Pinnacle Financial Partners Inc (PNFPP) 2012 Q1 法說會逐字稿

Good morning, everyone, and welcome to the Pinnacle Financial Partners first-quarter 2012 earnings conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer. He is joined by Harold Carpenter, Chief Financial Officer.

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

Before we begin, Pinnacle does not provide earnings guidance or forecast. 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 correctly comparable GAAP financial measures and a reconciliation of these 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 conference over to Mr. Terry Turner, Pinnacle's President and CEO.

Thank you, operator. Good morning. As you have seen, we have printed $0.21 in EPS in the first quarter. In my view, a great quarter for us. Throughout 2010 and 2011, we focused on two primary priorities -- one building the core earning capacity of the firm and the other aggressively dealing with credit issues. We continued that march again this quarter. So we will address our substantial progress on both of these fronts in this call.

Additionally last quarter we began highlighting two additional areas of focus -- growing the balance sheet and repaying TARP. Of course, growing the balance sheet could be viewed to be a component of building core earnings, but we broke it out given the significant focus. So we will update you on the ladder to priorities as well.

A quick snapshot of the quarter shows meaningful continued core earnings momentum. The two most significant levers that we have are accelerating loan volumes, particularly C&I volumes, and expanding the margin. Despite significant headwinds, we have still managed to grow end of period loans 1.4% on a linked-quarter basis and C&I plus owner-occupied real estate loans 2.5% on a linked-quarter basis, which translates to roughly 10% annualized rate of growth.

I highlight the C&I growth because, as most of you know, that is the primary thrust of our firm and now that I think we have found the floor on C and D loans, and the pace of NPA dispositions is beginning to slow, which Harold will highlight shortly. That growth in C&I will not be masked going forward to the extent it has been over the last couple of years. Consequently it is our expectation that quarterly net loan growth should accelerate meaningfully beginning in the second quarter.

A further point, as it relates to our ability to grow volumes, is that average non-interest-bearing deposits were down only slightly on a linked-quarter basis. But, as you can see, the year-over-year comparison is very strong, up 18%. I highlight that not only because of the impact it can have on the net interest margin, but because generally DD&A is the single best indicator of a bank's ability to gather primary banking relationships -- in other words, real clients.

You have heard me say before, as credit costs subside, in my opinion the real winners are going to be those that can reliably grow primary banking relationships.

In first quarter, the net interest margin expanded nicely from 3.65% last quarter to 3.74% this quarter. That was primarily aided by decreases in cost of funds quarter to quarter, and that represents meaningful progress on a linked-quarter basis and year over year. Net interest income, exclusive of security gains, was up 2.5% on a linked-quarter basis and 15.9% on a year-over-year basis.

During the first quarter, we realized significant growth in our Wealth Management fee income as investors are beginning to return to the market there. And we continue to benefit from the increased mortgage refinance business, resulting from the current interest rate environment.

Now let me summarize the asset quality improvements and specifically the reduction in problem loans. As you can see, we have continued to make meaningful progress, reducing virtually every important problem asset category this quarter year over year and consecutively for between seven and 12 quarters now. Net charge-offs were roughly $3.6 million for the quarter. That is down 42.7% from the previous quarter. But OREO expenses of $4.7 million were from the $4.2 million in the prior quarter. So combining those two, our total credit losses were down 21.1% in the first quarter, 40.9% year over year and for the seventh consecutive quarter.

Nonperforming loans shrank by roughly $5 million during the quarter from $48 million to $43 million. That is a linked-quarter reduction of 10.5%. That is the eight consecutive quarterly reduction there, down nearly 44% from last March. Nonperforming assets -- and that is defined as NPLs plus OREO here -- were down $10.7 million during the quarter. That is roughly 12.2%. Classified loans shrank by roughly $19.1 million during the first quarter, a linked-quarter reduction of nearly 9.6%. That is also the seventh consecutive quarterly reduction, down 30.7% from last year.

Potential problem loans shrank by approximately $4.1 million during the quarter and $47.5 million year over year. That is roughly 3.1% versus the fourth quarter of 2011 and 27.3% year over year.

As you can see, the pace of reduction in our construction and development portfolio has slowed meaningfully from that over the last three years to just 2.7% during the quarter. As I said earlier, I believe we have found the bottom in that category, and consequently it should discontinue to be a significant drag on loan growth going forward.

Despite these solid improvements, which we believe we had, we also continue to believe we've got room to improve core earnings as we continue to rid ourselves of problem assets. But, as you can see, the first quarter was a great quarter in terms of execution against our two primary objectives.

So I'm going to stop there and turn it over to Harold to review our performance in greater detail.

