth-quarter 2011 earnings call, more than two years ago. At that time, we felt we needed to provide better insight into the beliefs we had regarding the capacity and the opportunity for our firm to simultaneously grow the firm's customer base and increase its profitability significantly.

As you can see in the ROA graph on the left, we have made substantial progress, now operating at the midpoint of the target range of 1.10% to 1.30% for ROAA, with the last quarter to 1.20%, a record for our firm, and something every Pinnacle associate is proud to have achieved.

Also, as you can see on the smaller graphs to the right, we are now operating better than or within the published target ranges for three of the four key component measurements. As we noted on our last conference call, we felt like the net interest margin would see improvement in first quarter; and it did, in fact, increase to 3.76%. We also experienced reduced charge-offs this quarter, with only 9 basis points of net charge-offs.

We also feel like we should be able to maintain our fees to asset ratio for the next several quarters, which now operates above the targeted range, roughly 14 basis points above the midpoint. However, for the expense-to-asset ratio, we still are not operating within our targeted range, but we made 17 basis points of improvement over the last two years.

The key for us to continue the trajectory toward the targeted range for the expense-to-asset ratio is to contain expenses while continuing to grow assets and associated revenues, which we have successfully done each quarter for the last two-plus years.

In terms of our published long-term growth targets, we've also been highlighting this chart since January of 2012. It was our belief, at that time, that our existing relationship managers -- plus several new sales associates that we intended to, and, indeed, have hired -- had the capacity to produce approximately $1.27 billion in net loan growth over the three-year period beginning in 2012.

In this chart, we are plotting the actual production to date against that three-year target that we outlined two years ago. In total, during the first two-plus years since we announced our three-year loan growth target, we have added a total of $891 million, which equates to a CAGR of 11.2%. We anticipated that our first quarter 2014 net loan growth would be modest, and basically consistent with prior first quarters of the last few years.

That said, we still believe our three-year target is within reach; and that, barring any economic event that would warrant a significant reduction in business activity, we should be able to meet or exceed that target.

So, I am generally pleased with our first-quarter 2014 effort, as we continued to take market share and grow net loans; to grow revenues; and to realize a 120 ROA, which is something we have pursued with diligence and urgency over the last two years.

With that, I want to turn it over to Harold now to review, in somewhat greater detail, the results of the first quarter.

Thanks, Terry, and good morning everyone. We have been providing information on this slide for several quarters, albeit in various formats. On our last-quarter conference call, we noted that we anticipated a modest first-quarter in terms of net loan growth. As Terry mentioned, we still believe our three-year target is within reach by year-end 2014m and remain confident that our relationship managers will produce another big loan growth quarter, just like they have done over the last two years.

We have said it many times: net loan growth will be lumpy between quarters, and that we will not achieve our loan growth targets on a straight line. That said, we remain very pleased with the energy of our salesforce, as new loan originations during the first quarter equated to almost $300 million, which beats the first quarter of the last two years, thus providing the source of our optimism as we move forward into 2014.

As for the red bars, we expected and incurred significant levels of payoffs during the first quarter. This has been the most significant headwind for us toward our achievement of outsized net loan growth. As we have mentioned previously, it is the one thing that we underestimated when we charted out our anticipated growth prospects in the latter part of 2011.

We're hopeful that we are not experiencing a new normal. But with intermediate rates beginning to creep upward ever so slightly, we are also optimistic that these payoffs and paydowns will reduce at some point in the not-too-distant future.

To sum it all up, based on discussions with our relationship managers and their line leadership, we're looking forward to having another strong quarter of loan production during the second quarter of this year.

On last quarter's conference call, we mentioned that we would likely -- that there would likely be some margin expansion in the first quarter of 2014. We achieved the increase margin result for several reasons, but primarily due to meaningful expansion and average loan balances, as well as stabilization of our loan yields. We continue to believe our margin will remain within a 3.70% to 3.80% range in 2014, and that it would be based on loan growth and maintenance of our loan yields, as well as continued modest decreases in cost of funds.

More importantly, we did see continued improvement in our net interest income run rates in the first quarter. We are a reporting a record $45.9 million in the first quarter, and believe we should see increases in quarterly net interest income throughout 2014.

