Pinnacle Financial Partners Inc (PNFP) 2015 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Pinnacle Financial Partners third-quarter 2015 conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer, and Mr. Harold Carpenter, Chief Financial Officer.

Please note, Pinnacle's earnings release and this morning's presentation are available on the Investor Relations page on their website at www.pnfp.com. Today's call is being recorded and will be available for replay on Pinnacle's website for the next 90 days.

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

Before we begin, Pinnacle does not provide earnings guidance or forecasts. During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other facts that may cause actual results, performance, or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10-K.

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

In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com.

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

Thank you, operator. Good morning. As we always do, I will begin with a dashboard that is intended to give you a snapshot of our progress here in the quarter, our basic thesis for consistently driving our share price higher as over time revenue growth, earnings growth, and asset quality are the three most important valuation drivers. Also, through good times and bad, companies that consistently grow book value per share generally grow share prices, and so for quite some time, we have been providing this dashboard to highlight those key valuation drivers.

The top row autographs show real revenue and earnings growth with a 16.7% revenue growth rate year over year in the face of pretty stiff volume and margin headwinds, net income up a whopping 40.2% year over year, and core EPS, at $0.66, was a record high. 18 consecutive quarter of increase in EPS, up 26.9% year over year.

As you can see on the second row of graphs, we are getting outside of the balance sheet growth with end of period legacy loans, up 13.2% in the third quarter of 2015 compared to the same quarter last year. That is a rate of organic growth consistent with what we sustained over the last three or four years now. And looking at the right most chart on that second row, even after having initiated the dividend payout December 2013, we have continued to accrete capital with tangible book value per share up 13.9% year over year, which, as I just mentioned, is generally how we correlated the share price increases.

The third row provides information regarding our asset quality. Nonperforming assets, total assets decreased to 41 basis points, total loans -- excuse me, of total assets. Classified assets remained extraordinarily low. It did 17.1% of Tier 1 capital plus allowance. The overall improvement in our credit metrics, since the great recession, provided meaningful credit leverage over the last few years, and it appears to me that our allowance continues to be in line with our peers even after the incorporation of the acquired loan portfolios, which are mark-to-market in conjunction with purchase accounting.

I thought I would speak for just a second about future growth initiatives. I am asked from time to time by institutional investors, what do you think investors may not understand about your Company? And, obviously, investors understand the track record for growth that we have produced over an extended period of time, but they are naturally skeptical that we can or will sustain that growth going forward.

For those of you who have been following our firm for a while, you know that going into 2015, we outlined a number of initiatives that were intended to propel the future growth of the firm. As a reminder, we are attempting to build a $13 billion to $15 billion diversified financial services firm, concentrated in the four urban markets of Tennessee. Specifically we have said we are interested in getting through the Memphis and Chattanooga markets. We announced the acquisitions in April of CapitalMark in Chattanooga, Magna in Memphis. We completed the legal mergers of both of those banks during the third quarter of 2015. So the results in terms of the financial results were ahead of schedule and produced accretion there. The technology conversions are on schedule. The Magna conversion is targeted for November. So about a month away on that. And then the CapitalMark conversion is targeted for March of 2016.

We have focused intently on cultural integration. Generally, the system's integrations are easier than the cultural integrations, and we have conducted a three-day orientation. And when I say we, I am talking about myself and the key leaders in the firm for all of the CapitalMark and all of the Magna associates that will be coming on board with us, and we believe that we are building great buy-in, great understanding, and at least to date, we have lost no key revenues producers to keep people that we are trying to keep.

We also have talked about in several of our calls the fact that we have launched a CRE initiative, which is intended to replicate in the CRE business what we have done in the C&I business, which is really to build a dominant bank in our market, and that initiative is producing ahead of schedule. I will go over that a little bit later.

We have also talked about the fact that we intended to build a FINRA broker-dealer, which would provide capital market support to owner-managed businesses, and we have now received that approval. I will give you an update on the progress there as well.

And then, I think the fourth thing and really the foundation of our ability to grow our Company really has to do with hiring the great revenue producers in our market from our competitors and have them move here. It is how we have built this firm, and we are aggressively hiring or meaningfully ahead of our budgeted hires for 2015. I will give you a little more update on that in a few minutes.

But, with that as an overview, let me turn it over to Harold for a more detailed review of the quarter.

Thanks, Terry. Our third-quarter 2015 net interest income was up approximately $10.3 million over second quarter, which is primarily due to expansion of average loan balances from CapitalMark and Magna, but also due to about $175 million in organic low growth from the legacy Pinnacle franchise legacy, which we are obviously very proud of.

As for our margins, our margin increased this quarter to 3.66% with the increase attributable to the impact of the acquired franchises.