Thanks, Terry. As you can see, this slide details the quarterly trends of our net interest income and our net interest margin. We have been showing you this information for the last several quarters. We are pleased with the steady progress we have made on these measures. Both measures are up approximately 10% from the first quarter of last year.

As we mentioned in the press release last night, we are anticipating the increased loan growth in the second quarter and for the remainder of 2012.

It seems as though we are getting some traction from our business development efforts, something that we have been working on for the last year or so. We are gaining confidence that loan growth will replace funding costs as the primary engine to net interest income growth in the coming quarters.

As to funding costs, our total funding costs have decreased from 1.09% for the first quarter of last year to now down to 63 basis points in the first quarter of this year. We believe that we will make more progress on funding costs for the remainder of this year, although we believe the pace of the decrease will slow.

As to the third bullet, for margin drivers we have seen NPAs decrease by approximately $56 million over the last 12 months, but more on that later. We believe we still have room to expand our margins throughout 2012 as we continue to make progress toward our new goal of 3.8% to 3.86% over the next several quarters.

This slide, again, details some additional information on the good work we have done in growing our margin. As the blue bars indicate, we have seen our margin increase from 3.25% in the first quarter of 2010 to now 3.74%. This is driven largely by meaningful decreases in cost of deposits as the green line indicates.

We remain optimistic that a further reduction in cost of funds will occur in the second quarter of 2012 as our certificates of deposit reach maturity and re-price, and we focus on reducing specific money market accounts where the rates are beyond a reasonable premium for these accounts.

As to loan yields, we have experienced a decrease in loan yields this year from 4.88% in the first quarter of last year to 4.74% for the first quarter of this year, a decrease of 14 basis points. To be honest, we are pleased that yields are holding up where they are. Our relationship managers have been well-versed on asset pricing and have been provided various tools to help them get the appropriate yield for their loans, but we have got room to do better and are working all angles to increase our yields over the next few quarters. However, as we have mentioned before, loan pricing is very competitive in Nashville and Knoxville for quality borrowers.

That said, if we believe a customer deems Pinnacle to be their primary bank, we will do everything in our power to not lose that account based on pricing.

We really like the way this chart has shaped up over the last few quarters. I believe it is a good reflection of the margin trends between what we would deem to be our customer bank, the core of our franchise and the wholesale bank or the functions of our treasury unit. The top line represents the customer bank margin where we continue to see solid expansion. This is net interest income from loans funded by our customer deposits. You can see it has ramped up nicely over the last few quarters and continues to show a positive trend now with a 4.2% margin, which we believe is a strong indication of the high quality of our franchise in two very attractive banking markets.

The bottom line is the treasury margin, which is more volatile being impacted mostly driven by significant prepayments in our bond book. The treasury margin represents primarily net interest income from the bond book as funded by lower cost of funds and other wholesale deposits. It is also impacted by the absolute level of liquidity that we continue to maintain.

Our strategy for 2012 is to lessen the impact of our bond portfolio on our revenue streams and let cash flow from the bond book help us fund high quality lending opportunities. We have reduced the size of securities book by more than $125 million over the last year and anticipate seeing it decreased further in 2012.

We are obviously very pleased with the efforts of our relationship managers and the progress we have made with respect to increasing our customer margins during this economic cycle. We believe we continue to grow the red line -- that we will continue to grow the topline in 2012 as we focus on growing our loan portfolio, which Terry will speak to shortly.

As to margin enhancement opportunities, now I know that I sound like a broken record as we have been detailing this information on this slide for several quarters. A consistent margin improvement opportunity continues to be within our upcoming maturities on CDs. The $148 million represents approximately 22% of our CD book and, as you can see, these CDs are currently priced at approximately 1.04%, and our target is to re-price them in the 57 basis point range.

We should note that during this entire time the average maturity of our CD book has remained at approximately eight to nine months.

Similar to the good work we have done on CDs, our sales force has done a remarkable job managing client interest costs on our money market accounts. We have approximately $228 million in money market accounts where we believe we should continue to negotiate with these clients to get what we believe to be a fair rate in this interest rate environment.

From this point we believe 5 to 10 basis point improvement in money market rates represents a reasonable target over the next few quarters.

Now looking at our P&L trends, our adjusted pretax, pre-provision increased from $14.1 million in the first quarter of 2011 to $18.2 million in the first quarter of 2012, a year-over-year increase of 28.7%. The first quarter has been for us a more difficult quarter for bottom line operating growth.

Last year we saw our adjusted pretax, pre-provision decrease by $2 million, mostly due to implementation of incentive costs into our 2011 run-rates. We expect to see growth in our pretax, pre-provision profits based primarily on revenue growth for the remainder of this year.