Concerning loans specifically, as the chart indicates, average loans were $4.13 billion, while 1Q 2014 EOP loans were approximately $50 million greater than the average balances, signaling that we are hopeful to see average loan balances continue their quarter-to-quarter increases as we head into the second quarter.

As to loan yields, we're still on a war on loan pricing, but we are thankful that our average loan yields did increased modestly from 4.28% last quarter to 4.30% this quarter. We consider this a victory, as all bankers have been trying to find the bottom on loan yields for quite some time. We may or may not be at the bottom, but it does appear to us we have reason to be somewhat optimistic about loan yields for the remainder of this year.

As to deposits, again, here in the first quarter we were able to continue lowering our funding costs. We have mentioned for several quarters that our pace of reduction will slow; and it has, in fact, done that. We were also able to grow our average deposits by 2.3% during the quarter.

We continue to believe we have the opportunity to continue our gradual reduction in cost of funds in 2014. It will require another significant effort on the part of our relationship managers to accomplish [fund of] reductions, but we believe we have reason to believe they can make it happen.

As to deposit balances, we continue to grow our non-interest-bearing deposit business, which we believe may be the most valuable product in our bank, as it may be the best indicator that Pinnacle is that depositor's preferred bank, and that our business strategy continues to work, with year-over-year average non-interest-bearing demand deposit balances being up 18.5%.

We continue to explore the stickiness of our deposit balances, particularly our operating accounts, given the general thought that as debt fund rates increase next year, the high-growth banks may encounter stress on their deposit costs in order to hold on to their funding.

Our general belief is that funding will be the biggest challenge for growth banks at some point, so we concern ourselves with keeping the proper amount of attention on both sides of our balance sheet at all times.

As to our deposit book, we remain confident that we have attracted core depositors to our franchise, that there is undoubtedly some money that will find a higher-yielding home or other business investment in a higher-rate environment.

As to our business and consumer DDA accounts, we continue to grow both in terms of number of accounts and aggregate balances. We routinely review the average individual account balances for our DDA accounts in order to determine if those accounts are building balances, to potentially await a better investing opportunity.

Our conclusion is that over the last couple of years the balances of individual accounts have changed only slightly. The average balances of our business DDA accounts was approximately $48,000 during the first quarter of this year, which is up 1.3% over the two-year period from first-quarter 2012, while consumer DDA average account balances was $3300, up 6.4% over the same two-year period. Had we seen large increases, that could signal balances that are awaiting a better return.

Bridging now to non-interest income, our first-quarter core fee income was up 7% over the same quarter last year. We have seen sound growth in service charges, investment services, and trust, which should offset declines we were experiencing in our mortgage origination business. Insurance experienced their usual increase in first-quarter revenues, due to bonus contingency payments from the various carriers.

If you think about the long-term profitability targets that we've set for each major element of the P&L, for the algebra to work it is critical that we grow our [fee] income as fast as we are growing loans and deposits.

We think we can continue to do that in our fee businesses. We will be working to increase our revenues in wealth management in 2014, with greater focus on referrals, both to and from the commercial bankers. We also have several taxable items aimed at interchange in credit card that we believe will bolster these fee businesses in 2014.

We have experienced a 16% increase in the number of debit cards from the end of the first quarter of last year, while net interchange revenue was $1.66 million in the first quarter of 2014, up approximately 13.2% from last year.

Now as to operating leverage, our core efficiency ratio is at 56.3%, excluding the ORE expense and Federal Home Loan Bank restructuring charges, consistent with the fourth quarter. The first quarter of each year will always incur seasonal salary and benefit adjustments, as that is when we grant our merit raises for our associates, which was approximately 3% this year. We also start over on payroll taxes and 401(k) match expenses, which, over the course of the year, many associates will max out on their contributions.

First-quarter expenses came in about where we anticipated. As far as the remainder of 2014 is concerned, we are likely to see increases in our 2014 expense base, given we expect to hire people.

That said, I have great confidence in the senior leadership of this firm, and they will continue to find appropriate ways to increase the operating leverage of the firm.