As you know, even though our margins may fluctuate, we focused our efforts on growing net interest income by growing our customer base and our markets, while at the same time maintaining appropriate profitability thresholds.

Concerning loans, specifically, as the chart indicates, average legacy loans were $4.96 billion, which was year-over-year growth of 13.9%. The EOP loan balances are higher than average balances, and our sales pipelines remain strong for the remainder of 2015. And, at this point, we expect continued robust loan growth for the remainder of the year.

As noted, the impact to CapitalMark and Magna also added $727 million in average loan balances for the quarter as we expect continued growth from these two new franchises as well.

As to loan yields, our loan yields increased to 4.33% this quarter. We anticipate pricing will remain very competitive in all of our markets going into the fourth quarter. We are cautiously optimistic that our yields should remain fairly consistent in the fourth quarter.

We have been talking about this slide for quite some time. As of December 31, we have approximately $1.08 billion of floating-rate loans with forwards on our books with an average difference between the forward rate and the contract rate of 73 basis points. We have seen meaningful and intentional decrease in the absolute level of forwards at the latest legacy Pinnacle franchise such that we are pleased to report that through September 30, 2015, we have experienced about $200 million in reduced floating-rate loans in 2015. There was very little change in the Pinnacle legacy franchise at absolute level of forward loans during the third quarter. This obviously has impacted our loan yields and interest income, but we felt it was in the best interest of our balance sheet.

As the table indicates, the increase in forward loans in the third quarter of is attributable to the CapitalMark and Magna such that we are now back at approximately $1.1 billion in forward loan balances with a 64 basis point spread. We believe that we would like to operate with about $1 billion of loans with forwards, so we are very close to our target.

Our asset liability modeling will obviously improve once the technology conversions are completed, and we gain a higher level of precision as to the interest rate sensitivity characteristics of the acquired portfolios. That said, our calculations indicate that we are asset sensitive in the up 100 basis points rate bucket, currently. The legacy Pinnacle franchise, we believe, is neutral to asset sensitive on the first tick of a rate increase.

Now, if we can just get on with raising rates.

As to deposits, again, here in the third quarter, we were able to maintain our low funding costs. The slight increase in deposit rates is attributable to the acquired deposits from CapitalMark and Magna and believe we have some measured opportunities there to reduce the cost of several non-core funding sources.

As to deposit balances, we had a great quarter for legacy Pinnacle deposits growth. We had average deposit growth of approximately $252 million during the quarter. We are most pleased with the fact that our demand deposit growth has been really strong over the last several quarters with our third-quarter 2015 legacy Pinnacle average DDA balances being up approximately 16.8% over last year's third quarter. These remained core operating accounts that we would expect to keep regardless of the rate environment.

Switching now to noninterest income, excluding security gains, noninterest income for the second quarter -- for the third quarter increased 61% over the same period in the prior year, driven largely by our 30% ownership interest in BHG, which we announced and closed during the first week of February. Our wealth management fees are up approximately 9.8% over the same quarter prior year and remain a reliable earnings stream.

Our residential mortgage group had an outstanding quarter in terms of production, with approximately $146 million in loan sales this quarter at a yield spread of about 2.19%. Items included in other noninterest income tend to be lumpy and include such items as gains on other investments, as well as interchange fees.

As noted above, interchange and other consumer is up approximately 64% from last year as we continue to aggressively market our credit, debit and purchasing cards to our clients. We have also experienced meaningfully increase in client back to back swap fees from last year.

All things considered, approximately 94% of our third-quarter fee revenue is from the legacy Finical Pinnacle franchise. Appreciate that CapitalMark was in our numbers for only two months, and Magna is in for only one month. So there are rate run increases we are expecting in the fourth quarter of about $1.5 million to $2 million between the two franchises.

That said, we believe we have great fee opportunities in our two new markets that we intend to capitalize on quickly. Wealth management is an area that we are actively recruiting in both Chattanooga and Memphis.

Now as to operating leverage, our core efficiency ratio was 52.2%, which we consider very strong for the quarter and compares favorably to most peer groups. We continue to believe that we will be able to improve upon this level of efficiency for the combined franchise. Approximately 86% of our expense base in the third quarter was attributable to the core PNFP franchise. So similar to fees, there are some run rate increases that will occur in the fourth quarter, which we currently estimate at around $5 million to $5.5 million, excluding merger charges, but including the amortization of core deposit intangible. We are expecting that increased hires will drive our expense increases in the fourth quarter as we believe all other costs should be fairly stable.

I would like to highlight that our recruiting has been exceptional this year. Not only did we invest in a new Memphis platform, which now has eight revenue producers, we have also hired 19 other revenue producers to our ranks in Nashville and Knoxville, all of whom we are very excited about. Terry will speak more to that in a moment.