As we noted in the conference call last quarter, we anticipated an uptick in our efficiency ratio, which excludes OREO expenses during the first quarter of 2012.

As noted in the bottom of the chart, we have highlighted a few items which impacted our run rates, including securities transactions and ORE expenses. As to our expense run rates, our 2012 expense run-rate has increased slightly over the prior year, due primarily to increased compensation expenses associated with merit raises of around 4%, which started in January. I believe our expense run-rate will remain fairly consistent for the remainder of this year, absent an increase due to the addition of new relationship managers for the rest of this year.

As many of you know, we have largely completed our branch buildout in Nashville, but continue to believe we need to increase our presence in Knoxville. We are penciling in a new branch location in Knoxville toward the end of this year, which will impact our expenses moreso in 2013.

Given all these matters, we are projecting our efficiency ratio, ex-ORE costs, will trend down for the remainder of this year such that we are hopeful it will be around 60% or slightly below for the fourth quarter of 2012.

Switching gears briefly to our credit trends, we presented this slide for several quarters, and it continues to tell the same story. The top segment shows our non-accrual loans that are actually past-due. As in the past, although this statistic is not on the slide, about $21.4 million or slightly more than half of our non-accruals are not past-due. These loans are paying as agreed, but remain on non-accrual for a variety of reasons primarily because we are not satisfied with the cash flows being used to keep these loans current have the qualitative characteristics to return them to an accruing status at this time. When we believe the cash flows do meet our requirements for accrual, then we will return these loans to accruing status.

Now to the slide, the top section of the slide shows the loans both accruing and non-accruing that are past-due, which are being managed by our special assets personnel. But the point of the slide remains the last line. Our past-rated credits still handled by relationship managers had past-dues of just 11 basis points for this quarter. This number has been in a range of 8 to 20 basis points every quarter for at least the past year. This is extremely clean to us, and it says that there are not many credits still on the line which are having difficulty paying us.

Total credit costs continue to trend downward. As you know, we define credit costs for our firm as the sum of loan charge-offs and ORE expense. Thus, we review these trends together. This bar graph shows that the sum of these two numbers has been decreasing and decreasing steadily for the past six quarters.

Over time, as our ORE book continues to trend downward, expenses associated with managing and disposal of these properties should trend likewise. We estimate that approximately 20% of our ORE cost is tied up in the cost to maintain these assets, legal fees, maintenance, insurance taxes and so on and so forth.

Included in these costs are appraisal markdowns and/or losses on dispositions. So we are incented to continue to get these assets through the process and into the hands of an owner who appreciates them more than we do. We are anticipating meaningful decrease in ORE expense this year.

Not included in ORE expenses are the ancillary costs associated with troubled asset dispositions. We have been pleased with the efforts of our special assets group professionals over the last couple of years. Our goal would be over time that we are able to decrease our expenses in this area as well. At the peak this area required 29 employees. We are now at around 19 and intend to reduce to approximately 12 to 14 by the end of 2012.

As to charge-off, we recorded $3.6 million in net charge-offs in the first quarter. We continue to believe that our previous guidance of 25 to 35 basis points of net charge-offs for 2012 remains a reasonable estimate.

We really like this slide. NPLs continue to trend downward. In addition, the line shows the ratio of our allowance NPLs is around 167% at the end of the first quarter, up significantly from all previous levels and increasing each quarter. Based on the pure information that we look at, we believe this amount will compare favorably to most peer groups.

This next slide is about our nonperforming asset inflows and disposition activity in 2011 and as we outline for you as our target's disposition approximated a range of $30 million to $45 million each quarter. Most of our nonperforming asset dispositions during these quarters were getting accomplished by selling nonperforming assets or selling off properties. Given that we believe the absolute balances of our NPAs will trend downward, we reduced our target disposition range last quarter such that we feel like we should approximate $75 million to $100 million of dispositions during 2012 compared to $133 million in 2011.

Now some really good news. NPL inflows decreased to below $15 million in the first quarter of 2012, and we believe that we will see continued reductions in the second quarter.

This next slide is, again, intended to convey that we believe we have our real estate, our other real estate owned marked appropriately. The first column shows for all ORE dispositions during the first quarter of 2012 the loan amount less any charge-offs prior to foreclosure, valuation losses typically from reappraisals and the loss on disposition. So the 61.5% number represents when we ended up collecting on the loan after client payments for all the ORE dispositions so far this year.

The right column uses the same methodology for the properties we still have in ORE as of March 31. It shows that we have already written down a loan to 55.7%. Since we have already written the remaining ORE down to less than what our loss experience has been, we don't anticipate significant additional losses related to the eventual disposition of these assets.