Terry mentioned our expense-to-asset ratio, which we calculated at 2.43% for the first quarter. As we have stated for the last two years, the primary strategy to decrease and to ultimately achieve our long-term expense-to-asset ratio target will be growing the loan portfolio of this firm, with a corresponding increase in operating revenues and earnings. As it sits right now, we need slightly more than $200 million in additional earning assets for expense-to-asset ratio to be at the high end of our targeted range. Thus, we believe we are getting within reach of our target, provided we remain disciplined on expense growth.

Finally, our adjusted pre-tax, pre-provision increased from $25.1 million in the fourth quarter of 2013 to $25.6 million in the first quarter of 2014; a linked quarter increase of 2.1%, which equates to an annualized growth rate of 8.3%. Increasing our pre-tax, pre-provision results in the first quarter in any year has typically been a challenge for us, as the first quarter will see the impact of fewer operating days, which impacts net interest income, as well as merit raises and increases in payroll taxes.

Again, the key to our ability to growing our operating earnings is gathering low-cost deposits and finding quality lending opportunities, which is what we will focus on again this year. Our primary mission remains our continued organic growth in Nashville and Knoxville.

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

Thanks, Harold. I thought I'd close today with some comments about valuation. They are consistent with what we discussed last quarter, but I believe bear repeating. Occasionally, someone will comment they think the stock is expensive, and that multiple expansion for small-cap banks has been unbelievable. But I wanted to offer my views on the relative attractiveness of our shares going forward.

I am not necessarily a Warren Buffett groupie, but I agree with his philosophy to manage the fundamentals, tell the story, and let the share price take care of itself. That's exactly what we try to do at Pinnacle. So my purpose here is not to debate the markets, but to simply put forth why I personally like PNFP as an investment, which makes up essentially 100% of my liquid net worth; and, consequently, requires me to think like a shareholder continuously.

Number one, we continue to set high goals -- a few set multi-year, double-digit, organic balance sheet growth targets. But we set them, published them, and we are fundamentally on target. Our relationship managers and leadership have executed with precision. And because of that, we are now operating inside or better than the targeted ranges for ROA, net interest margin, non-interest income, and net charge-offs.

We grew the balance sheet and earnings at a double-digit pace. And in terms of our track record for shareholders, our shares appreciated 72% during 2013, and are now up another 7% since year-end, even after the most recent pullback. And, so, had we not executed on the fundamentals, it's my thesis that our shares would not have performed like they have performed.

I recognize and appreciate the there are other banks that have still higher multiples, and I genuinely applaud their accomplishments, because that gives us something to shoot for in the future.

And, so, now we are down to the real question, which is, how should PNFP shares be valued going forward? Here is how I think about it. If we continue to set aggressive targets for soundness, growth, and profitability, our earnings are based on a proven ability to grow revenues; and, in my judgment, that's a more valuable income stream than one built on expense-cutting, and one that's distinctive in this industry right now.

That revenue growth is organic. We are not required to take on risks associated with M&A in order to produce outsized revenue growth. We may, but don't have to, in order to produce the outsized growth. We are able to produce outsized growth because our markets are relatively more vibrant than most, and because we have created competitive distinction in those markets. We have a track record for continuous market share take-away. We take share year-in, year-out.

Quickly, roughly 84% of our loan assets are in Nashville, Tennessee, which continues its two-decade-long track record for attracting jobs, and has been the second-fastest growing MSA in the nation since the recovery began. And not only that, but third-party research substantiates that we now have established a number-one lead bank market share among businesses with sales from $1 million to $500 million in Nashville. Despite now being the leader, it's not inconceivable to me that we could still double our current lead bank share in Nashville. And we continue to be the fastest-growing bank in Knoxville, since we launched there in 2007.

Again, based on third-party research, our client satisfaction scores are meaningfully higher than all of our major competitors in Nashville and Knoxville, which bodes well for our continuing ability to take share. And since the competitive distinction that we have achieved is primarily based on our people, hiring the best bankers in the market; and since we were recently recognized by the American Banker as the Best Bank in America to Work For, our competitive advantage should be a sustainable one.

Of course, asset quality is the third critical element of sustainable shareholder value creation. Some investors may not remember that our natural model produces blended construction acquisition, land acquisition and development exposure, generally less than 10% of loans outstanding.

For the first seven years of this firm's existence, we operated with very limited exposure to residential construction, land acquisition and development, and sustained just 5 basis points of net charge-offs for the entire first eight-year period of our firm's existence.