Our core expense asset ratio was 2.3% for the third quarter of 2015, so we finally achieved our operating target this quarter and, for that, we are very excited as we have been chasing that number for the last three years.

As we have consistently stated, the primary strategy to ultimately achieve our long-term expense asset ratio target is to grow the loan portfolio of this firm with the corresponding increase in operating revenues and earnings. That will also be the strategy we will continue to deploy with CapitalMark and Magna.

Our synergy case for both acquisitions remains in place, which will eventual eventually help us to create more operating leverage in future quarters as we fully expect to achieve the targeted EPS accretion targets in 2016 that we spoke about on the acquisition conference calls. Terry will also speak to those matters in a few moments as well.

We do remain committed to increased operating leverage with careful and mindful attention to our expense base.

That said, our focus remains on long-term shareholder value creation by growing our customer base. We believe the best way to grow our customer base is to hire the best financial professionals in our markets. This year, we enjoyed a meaningful uptick in our revenues and profitability metrics, which has given us more latitude in hiring revenue producers in our markets. Again, we are mindful of our expense base and we will pay close attention, but if the opportunity arises where high quality relationship management managers are available to us, we will continue to seize those opportunities.

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

Okay. Thank you, Harold. Earlier this month, Wall Street Journal published an article with a pretty gloomy outlook for upcoming bank earnings reports for the third quarter.

Specifically, the writer projected a very negative outlook for the banks that credit leverage is generally played out at stubbornly low rates. So weight on net interest margins and that the margin compression would lead banks to attack expenses, which further jeopardizes future earnings and diminished service levels, which, in turn, jeopardizes high-value core deposits. Mortgage revenues would slow, and oil prices would create weakness in credit, particularly in the energy and related sectors. And in many cases, I think those forecasts have materialized for a number of banks.

But I think the Pinnacle story is different. Our recent acquisitions enabled us to actually improve our margin one bit even even as we continue to reposition for rising rates. And perhaps, most importantly, our markets support volume growth that facilitates net interest income growth, despite margin compression, both as a result of their economic vibrance and as a result of competitive vulnerabilities.

Our recent acquisitions of CapitalMark and Magna and our investment in BHG all appear significantly accretive, even prior to obtaining our cost takeouts and before we have had any opportunities to produce revenue synergies, which we believe we will ultimately get.

As I just mentioned, we have successfully launched our CRE initiative, which is aimed at our market's best real estate developers and owners. I will talk more about the growth that we are seeing there in just a minute, and we're way ahead of our hiring schedule through the first nine months, as you just heard from Harold, which means we are incurring significant costs today for revenue we expect to materialize over the next two to three years. And, despite that investment, we still have top-tier efficiency ratios, ROAs, and expense to asset ratios.

We are now positioned in all four of our target geographic markets with meaningful opportunities to take share and increase product penetration going forward. So our growth outlook continues to be strong, despite the headwinds that the industry faces.

More than three years ago, we laid out our sustainable business model, which, at the time, called for a targeted range of [110] to [130] for ROAA. We also broke down targets for the full critical component required to produce that ROAA, the margin and noninterest income to assets, the noninterest expense to assets, and net charge-offs since, in ordinary times, charge-offs are the primary influence on provision expense.

In mid-2014, in conjunction with our 2014 to 2016 strategic plan, we increased our ROAA target range by 10 basis points to a range of 1.20% to 1.40%.

Now, in conjunction with our recently completed 2015 to 2017 strategic planning process, we decided to leave the ROAA target as it is. In other words, target range of 1.20% to 1.40%. And, as it relates to the four individual components, we decided to increase the non-interest income to average asset target range for the noninterest income to average assets by 10 basis points and decrease the target range for the net interest margin 10 basis points to reflect the current operating environment, again, to facilitate the continued targeting of a 1.2% to 1.4% ROAA.

In quite some time, the only component measured not performing in or better than the target range has been the noninterest expense to asset ratio as you just heard Harold say. Our approach to rightsizing has really been to grow our earnings and our earning assets in the form of loans. And so with the strong asset growth in the third quarter, we are now at that target range and believe that we have continued operating leverage that we will achieve as we move forward.

So overall, third quarter was another outstanding quarter. Record EPS, excluding merger-related expenses and ROAA well north of the midpoint or well north in the target range.

I mentioned earlier that we would try to give you an update on the mergers. So here is another slide with a lot of information on it that is intended to flesh out the impact of the two recent bank mergers.

What we thought we would do is update you with respect to some of the more significant assumptions that we talked about when we announced the CapitalMark and Magna mergers. As to total transaction cost, CapitalMark transaction settled out higher than anticipated, due to a run-up in PNFP shares, while Magna's total transaction costs approximated amount at the announcement date. The more significant purchase accounting adjustments were basically consistent with our estimates. In the case of ORE, there is a difference there that are really due to several transactions that were executed by both banks prior to the merger date.