We presented this slide for the first time at the end of the third quarter of last year. The objective of the slide is to relay our current thoughts on how long it will take to rid ourselves of these properties. The slide shows that we expect $7.7 million of ORE properties should be off our balance sheet within the next three to six months.

In the next column, we have shown how much of our ORE is in active projects where the sales activity continues, and we expect the total liquidation to take place within a two-year timeframe. The final column labeled Other Properties is where we do not have sales activity that would indicate a near-term sale. The total of this slowly moving real estate is $5.8 million, all of which is in lots and land. This amount was around $6.5 million last quarter. Clearly this is where our challenges are, but fortunately this is a relatively low number as a percentage of our total ORE balances.

With that, I will turn it over to Terry to finish up.

Okay. Thanks, Harold. As we move through 2012 and as I have discussed at the outset, it is my expectation that we will continue to make meaningful reductions in credit costs from 2011 levels. But beyond that, I expect three principal profit improvement levers to be outsized loan growth, continuing expansion of the margin and redeeming the remainder of TARP.

To focus on our ability to grow balance sheet volumes, I want to further highlight what the current trends are. This slide details the strong and generally consistent growth we have experienced in average DDA balances since the first quarter of 2010. In the first quarter of 2012, we were actually down a tick from Q4. But given normal seasonal shrinking that you typically see there in the first quarter, I still consider it an excellent quarter.

As I mentioned earlier, year-over-year growth in balances is approximately 18%. At March 31, 2012, our average DDA account was $17,000 as compared to $17,000 a year ago. At the same time, the absolute number of accounts is up 17%. So we continue to add extremely high value accounts.

Most of you have heard me say this before, but I really do believe that the real winners in this business will be those that can reliably grow primary banking relationships, and those are presently measured by DDAs. Also, the fact that the growth rate of accounts matches the growth imbalances likely suggests a stickiness of those balances when unlimited FDIC insurance coverage reverts to its previous limits at year-end.

Continuing to focus on current volume growth trends, this slide details the quarterly growth that we have experienced in loans. I want to remind you that this growth momentum has been established in the face of, number one, a rapid run down in the residential real estate portfolio, which we now believe is at a bottom. And number two, rapid problem loan dispositions, which as Harold just highlighted, are expected to be significantly less in 2012 than in 2011. But even with the significant headwinds, first-quarter loan growth annualized was roughly 5.7% and for C&I plus owner-occupied real estate roughly 5.8%. So with little or no help from the economy, it appears that our focused organic growth strategies are, indeed, working.

Also related to loan growth, we included this slide to help quantify the drag associated with NPL dispositions, which has been significant, but, as you can see and as Harold has pointed out earlier, is slowing. We expect further slowing through the remainder of 2012, which should serve to accelerate loan growth based on nothing but current trends.

Now still focusing on growth, let me remind you of this growth capacity data that we provided in last quarter's call. Since our inception in 2000, we built a great track record for hiring high-producing relationship managers and enabling them to move their long-term clients to us. Prior to the second-half of 2011, we had suspended our recruitment efforts over the last two years as we focused on problem asset resolution. So, as you might expect, during that period, much of the relationship consolidation by the latter hires was deferred. And now, as we move forward, we believe that our existing financial advisors are now in a position to resume consolidating their books of business and should produce an additional $900 million in loan growth.

Also, we have recently rekindled our recruitment efforts. I mentioned in a previous call that we would hire approximately 10 new advisors now, including someone to build our indirect auto lending program. We have updated that to an expectation for 11 new hires. 10 of those are onboard, and with several others in various stages of equipment, it seems apparent to me that we will exceed the targeted 11 hires.

The average experience in our market for all 10 of these recent hires is well north of 20 years, so these are high-value hires. And so when you consider the recent and projected hires, which total 11, they should produce another $375 million in loans by consolidating their previous clients. This is the same exact strategy that we deployed so successfully during the first seven or eight years of our existence. It is the single best way I know to take market share and grow a bank without taking on increased credit risk.

These relationship managers move their long-standing relationships. They leave any bad credits behind. You get relatively rapid growth with extraordinary asset quality. Our experience during the first eight years of the firm's existence deploying this strategy, we only incurred roughly 5 basis points in net charge-offs. So, again, the idea it is a relatively safe way to grow the balance sheet, particularly during a period of tepid economic growth.