Unfortunately, immediately prior to the great recession, we made two acquisitions that significantly altered our loan mix, creating a concentration in construction, land ac and development, just in excess of 20% of the loan book at the worst time since the great depression. Our shareholders paid a large price as result of that concentration, but we have now eliminated that; and, frankly, any credit concentration, with public exposure to construction and land development lending now just 7% of total loans -- that's below pre-recession levels. Net charge-offs are extraordinarily low, and, we believe, sustainable.

So in terms of valuation, it seems to me that a firm that consistently produces outsized topline revenue growth and bottom-line earnings growth does so organically, based on a sustainable competitive advantage, and with outstanding asset quality is an extremely valuable franchise.

Operator, with that, we will stop and be glad to respond to any questions.

(Operator Instructions). Michael Rose, Raymond James.

I just wanted to get a sense -- on the press release, you noted that you expect to expand the expense base and continue to hire relationship managers. Several banks have more recently come into Nashville, specifically, maybe with more targeted strategies. But what's the climate like for hiring additional lenders? And I would expect that with the performance that you put up, it is probably being used as a recruiting tool, and probably getting maybe a little bit easier to recruit lenders from other institutions. Can you just give some color and context there, and what you expect in terms of hiring for this year, and maybe what you added last year? Thanks.

Let me start with the growth; I guess the growth and the hiring profile of the Company. What we are really trying to do in 2014 is fundamentally the same thing that we did in 2013 and 2012. We talk about the $1.27 billion in loan growth. I think, as Harold pointed out in his slides, we did $432 million and $420 million in 2013 and 2012. And so we need to do about that -- just a hair less than that -- this year to hit the $1.27 billion. That's what our outlook is and what we believe should take place.

In terms of the hiring that supports that, when we announced those targets I think we said we would hire 12 people. We might have said 11, and came back later and updated it to 12. I don't remember. But we basically had a target we would hire about 12 people in 2012, which we did. We hired roughly that number and 2013. And my expectation is, and our budget calls for, is to hire a number of roughly that in 2014.

In terms of hiring, Michael, I think you probably know this. The big hiring months for us, and I think a lot of banks, is really the second and third quarter of the year. In the first quarter, people are waiting to get paid their incentives, so they are not likely to move at that point. And in the fourth quarter, generally most people can sort of smell paydirt. In other words, they are far enough through their performance year, they feel like they're going to earn big incentives, and so it's hard to get them out. So, first and fourth quarter, generally slow hiring quarters. But, again, we would expect to hit a hiring number similar to what we did in 2012 and 2013.

In terms of the environment, you mentioned the competitiveness of recruiting. There's no doubt that Nashville is tremendously attractive. It's drawing all kinds of people. And there are a lot of folks that are banging around, trying to hire bankers, so I think that's true, and would be reflective of a difficult recruiting environment.

The other side of that is what you said, our reputation in this market is so strong as the largest locally owned bank, and our reputation for being a great place to work; and, quite honestly, success breeds success. By that, I mean we have hired the best bankers in the market, which makes it easier to go hire the remaining best bankers in the market. And, so, again, I would say it is competitive, and a lot of people banging around. But I don't find it to be meaningfully more difficult than it has ever been to either keep our people or hire new people. So, hopefully, that's helpful.

Yes, it is. And as a follow-up, you mentioned in the press release, as well, that loan yields have maybe stabilized here. How does that dovetail with the increased competitiveness in Nashville? And then, are you seeing anything on the pricing and structure side that maybe gives you a chance for worry? You are clearly below your charge-off targets at this point. But things are good until they are not, obviously; and we did see a little tick-up in the classified asset ratio this quarter. Is there anything to read into that? Thanks.

Yes, I think on the -- let me start with loan yields, and I guess I'll hit it -- asset quality. I think on the loan yields, Harold's comments I believe were accurate. What he said is it has been our belief a while that bankers have been trying to find the bottom. You know the overarching themes here -- there's too much liquidity in the system; too much money chasing too few deals. That's the competitive landscape, and has put pressure on pricing. But we have felt a slowing down of that pricing pressure over the last few quarters, which, I think, is a good sign.