As Harold indicated, we remain confident in the expense saves that we expect to achieve from both mergers, and as to EPS accretion, we remain confident that the EPS accretion percentages we discussed as of the announcement dates will certainly be achieved and believe that the two mergers collectively contributed about $0.02 in EPS during the third quarter. As Harold mentioned, that is with two months' impact for CapitalMark and one month impact for Magna. Again, for the two mergers collectively, we believe the tangible book value dilution as of the merger date is negligible at less than 1%. So we remain very excited about these transactions.

Here is a little more information as it relates -- try to give you, I guess, some insight into our hiring and pace of hiring and the impact that it has on us. We pay close attention to our personnel costs. That is the largest expense component of our expense base, but it obviously represents our most valuable asset. I commented earlier in the call, really, the foundation of this Company and its track record for growth is our ability to take the best revenue producers from our competitors, have them come here and bring those books of business to us.

Basically, the top set of numbers on this chart are revenue producers. We call them client advisors for purposes of this morning's discussion. Our goal is to expand this group as opportunities present themselves. As Harold mentioned, we are having a great year and anticipate having a good number of hires going forward. As Harold mentioned, because of the revenue -- extraordinary revenue year that we have had this year, it is put us in a position to ramp up our recruiting efforts and garner some of the tremendously valuable players from other banks that are in our area this year. So far, we are on pace to hire more than 2X our normal hiring when compared to the last few years. So again, it is a pretty dramatic hiring pace.

I might also just add as an aside, we have given you the support unit investment also, and traditionally it is sort of a 2 to 1 ratio. And what is important about that is, we are winning versus competitors based on distinctive service and effective advice. And so we don't just hire the revenue producer, we hire the necessary support to ensure that we continue to be distinctive in terms of our service and advice.

Coming out of last year's strategic planning process, we disclosed our intent to increase our focus and discipline in CRE. We made a number of key hires during the first quarter of 2015. You can see the impact that the new emphasis is having in that chart that is on the bottom right of the slide. It was roughly $206 million growth in the legacy Pinnacle footprint in outstandings in the second and third quarters with meaningful increase in exposure, which should yield meaningful growth in outstandings in future periods.

I would just comment as an aside that there is also $436 million in growth attributable to the acquisitions. We have discussed the attractiveness of the Magna acquisition, not only because it gives us a toehold in Memphis, but because of the significant CRE capabilities that that firm has and which we can lever across our entire footprint in conjunction with our effort to become the premier CRE bank in the state of Tennessee.

One of those capabilities is their exclusive brokerage arrangement with a number of insurance companies and mortgage conduits. Those effectively give us a mortgage banking capability to place large, long-term commercial real estate loans with traditional providers for those products, which are not well suited to our balance sheet. Of course, we generate fee income in association with that brokerage. We expect to produce meaningful volume with those mortgage brokerage commissions throughout our full market footprint.

Additionally, Freddie Mac has a robust multifamily lending division, and as a result of the Magna acquisition, Pinnacle Bank has one of only 11 seller-servers or licenses issued in the United States to originate and service multifamily loans under the small balanced loan program. The small balanced loan program was initiated in late 2014 by Freddie Mac to complement their multifamily large loan program. The intent was to target loans from $1 million to $5 million to support small balance loan borrowers, which has been an underserved market by Freddie Mac.

Pinnacle Bank started marketing that program in June of 2015 expect it to close about $25 million in loans this year, but the forecast for loans closed under the SPL program 2016 would be between $150 million and $200 million. Basically, Pinnacle Bank originates the small balance loans. They submit them to Freddie Mac for their review and approval. And after the closing of the loan in the bank's name, we sell the loan to Freddie Mac, typically within 30 days of the loan closing. And, of course, as I mentioned earlier, we generate income from the small balance loan program via the loan origination fees, servicing fees, securitization fees, spread income and free escrow. So it is a tremendously powerful program that we can leverage throughout our firm.

So we are tracking very well on our quest to replicate in the CRE business what we have achieved in the C&I business, which is the premier bank status.

Also, in conjunction with last year's strategic plan, we disclosed we would build a capital market unit which would focus on owner-managed businesses to assist them primarily in M&A and valuation work. Again, we are focused on smaller owner-managed businesses that are generally underserved by larger investment banking firms.

We made three key hires in January of this year. We have now completed all registrations and have been approved as a syndrome broker-dealer, and that is what puts us in a position to get paid for this advisory work. We expect to sign our first engagement letter this week with a small owner-managed business that is seeking an acquirer.