We don't normally include these kinds of slides in our investment presentations, but it so succinctly captures what we are doing, we wanted to include it. It was published yesterday in the Nashville Post, and it just highlights a recent hire that we announced yesterday -- this one from Bank of America -- as part of a big talent push launched last spring. His hiring comes a few weeks after Pinnacle scooped up a former SunTrust executive to market to law firms. A $5 billion downtown-based bank is also since the summer recruited senior lenders from JPMorgan, First Tennessee and others as part of a marketshare push reminiscent of its early growth days. Again, I think that focuses on exactly what we are trying to do.

Now shifting gears to the margin, we have made significant progress on the net interest margin from its low of 2.72% in March of 2009 to 3.47% last quarter. As the six consecutive quarterly expansion and as Harold has already pointed out, we expect continued margin expansion for the next several quarters.

To help you think about the size of the ongoing margin expansion opportunity, let me start with loan growth. Over the last year or so, we have chosen to maintain excess liquidity on our balance sheet. As we begin to replace that liquidity with loan growth, we expect to add another 2 to 4 basis points of net interest margin.

Next Harold highlighted the cost of funds reduction opportunity just a few minutes ago. That continues to be our most significant margin expansion opportunity. Over time we would expect that to translate to 3 to 5 basis points in margin. And finally, as we continue to reduce the level of NPAs and as we replace nonperforming assets with performing loans, that lift in loan volume represents significant margin expansion opportunity also. So, even if we only moved from the first quarter NPA to total assets and OREO ratio of 2.30% to just 1.50% and reinvest in performing assets, that would improve the margin 1 to 3 basis points.

So you can see over time we believe that we still have a pretty good opportunity to grow our NIM, save from the current level of 3.74% to something in the range of 3.80% to 3.86%.

The loan growth targets I just reviewed simply anticipate an economy that gets no worse. And while I am not particularly optimistic about economic growth over the next several years on a national basis, I do expect our two markets to outperform the nation. Here is a look at the job recovery in Nashville and Knoxville.

The top left chart shows that since peak employment for the US in late 2007, the nation consistently lost jobs through mid-2010 before beginning to create jobs such that now, even after beginning to create jobs, the net number of jobs still appears to be nearly 4% less than peak employment at the end of 2007.

You can compare that trend to the Nashville and Knoxville trends in the charts on the right. Nashville and Knoxville have nearly recovered all the jobs lost in peak employment in the second half of 2000 with Nashville now down only 0.9% and Knoxville down just 0.5%. So our markets do appear to be recovering more quickly.

Let me focus just a minute on the third profit improvement lever, which was TARP repayment. Following our 25% TARP redemption, the capital of the firm remains strong. The remaining TARP balances total roughly $70 million. Of course, we continued to create the capital in the first quarter, and we still maintain about $41 million in cash at the holding company. Annual cash requirements for the holding company, exclusive of TARP dividends, currently total about $8 million, and generally regulators like to see you maintain at least two years' requirements.

The bank currently has $31 million in dividend capacity. That is based on the regulatory formula which limits dividends from the bank to retained earnings during the current year plus the last two years. And while it would take a special appeal to the OCC to gain approval, the bank could technically dividend $81 million to the holding company and still maintain an 8% leverage and a 12% total risk-based capital ratio, which are now our internal targets. So our capital position is very strong.

For the last five or six quarters, I have tried to communicate our desire to be patient as it relates to TARP repayment in an effort to allow things to stabilize and to minimize or avoid common share dilution. At this point that continues to be my view of the course we should take.

That said, I believe our substantial progress this quarter, combined with our current outlook for the next several quarters, will likely accelerate our opportunity to do that.

First of all -- and this is important -- we don't know what the Fed will require of us to repay TARP. But, based on our analysis of those who have redeemed 100% of TARP through December 31, 2011, if you consider our current Tier 1 leverage ratio less TARP repayment, we would be at the median of Tier 1 leverage ratios based on analysis of approximately 160 TARP redeemers.

To be clear, I am comparing what our Tier 1 leverage would be post-TARP repayment to the current capital positions of all those who have repaid TARP, regardless of when they repaid TARP and after any common raises or subsequent earnings that they have produced.

As to total risk-based capital, our argument is not quite as strong there. But total risk-based capital includes Tier 2 capital, which could be easily augmented with a number of non-dilutive alternatives.

Following this quarter's results, I now feel in a position to accelerate dialogue regarding TARP repayment with our regulators. Again, just to emphasize, we need regulatory Corporation to accomplish any of the repayment approaches that we have considered. But given the low cost of capital that TARP represents, I would still be willing to continue asset quality improvements and capital accretion through earnings or some other alternative noncapital instrument in an effort to qualify for TARP repayment with little or no common dilution.