I can't guarantee that it will be that way. But, again, I think we had said last quarter we felt like they would stabilize. They did stabilize. Our outlook is, we may bounce around here where they are, maybe up a few ticks, down a few ticks, but it feels like we have got a bottom here on loan yields.

I think on the asset quality thing, Michael, you know our numbers pretty well. Because of the commercial nature of the portfolio, some of the things are -- some of the ratios are lumpy in terms of their movements. You get one payoff that you think is going to come in -- you are looking for one payoff on a classified loan in the last week of the quarter, and it doesn't come in until the second week of the next quarter. It will cause ratio to be choppy, but it doesn't mean anything in the grand scheme of things.

And so, I don't see anything going on that gives me concern, relative to classified assets. I believe that we will continue, frankly, to advance. And I would guess that we will have lower NPAs and classified assets as we exit 2014 than we did when we entered 2014. So, again, I expect continued improvement in asset quality. But we may find quarters where you get one big loan moved to an NPA, or one big loan not pay off that you thought -- that may cause the ratio to bounce around. But I would be surprised if we don't see continued forward progress, quarterly, through 2014.

Yes, that's what I figured. I just wanted to check. Thanks a lot for my questions, guys.

All right, before the next question, on that whole idea about some credit leverage and some credit ratios moving a little bit north of us, we went through a lot of that at the end of the quarter. We still think we've got credit leverage on our P&L. We saw the reserve come down about 3 ticks this quarter. We saw probably one of our best charge-off quarters in recent memory, I guess, in the first quarter.

So, I think in terms of soundness of our firm and our loan book, we are really optimistic that we will continue to see additional credit leverage coming to our P&L over the rest of this year.

Okay, thanks, guys.

Jefferson Harralson, KBW.

I might just follow up with that credit leverage question. You had $0.5 million provision this quarter. But you also say you expect the net charge-offs to remain low and stable, so -- but you have a huge reserve, relative to your NPAs. So, it sounds like you are saying that you expect this provision to be in this range, or lower, when you make that comment. Is that what you're thinking?

Yes, I think the provision is going to bounce around with loan growth. This quarter, we had a -- net loan growth was around $37 million, which was modest at best. So, we believe over the next three quarters, we will experience a lot higher in loan growth, and that will drive some of this provisioning.

So, with that and the low charge-offs and some credit leverage, you should see bigger provisioning going forward, Jefferson, but it's only because of a function of loan growth.

Got you, got you. All right, on the asset sensitivity, the liability sensitivity, it looks like some of your durations came down this quarter in securities portfolio. But can you talk about -- you had mentioned before, you think you are liability-sensitive for some period of time. Are you liability-sensitive in the first 50, the first 75, in the first 100 basis points? Or where does that click over to be asset-sensitive, do you think?

After 100.

Okay.

Right now, the floors are still about 85 basis points above the contract rates. So, we need about 100 basis points, we think, to manage through it. But given the comments from the Fed, we think we've got time to work on that to maybe reduce that exposure over the next year or so.

We've got some tactical things that we are exploring currently that we could also implement. And you are right, the durations of our investment book did come down in the first quarter, primarily because we have been buying a lot shorter on the curve.

All right, thank you, guys.

I want to go back on your question. I think this was clear, but I just want to make sure. I think the -- two major factors that influence the provision really are what's the level of allowance that's required to support the loan portfolio; and then, how much growth are you adding? How much incremental allowance needs to be added to support the new growth? And, so, those are opposite trends. You would expect continued downward pressure on the general percentage of loans that need to be set aside for the loan portfolio, and then you've got growth that cuts back against that. But the net of those ought to be continued credit leverage for us.

And do you have a rule of thumb for what amount of reserve you need to set aside for a new loan?

We do not. I think -- the point is that we run a pretty sophisticated reserve methodology. And, so, you're going through every loan in the portfolio, every risk rating. You're looking at all the migration trends. And it is some pretty sophisticated algebra that actually produces what the loan-loss allowance has to be. If you are just asking, as the CEO of the Company, how do I plan and how do I think about it -- sort of back of the envelope, what I believe is that I am on -- generally, if I've got an allowance at a 1.61% in total, I theoretically assume I'm going to put up 1.61% of the new loan growth.