Also, while we have been building that infrastructure, the group has also had responsibility for client swaps, which are back to back swaps that we sell to our clients as protection on their loans. As you can see on the chart at the lower right of the slide, year to date we have produced approximately $1.5 million in swap fee income, and that is compared to just over $100,000 for all of last year. So again, I think we're making great progress on another key growth initiative.

So to wrap it up, here it is. We are attempting to build a $13 billion to $15 billion bank, Tennessee's four urban markets. In each market, we will most likely have to be one of the top three banks in terms of FDIC deposits. Not only are we positioned in vibrant, growing markets, but as has been the case since our founding, we rely on our truly distinctive service and effective advice to take share from the vulnerable large regional and national franchises that have previously dominated those markets.

So operator, with that, we will stop and take questions.

(Operator Instructions) Tyler Stafford, Stephens.

I wanted to start on expenses and, Harold, I appreciate the color on the Q4 step-up in expenses. I just want to make sure I heard you correctly that you do expect a $5 million to $5.5 million increase in Q4 just from the prior two acquisitions that you closed this quarter, and that does not include the legacy expense growth?

That's right, Tyler. The only thing that we expect out of legacy Pinnacle is the result of any hiring expenses that we have got. So, yes, $5 million to $5.5 million would also include the core deposit intangibles.

Okay. On BHG, that obviously had another really strong quarter. Any help on how to think about the growth out of that or the expectations for that business in 2016? And, remind us, does that have any seasonality to it for any reason?

No. I don't know about seasonality. I think they are on a growth track not too dissimilar to us. So I would imagine that if you were to model out what you believe their growth would be, it would be fairly consistent with what you think Pinnacles growth rate would be.

Got it. Okay. And then, last one for me on the small business loan program that Terry just touched on, any initial thoughts on what the gain on sales to Freddie Mac would be like if you are able to originate and sell that $150 million to $200 million next year? And, just to be clear, you said you would or would not continue to service those loans after you sell them.

Yes, I think I would rather not get into each component of the revenue stream, but, I mean, it is obvious components where you do pick up a gain on sale, but you have other revenue streams for originating fees and for servicing, Tyler, which is to say, yes, we would continue to service those loans.

Got it. Thanks, guys, and congrats on a good quarter.

Steven Scouten, Sandler O'Neill.

A question for you on the NIM if we don't see higher rates. Where do you think that will be able to shake out in 2016, or what do you think the path would be if we are not able to see an uptick in the rate environment?

Yes. I think our consistent response to that has been, if we don't get an uptick in rates, I think we will all experience NIM pressure. As far as how much and how extensive, I don't really know that, but it is not too difficult to discern. We think we are all at pretty much bottoms on the deposit side, and so, if you don't get a rate increase, the assets on our balance sheet will continue to have a lot of competitive pressure.

Okay. And you said in Q4, while it is competitive, you think yields will remain relatively flat, though, right?

Yes. I think Q4, we feel pretty good about where we are. We are not anticipating a rate increase in October -- well, obviously -- but we are still planning on one in December. And I think that is what most people have in their modeling.

What we are fortunate to have, Steven, is markets that do allow us the ability to grow. And so the pipelines -- the loan pipelines remain really strong right now until we are so we are optimistic about Nashville and Knoxville, Memphis and Chattanooga.

Okay. Sounds good. And as it pertains to the continual growth in new hires, based on your commentary about double the annualized rate that is normal, that implies you are going to continue adding people here in Q4. And I guess, within that, are there any parts of the bank or parts of the production line that these are concentrated in? Is it additional CRE people, or where are these new hires? What business lines are they falling into?

That is a great question. I think, first of all, as it relates to fourth-quarter hiring, do we anticipate continuing to hire, I would assume a straight line on the hiring curve, and we were talking to a number of revenue producers that I am hopeful we will close the sale on here in the fourth quarter.

In terms of product areas, I would say that we are not particularly focused on hiring in the CRE segment. We made significant hires early on to build that business, so we are about harvesting that right now. I would say that the concentration of hiring would be on C&I relationship managers, as well as other fee income businesses. We are hiring mortgage originators. We are hiring trust administrators. We are hiring brokers -- investment brokers. And so really across the gamut of commercial relationship, managers -- private banking relationship managers, and then those various fee income businesses.

Okay. Great. Thanks for the color there. And I don't know if you guys can frame up the quarter-over-quarter costs -- incremental costs to those seven new people, but is there any detail you can give about what we are going to see in that legacy cost increase quarter over quarter?

Yes. I don't have that number in front of me, but we are talking folks that probably have salary requirements of $80,000 to $120,000 on average, and then you have got the benefit cost on top of that.

Congrats.

David Feister, Raymond James.