So specifically, as it relates to second quarter, lending opportunities from both clients and prospects appear to be increasing. So we expect growing momentum in loan growth, particularly C&I. You heard Harold size the volume of CDs to be repriced in the first quarter at roughly $148 million. That rate pickup should approximate 50 to 75 basis points. That, in conjunction with the reinvestment of nonperforming assets and performing loans, should lead to continued margin expansion in the quarter. The combination of growing balance sheet and improving margins should lead to increased interest income. And, as it relates to NPL and NPA resolution, we expect that pace, as Harold said, to slow slightly in the remainder of 2012 and then very meaningfully thereafter.

So, as we move into the second quarter of 2012, we are nearing the completion of our asset quality rehabilitation, and we are now focused primarily on building balance sheet volumes and expanding our margin as our march back to high performance continues.

Operator, I'm going to stop there, and we will open the floor for questions.

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

Just a quick question clarifying what you just went over, Terry, about how you are looking at TARP. I understand you are more comfortable accelerating that dialogue with regulators and you say you have -- basically have to repay $70 million or thereabouts. You have about a little over $40 million in cash at the holding company, and the bank could dividend up about $30 million based on results, the last two years' results. But do you think from a liquidity standpoint, not looking at the capital ratios but from a liquidity standpoint, are the regulators likely going to want to see continued improvement in results before they let the bank dividend up all that amount, or do you feel throughout this whole dialogue that they are getting close to that point?

The conversations that we have had with both OCC and the Federal Reserve, we believe, have been very productive on that point. They seem to be willing to consider a whole host of different strategies or capital planning transactions for us to achieve what we are trying to achieve. We cannot make any promises about any component of the strategy, but we believe, as respect to the capital capacity of the bank to dividend to the holding company, that that, too, is fair game and we believe that over the next few weeks or whatever that we are talking to regulators, that we think we can get them over the trend.

Kevin, if I could add to Harold's comments there quickly, I guess, I did not mean to create an impression that we were going to dividend $81 million from the bank to the holding company. I really was just trying to defend the capital adequacy of the Company as a whole. And we certainly could look at some portion of that, but, at this point, I would not expect that I would recommend that we dividend the full dividend capacity out of the bank.

Right. And I was not suggesting the $80 million; I was more looking at the $30 million that if you made that argument that based on the past two years' results, we would request to dividend up $30 million and, therefore, you have got another cash to take care of that. I am just trying to gauge the willingness of them to grant that versus maybe wanting to see a few more quarters of results.

And then just one quick follow-up. Just it seems like you are much more optimistic in terms of the loan pipelines, and probably a big reason for that is that it is not so much organic growth, but it is that you have this model working to take market share. But then that also I guess comes with the byproduct of the expenses being a little higher as you hire these people away. How do you all look at or target your profitability? Because when I look at pretax, pre-credit profitability like ROA, you all are a little bit below the pure median. So is it just a timing issue where you are going to be a little lower than peer initially because it takes time for those loan officers to produce their respective revenues, or is there a certain time lag to consider there, if you can help us there?

Yes, let me -- Kevin, I will answer specifically on the loan thing just to finish up on the question as it related to the dividending of money from the bank to the holding company. In the case of the $31 million dividend capacity, that dividend capacity would not require regulatory approval. So I don't know if that helps you.

That is helpful. Thank you. Yes.

Okay. Now, I think, as it relates to the loan growth strategy associated with hiring people, I don't know if you and I have had this conversation or not, but if you go back to the first seven or eight years of the Company when we were deploying this strategy, there were two drags on ROA that were created by the strategy. Of course, the first one is the hiring of people and, as you alluded, you incur 100% of their expense before they produce a revenue dollar. And so you have to have time to grow into it. And similarly we were building out offices at a pace of about one a year, which we have said we intend to build out several more offices in Knoxville at a pace of about one a year.

My belief during those years of growth was that we had 20 to 20 -- at least 20 basis points of ROA tied up in that growth strategy that did ultimately produce a pretty high return. You know, we operated -- I guess we had a quarter or two north of 1%, maybe 1.08% or something might have been a peak for us, Kevin.

So to answer your question specifically, yes, we do intend to make the investment to produce the growth. It does create a slight drag on ROA, but it produces meaningful long-term value, and so we will continue in that vein.

I think the other item, as you compare us to peers, again, we still continue to have pretty heavy credit-related expenses, both OREO expenses that are directly itemize but other credit-related expenses as Harold hit at in terms of people associated with problem asset resolution, elevated appraisal expenses, elevated legal expenses and so forth. And so I think that combination of drag will diminish, and I think that is really the signal we are trying to send. We have seen those items diminish, although they are still relative to high versus peers. But we expect to more or less complete our balance sheet rehabilitation during 2012 and have those costs dissipate, which gives you a pretty meaningful pickup either on ROA or efficiency.