Got you. Got you. Very helpful. Thank you.

(Operator Instructions). Matt Olney, Stephens.

This is actually Tyler Stafford in for Matt. My first question is on the fee income. I think you may have touched on this a bit in your prepared remarks. But service charges were up, call it, 13% year-over-year. I'm just wondering what your thoughts on -- what was driving this growth?

Tyler, this is Harold. We have been looking at several taxable items and service charges, primarily around our analysis charges. And we implemented some of that during the first quarter. So, I think that helped it. But I think, overall, what really drove the increase was just the number of accounts and the growth in balance. So I think it correlated fairly closely with that.

Okay. Thanks. And then on mortgage, I was wondering if you had the new purchase versus refi breakdown within your mortgage volumes handy for 1Q?

I don't have it at my disposal this morning. But I would imagine that it is going to be probably 60% to 70% purchase, and the rest would be obviously refi.

Okay, thanks, Harold.

Peyton Green, Sterne, Agee.

Terry, I was wondering maybe if you could comment a little bit on customer behavior, and just maybe changes you are seeing. I think there was a slide in the deck that referenced that about 36% of your business in the first quarter, -- which, as Bill noted, is a slow quarter for you all historically -- was due to new client take-away. And I was just wondering, on the existing clients, what are you hearing from your customers? Are they moving forward in the economy different than they were six months ago, or a year ago?

I think that's a great question. I don't think they're moving forward differently than six months or a year ago. And by that I mean, I think that, again, just -- I'm not basing this on data. I am basing it on just discussions with lots of business owners over the last six to twelve months. I think the business owners are comfortable with where the economy is, meaning they are not panicked. They don't feel like they are in a difficult position.

On the other hand, they are not optimistic. They are concerned about economic stability. They are concerned about rates. They are concerned about healthcare. And they have lots of those kinds of things that weigh on them. And, so, what I think what you see is that the economy is moving forward at a very slow pace. I don't think -- it's hard for me to detect anything in sentiment that says, hey, this thing is really going to get hot. Specifically, I look at other data. If you look at things like our utilization -- line utilization, our line utilization is as low as it was at the trough of the recession, which would suggest that the working capital cycle is not moving forward. The sales cycle is not moving forward at a very dramatic pace.

I think some of it can be masked by the liquidity that corporate America has stored up. But I really think that the sales cycle is just not moving forward at a very rapid pace. We don't talk to people -- we don't have substantial demand for what I call through expansion. The equipment-type lending that we do is generally deferred capital expenditures. We are not seeing people that are saying, I'd like to add a new plant, or add a new shift, or do any bona fide expansion.

So, I don't know if that's helpful. It's all sort of based on sentiment. But I would say that -- I would describe the business owners that we deal with as generally comfortable, but not confident enough to do -- take any meaningful risk going forward.

Okay, so it's fair to think that there is probably more commercial real estate activity over the next couple of quarters, unless something changes in that sales cycle.

I think that's true.

Okay. And then just a comment, maybe, on -- this is more corporate-wide -- but in terms of a cash dividend, I know you all just instituted one a couple of quarters ago. And just wondering what you think the right payout ratio is, with the improvement in the ROA and ROE; and you all are in a position where you're really building capital. What would you expect the range to do over time?

Yes, Peyton, thanks. A couple of points and that. One is that when we originally started setting up the dividend, a 20% payout ratio was a general consensus of our Board as to what they thought was reasonable at the time. Obviously, with growth in earnings, that number is going to come down some. So to get to my second point, we will be going through our strategic planning effort here over the summer. Capital, and capital utilization and deployment, will obviously be a point that we will discuss quite diligently with our Board. And then we will see -- that will give us the tone and tenor of how we will talk about capital after that.

Okay, and then last question. Terry, maybe you can comment. You referenced that, I guess, in a slight way, but what is the M&A opportunity? I think we still see more of an episodic lifecycle throughout the space. I was just wondering if you are seeing any change.

I think I would be -- when you say, seeing any change, I guess change compared to what or when. But I do think there are probably more small banks that are -- I guess I would use the word -- contemplating what their long-term strategy is. There's a lot of sentiment, a lot of talk, about the difficulty of the environment, the cost of regulation, the difficulty producing returns. And, so, I think you do have a lot of what I might refer to as downstream banks for us that are more seriously considering their alternatives.