Most of my questions have been answered, but, first one, let's talk about the capital markets group. Glad to see that guys got FINRA approval and you got a couple of employees in the group and have started ramping up revenues, but could you maybe talk about your expectations for this group going forward in terms of the potential contribution?

Yes. Let me give it to you as a long-term target, say, five to seven years. It would be our belief that that could produce a $7 million to $10 million income stream out at that pace. Again, it is a little harder to figure out on the short-term, straight line, how that works. As you know, we are in the process at this point of going out and introducing the capabilities. I mentioned I believe we will sign our first engagement letter this week on a relatively small sale -- transaction, but you know how that works. That is a spotty business or a lumpy business. It is not something that really comes out on a straight line.

Okay. Now, post the close of CapitalMark and Magna, you are sitting at $8.5 billion in assets, and given the growth rate you all are growing organically, a $10 billion threshold is nearing, likely in the next 24 months or so. We have talked in the past about the impacts of crossing that threshold, but I would like to hear your thoughts on how you expect to cross it, whether it is organic, or would you consider doing a larger M&A deal. I know you mentioned that you want to be a $13 billion to $15 billion Tennessee bank, but would you ever even consider leaving the Tennessee market?

Yes, I guess. Let me try to hit at two or three components of your question there. I guess the first thing of how we would cross it, I think -- I would say, we will take the natural course to cross it. So what does that mean? What it means is that we are willing to just grow through it organically or we are willing to make an acquisition. But I think the thing I would want to emphasize is that we are not going to go do some wildly different strategy for the sake of financial engineering as it relates to the Durbin amendment. And all I am saying there is -- I know some people will say, yes, well, we are going to get the $9 billion and then we are going to acquire $9 billion and it is not going to an impact. And so I just don't think you ought to expect that kind of mindset from us. We have tried to be candid that we think primarily about our company as an organic growth company.

So if you size that for just a minute, think about that, just take the historical growth rate -- take the loan growth rate in our Company and in the two banks that we have just acquired, you have got something that nears $1 billion in organic growth a year. And so you have got -- you know, you have got a staggered implementation on when these things impact you and when (inaudible) comes in and all those kinds of things. But when you have a $1 billion organic growth capacity a year, you can afford to organically grow through it. You might take a little hit to earnings, but it wouldn't be meaningful.

And then, we have also tried to say and that we think of ourselves primarily as an organic grower, that we do have M&A opportunities. There is a lot of chatter out there, I would guess. I get paid to think this. I mean I think we are the preferred acquirer in the state of Tennessee. So if there is a lot of chatter, that means we have got a lot of opportunities and we probably declined more than we look at. But I would just say, I believe that it would be unlikely we wouldn't have an M&A transaction or two that would be at or near the time we crossed the $10 million.

So I know that sounds nebulous, but I guess the point of it is, we are not going to take any unnatural moves in order to dance around the impact of the Durbin amendment. And we have great organic growth opportunities and great M&A opportunities, and we will take them as they fit our strategy, not as a financial engineering technique.

And the last part of that question, would you ever consider leaving the Tennessee market, or are you solely focused there?

I think -- my father taught me never say never, and so I don't want to say never, but I would say it is highly unlikely. I think we have said, I think, for 15 years that our growth is operating in the urban markets of Tennessee. They are markets that we know and understand, and my belief is that if we build a $13 billion to $15 billion company that has a 1.20% to 1.40% ROAA, that will be a handsome earnings stream for our shareholders and probably serve us better than getting out into markets that we know less about and understand less of.

Jefferson Harralson, KBW.

My first question is a margin one. You guys have a little tailwind coming from the full impact of both the deals? I think CapitalMark had a 390 margin, and did that help the margin this quarter with the blending of those two banks or did Magna pull it down towards about even?

No. Jefferson, you are right. We fully expected some accretion to margin number from the CapitalMark and Magna. I think Magna's margins were pretty similar to ours. Maybe a little bit more north of ours, but CapitalMark's were, like you were talking, 20 or 30 basis points.

So we have to submit a tailwind next quarter, so is that incorporated into your guidance, or how do you think about that for next year?

Yes.

(multiple speakers).

Yes. We think we will have at least flat to maybe a rising margin next quarter.

Okay. Looking back at Bankers Healthcare Group and looking at the money they made this quarter and the way it is growing, my math could be off here, but has this deal turned out to be close to 20% accretive on the shares that existed at the time you did it? I mean, this thing seems like it is making a lot more money than we thought.

Yes. We are obviously ahead of where we thought it would be initial accretion levels of 7% to 9%. I think we're going to get to 20%, but they are having a really good year.

Okay. And my last one is on the two times normal hiring. Is there disproportionate methods, or can you talk about that with the respect to geographies?