Have you all ever quantified that, the other than OREO costs, what is in your expense base that could come out with a more normalized credit environment?

Kevin, we have done it; we have not talked about it. But we go through it as part of our budgeting and strategic planning exercise where we look at a lot of legal bills and a lot of appraisal bills.

Jefferson Harralson, KBW.

I was going to ask on the OREO costs, you mentioned that 20% of those costs are maintenance; the other 80% are marks in sales. Then you mention that you expect no more losses on sales. Can you just triangulate that and help us think about the forward progression of OREO costs?

Sure. The 20% is going to be occurring over a probably 12-month time frame. We believe that the marks that we take on these properties, they are all within GAAP and all that stuff, but we are still aggressively pursuing disposition. And so as potential buyers come to the table -- and we have mentioned this several times -- if they are close to our price, then they are going to own that property.

So your question is a good one in that if we think the marks were good, why are we still having losses? That is primarily because we are still in the mode of accelerated disposition, and I don't see us backing off that for the next several quarters.

Yes, I think the other thing to point out, I'm not sure I understood exactly all the wording in your question, but in addition to the maintenance costs, in addition to the loss on disposition, you continue to have appraisal marks as well. We continue to evaluate and require appraisals on problem assets every nine months. So we continued, I think, in this quarter to have $1 million or as a round number, I guess, closer to $2 million in appraisal marks, too. So it is not just loss on disposition, and it is not just cost of maintenance.

Okay. I got it. And a follow-up is ex-all OREO costs, you are sitting at a 1% ROA by my estimate, and with the guidance for a lower efficiency ratio, that is set to move higher it looks like. Do you think -- I will bring back an old question of, how do you think about profitability versus growth here? You are making some new hires and expanding but at a more slower rate than you have in the past. Is this a timeframe for Pinnacle to show greater profitability growth, or is it time to take away market share and build value that way?

That is a great question. I think clearly I believe that our Company continues to be well positioned and probably unusually positioned to reduce organic growth. I'm not sure how many companies are going to be able to do that in this economic environment, but I believe that is the case. I also believe that we are unusually positioned against competitors as the largest locally owned alternative and now the lead bank in terms of lead market share among businesses in Nashville, Tennessee. I think we are in an unusual position to take market share that most people are not. And so we will make an investment in growing and taking market share.

That said, I don't know if you have had a chance to review the annual report, but there we tried to characterize the Company in three stages. Sort of the first eight years or so were focused, as you alluded to, a really strong focus on growth, less focus on profitability. Of course the last two to three years have really been focused on rehabilitating the balance sheet and working through the credit issues and rebuilding the margin and so forth. And I think we are now turning into a third chapter here where we capitalize on disciplines that have built over the last two or three years, but returned to much more of an organic growth strategy that we had in the first eight years but do them both. That is a long-winded way to say we are going to invest in growth, but I expect that we will have a keener focus on profitability than we did in the first eight years.

Michael Rose, Raymond James.

Just a question, I am looking on your slide deck and you are talking about the recovery in the job market in both Nashville and Knoxville, and it looks like we are almost back to normal levels or at least peak levels. How much of that is baked into your loan growth forecast?

What we have said is that the loan growth forecast is more a function of what our borrowers -- excuse me, what our financial advisors or maybe in your vernacular relationship managers capacity to produce volume is and not requiring an improved economic environment. It would hurt us if it failed to improve, but as long as it remains stable, we believe we would produce that growth. To the extent we get a hotter economy, we think it would accelerate those growth forecasts.

Okay. And then secondarily, the lenders that you are hiring or have recently hired, is there any difference in the types of loan that they generate? Meaning are they more C&I lenders, are they more CRE lenders, any sort of context there would be great?

I think the folks that we have hired in every case resemble the folks that we have previously hired. Out of the 10, roughly half would be, I think, considered middle-market type lenders. A number would be considered more private bank type lender, private banking type lenders. There are several that are small business focused on companies with annual sales of $5 million and less, and then there is one CRE lender in there.

Okay. That is helpful. Thanks, guys.

Mac Hodgson, SunTrust Robinson Humphrey.

This is Michael Young in for Mac. You mentioned your improved loan pipeline heading into the second quarter that you expected to increase meaningfully. Can you give any sort of quantification of how that pipeline has changed either quarter over quarter or what sort of loan growth you are expecting as a result?

Going into the first quarter of any year, our pipelines are generally down from quarter to quarter. But we have seen in going into the second quarter a significant uptick. We have got several loans that we thought we would be able to close in March that have moved over into April. But I think what we will do is we will stick with the term meaningful. It will be based on what we are looking at now, a nice number here when we talk to you in July.