But, that said, my own view is that the gap between the bid and ask is still pretty wide. And, so, I don't look for -- I think you word, episodic, is probably good. It may be sporadic. I think you're going to find deals will materialize because of some of the discussions that are going on. But I don't look for it to be dramatically better than, say, 2013; probably be a little better, but not dramatically better, in terms of whole bank transactions in 2014.

I think, as it relates to us, we have always said it's a pretty short list of acquisition opportunities, just because of the unique nature of our culture and brand and what we do for a living, and the fact that we only want to operate in urban markets, and those kinds of things. So, that's a pretty limited list, and I wouldn't characterize it any differently today than I have in the past.

Great. Thank you for taking my questions.

Brian Martin, FIG Partners.

Nice quarter. Peyton got my question. The other one I had was just on -- maybe, Harold, as it relates to fee income and just talking through some of the algebra to make your profitability targets work, and the fee income will continue to be strong the next couple of quarters.

Do you guys look at it as doable to put up double-digit growth in fee income in 2014, even with the decline in mortgage? And, if so, what are the real catalysts to achieving a double-digit type of growth in fee income this year? Is there anything that we are not seeing currently that you are anticipating?

You know, Brian, I really don't think there's anything there other than what we have talked about. There are several tactical initiatives. I mentioned interchange. I mentioned increasing referrals. All of that is just blocking and tackling, and making sure that the salesforce is focused on their fee businesses. We want to try to help our mortgage originators. We want to help our insurance guys. We want to help our broker guys and our trust guys, to help them maximize their capacity that they have in their businesses.

So, I don't think there is anything new and different that we may be tackling, other than just trying to ramp up the volume and the intensity.

Okay, is double-digit type of growth is achievable, I guess, is your expectation?

Yes, we think so. We think so, for sure.

Okay. All right, that's all I have. Thanks, guys.

Mikhail Goberman, Portales Partners.

If I could piggyback on a prior question about the credit leverage, do you have a -- where do you think the reserve ratio could -- how low do you think you can push it down, basically?

Yes, Mikhail, that's probably the $64 million question that we can't answer, although we try to. So, we think there is continued improvement in our loan book. We ought to see some reductions, continued reductions in our allowance, over the course of this year at least.

Okay. And changing subjects -- this quarter, you guys had a shift, really good growth in CRE loans -- period-end CRE loans, while C&I ticked down a little bit. Do you see that trend continuing the next few quarters, or different?

I think that we -- I'd break it apart. I think the trend for CRE is, I think there will be continued growth opportunities there. I would not expect our C&I loans to shrink. In fact, I would expect them to expand pretty meaningfully. We have, I guess, tried to study and highlight what is going on in the commercial payoff. And I don't want to spend too much time rehashing old things. But I would just say that the payoffs are higher than I remember. One of the big factors in those payoffs is the fact that we deal with owner-managed businesses; owners were unable to find exits. A lot of these baby boomers were looking for exits, but over the last four or five years, they just weren't able to exit. There was no market. And the takeouts, if they existed, were not at accessible prices.

And so, you have a lot of pent-up demand for owner-managers to exit. And that's occurring at the same time there is an unbelievable amount of money -- private equity money, in particular -- that are looking for transactions. And so, we have just seen an extraordinary volume of pay downs, where private equity firms are coming in and taking out some of these owner-managed businesses.

We went win in some of those transactions, to the extent that we deal with a number of the local PE firms. But we sometimes lose in those transactions, when you're dealing with larger, out-of-market PE firms; because, generally, when they come to the table, they come with their bank, not us. And so, that has resulted in a lot of paydowns.

So, again, I don't want to ramble on too long, but it just happens that the first quarter saw a large volume of those kinds of transactions, which is not our expectation for the second quarter. But again, you never know what could happen. But what we are aware of looks like we will have reduced payouts, and we are -- maybe with less of those kinds of transactions in front of us than behind us.

So, that's a long-winded way to say, I think CRE should grow, but I think C&I should growth meaningfully in the second quarter.

All right, thank you very much, gentlemen. Appreciate it.

I am showing no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect, and have a wonderful day.