Yes. The 2X comment, Jefferson, it really relates to legacy size hiring, and so we are thinking of that exclusive of the Memphis lift out.

Okay. Yes, exactly. I was just wondering on that -- are there additional Memphis hires besides the lift out, I guess is where I was going with that?

Yes. I'm sorry. There have been additional hires of both revenue producing and support personnel there. Harold, help me. Can you say (multiple speakers).

I think there has been a couple over and above the initial April lift out group.

I think the April (multiple speakers) if I remember right, Jefferson, in that press release, I think we announced eight hires, and I think there are 13 folks there today.

Will Curtiss, SunTrust Robinson.

I am all set. All my questions have been addressed. Thank you.

Brian Martin, FIG Partners.

Maybe just two quick things. Can we just talk about -- Terry, I think you talked about in the past the credit leverage. It has been continuing, and this quarter you have talked about the reserve levels being in line with peer. I guess just kind of how you guys have been thinking about that. And just anything on -- it seems like credit is about as good as it can get. I was just wondering if there are any pressure points you guys are seeing as you are growing and are a bit more mindful of -- as you look going forward?

Brian, this is Harold. I will talk about the credit leverage question, and I will let Terry cover what he is seeing as far as credit trends. We still believe we have got credit leverage in the legacy Pinnacle franchise. Obviously, the ratio of allowance to total loans dipped down because of the mergers, but we still believe we have got some more reductions, I guess is the right word, from our allowance for loan ratio because of the improving credit leverage in our legacy Pinnacle book, particularly in C&I and commercial real estate.

Yes, Brian, I would say, going forward, in terms of pressure points, I feel really good about the asset quality of the Company. You can see the numbers that are generally predictive of future problems, things like (inaudible) classified asset levels, nonperforming asset levels, past dues. I mean, all those sorts of things are generally predictive of coming credit problems, and all those metrics are, I think, really exceptional. And we are at the point now where we have all but eliminated OREO. And so all those things inspire confidence about our credit trends going forward.

I think if you look at what is going on inside those numbers, our largest asset class by far is the C&I book and then CRE and so forth. Our consumer book is really small. We have, I think, going back over the last two years or three years, we have dabbled around with a variety of consumer instruments that are generally intended to try to build better balance into our loan portfolio, trying to higher-yielding asset class that will be good for our balance sheet.

And so we said, I think, Brian, if I remember right, maybe two years ago we said we would take 5% of our loan book and allocate it to a variety of these experiments with higher-yielding loans categories. Some of those have worked well for us. Some of them haven't. We have taken some losses in and (inaudible) loan portfolio book, but believe that we have pretty well wrestled that thing down. And so again, we have just got things that happen around the fringe with the core of the asset quality, and the expectation for the asset quality trend continues to be very strong.

Okay. That's helpful. And then maybe, Harold, just a little bit on the funding class. It sounded like you had a little bit more opportunity on -- I mean they were up this quarter just with Magna. I guess as you fund the loans growth going forward, with primarily core deposits and (inaudible) tax on core funding, in the funding process, if you could give a little color.

Yes. I think, particularly CapitalMark had a really strong deposit growth quarter here in the third quarter. That was a pleasant surprise for all of us. Where I think we have opportunities on deposit cost is in our wholesale books. We have already started working on some of the federal home loan bank borrowings. We have already started working on some other non-core funding sources that both banks had in their funding book, and we will probably get all that wrapped up here within the next three months or so. We have also repositioned a lot of the bond book at both banks here in the third quarter, so we think that will work to our advantage as well as we go into probably -- as we hopefully go into this rising rate.

Okay. Perfect. Good quarter, guys.

Nancy Bush, NAB Research.

I have another question on this hiring -- what you had to say about hiring. One of your Alabama peers had a conference call a couple of days ago and made some similar commentary. I think they said that day they had had two calls from revenue producers that wanted to join them. So I guess my question is, where are these people coming from? I mean, are you seeing people coming to you from the large banks, from the community banks, that might be targets? If you could just give us a little color, I would appreciate it.

The specific answer to your question is, it would almost be exclusively from the large regional and national branch houses with whom we compete, and it might just be worth developing the hiring model here. Basically, we don't hire -- we don't take calls from headhunters. We don't hire people that are seeking placement by a headhunter. We don't hire people that are sending us resumes. And we don't -- I guess, again, that's enough on that, just to make the point that our basic philosophy is folks that are generally out looking for job, they are looking for a job because they are either unhappy or unsuccessful where they are. And that is just not the pool we want to hire out of.

And so for the most part, our hiring comes from folks that we target. We use a mechanism inside our firm to have our associates, all of whom came from these large regional banks, to tell us to the folks are, who share our values, and who are reliable producers, and we recruit them and chase them over an extended period of time and try to hire them.

So certainly, it is a fact that we aim at capitalizing on the vulnerabilities in these large regional banks, but, again, I would just try to make a distinction. It is not that we are hiring people that are bailing out of these companies as much is we are trying to hire people that we are recruiting from these companies, which is a slightly different thrust. In terms of, I guess, trying to give you some color on why -- how it works or why it works that way, I just think it is a hard experience for high producing people in large regional companies. For the most part, they love looking after clients and treating them well. It bears on them, weighs on them when they have to keep defending their company from countless errors and processing, account analysis, charges, those kinds of things. And then I think, more importantly, it is hard for them to loan money. Generally, they have to get their loans approved by somebody they don't know very well in another city. And that person doesn't know their client well, and it is a difficult experience, and the credit guys that they don't know talk to them like they are stupid, and you just have all that sort of stuff going on. And that is the kind of stuff that we see, and I think that's why people leave the large regional banks for companies like ours.

I think, again, we are so well positioned. There are lot of smaller banks in our market who can hire some folks, but they are not going to hire people that handle upper middle market companies because they don't have big enough lending limits nor do they have the product sophistication in terms of treasury management, wealth management and so forth to handle those kinds of clients.

And so for folks that leave these large regional banks, they come to a company like ours, generally they have got plenty of lending limits and they have all the product sophistication so they are not taking a step back on that when they come here.

Great. Thank you. And if I could ask just one follow-up, and I think this would just require your perspective, Terry. I am old enough and have been in the business long enough to remember when CRE in Tennessee was not necessarily a winning proposition, and I would just ask -- (multiple speakers). I would ask on your CRE initiatives and on your buildout in that business, how do you see the business now as opposed to what we remember it historically?

Yes. I think for us, there are two or three things. Let me just talk about the market and then let me talk about our approach to the market. And so from a market perspective, my belief is that Tennessee does extraordinarily well. And I won't cite all the accolades from site selection firms and economic development firms and so forth. But Tennessee is a net migrator of jobs year after year, and again, I could give you a Chamber of Commerce speech. But if you cut down to the bottom of it, it primarily has to do with the fact that we are a no income tax state, a low business tax state, a business friendly right to work state, and those kinds of things. So we are going to need migrator jobs, and that bodes well for the state of Tennessee and it particularly bodes well for the urban markets in Tennessee, which is where all of our stuff is concentrated. And so, again, you are right. The fact that they are doing well today doesn't mean that they will always do well. In fact, they certainly won't. But, again, I do think Tennessee is in a net advantaged position over a long period of time because of primarily the tax structure and business friendly environment in the state.

So I think that is an important aspect of what goes on in the market. Now, in terms of our approach to the market, what is different? I think, for us, what we are trying to do -- and, again, I don't want to bore you with all this. You know our Company has heard a lot of this stuff over a long period of time. We have built the preeminent C&I bank in our markets. We have (inaudible) lead bank share positions better than virtually all of the folks in our markets. Our client satisfaction is better, and we have easily been the fastest growing bank over an extended period of time, moving market share from these large regional banks. We have never focused on the CRE segment like we did the C&I segment, and that is for several reasons.

One, as you point out, there is some volatility there, and my judgment is different than the C&I business. But, more importantly is the small bank. We started this company we went for several years, our house lending limit was $1.8 million. So you are just not going to be a player in the CRE segment with limited capacity.

Today, for investment grade credits, we would go up to $40 million. And so that puts us in a position to deal with the top tier real estate developers and owners in these urban markets. And so, again, what we have set out to do, just like the C&I segment, is hire the best relationship managers in these markets and have them focus on the best owners and developers. And I believe client selection is more important than project selection when you get down to difficult times.

And so I think if you go back -- again, you know our story well -- you saw the fabulous credit performance for eight years and then, wham, during the recession and so forth, if you go back and look at and compare our performance through the cycle -- through the difficult cycle, against all those big regional banks with whom we compete -- Regions, SunTrust, Bank of America, First Tennessee -- we outperformed them meaningfully because, in my judgment, client selection enabled us to get through that turn quicker and lose less money than our competitors.

Again, we might have had as much in terms of criticized classified assets, but we didn't lose nearly as much money as a result of client selection. And so that is our approach to the CRE business. That is kind of a long-winded answer, but maybe help you understand how we think about it.

I am showing no further questions. I would like to turn the call back over to Mr. Turner.

All right. Thank you, operator. Folks, thanks for participating with us. I hope we have been able to provide you some color into our performance in the third quarter and give you some sense of our strategic direction and growth outlook going forward. Thanks for participating. Feel free to get back with Harold or myself, if you have questions.

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