Okay. And then I guess a caveat to that. We saw good loan growth here in Q1, but earning asset growth did not materialize. And you are mentioning that the C&D portfolio is kind of concluding its runoff. So will this additional loan growth be funded from cash flows from the bond book in securities and, therefore, we are going to continue to see flattish earning asset growth, or are we going to see an acceleration of earning asset growth in coming quarters?

I think net net you will see an increase in earning asset growth, but I think we will fund some of our loan growth with cash flows coming out of the bond book. So it will not be total, just right side of the balance sheet funding to accomplish our loan growth objectives. We will use some cash flows from the bond book to get this done.

Okay. So not necessarily sort of one-to-one growth sort of profile?

That is right.

Brian Martin, FIG Partners.

Terry, maybe just the loan growth you articulated over the next couple of years and the new people you have brought aboard, can you just give some color as far as your expectations on where that comes from as far as Nashville and Knoxville and just how that plays out?

Maybe just, Harold, on the bond book, what kind of limits as far as -- how small can that bond book get relative to where it is at today as you look to use some of that to fund the loan growth?

Okay. On the distribution of the growth, I think you can think about it this way, Brian. Out of the 10 people that have been hired, two are in Knoxville. So, if you are talking about incremental growth created by new hires as for lack of a better estimate, you know, 20% would be there versus Nashville.

That is probably not a bad way to think about it in terms of relationship consolidation either. In round numbers today, Knoxville would be a little more than 10% of the total loan book, and it will produce -- off a lower base, it will produce a higher growth rate than the Nashville quote well. So I would say, using those two things to try to anchor some thoughts about the proportion, roughly 20% ought to be Knoxville and the remainder in Nashville.

As to the bond book, Brian, we had a high based on how we calculate it that the bond book had about 21% of our total asset base probably a year and a half ago. We are down to about 17.5%. We can see that number going down into the low 16s, high 15s. We are still getting quite a bit of cash flow off the bond book due to the refinance business that is going on across the country. So yes, we can run it down some more.

Okay. And then just the last thing, Terry, you talked about the new hires, the 11 people that you have already kind of met that level. I mean how much more potential is there to bring people aboard in 2012, and is it only minimal, or could it be another 10 people or so? Can you give any color on that?

I'm not sure that I want to put another number out there. I mean we have got a lot of numbers, and sometimes they are confusing to people when you are matching this number to that number and so forth. I would probably rather stick with what I have got on the table, but just say we will definitely hire more people than the 11 that we targeted.

Carter Bundy, Stifel Nicolaus.

Harold, could you provide a little color on the securities on the bond book yields and sort of how you think about that going forward?

Well, we think bond yields have about reached their bottom. They will probably go down some more for the rest of this year, but we are seeing some slow down in paying principal reductions. So we are hopeful that we are near a bottom on yield.

So assuming a sort of all-else equal site interest rate environment, not much movement?

Yes, I think right now we can get bonds in the [240] range, [230] range. We were at about a [290] average here for the first quarter. So hopefully we will not see much more degradation in that yield for the rest of the year.

Okay. And then, Harold, on the charge-off number, you talked about 25 to 30 bps. Was that a full year run-rate, or was that by year-end 2012?

That ought to be -- we ought to be inside that for the whole year based on the forecast we are looking at today.

Okay. And then, Terry, a final question, when you talk about the capacity for the new hires that you have in terms of moving share, I guess two questions. What kind of success rate are you attributing in terms of moving old books of business over? And then secondarily, what kind of timeline in a best case scenario would that entail?

Generally there is variability depending upon whether they are middle market, private banking or small business type FA, so there is some variability to it. But generally, as a general planning parameter, we generally expect people to move about 80% of their loan book over about a three-year period of time.

Okay. Well, thank you all very much. Appreciate it. Good quarter.

I think -- I'm not sure -- somebody said you might have mentioned that we thought 25 to 30 basis points for the year. I think I said 25 to 35.

Okay. For the full year, though?

For the full year.

Bill Dezellem, Tieton Capital Management.

Would you share with us a little bit about the dynamics of the $8.5 million inflow into commercial real estate nonperformers in the quarter? It seemed to be about the only standout item in the bad loan arena.

Let me find that sheet of paper, and then we will -- it may take me a second.

Just so you know, the particular number I am looking at is part of the body of the press release, not the tables at the end, and you are showing the inflows.

Yes, that is the right number. What I'm looking for is I have a detail of that data somewhere in this pile of information. So it may take me a second to find it as to what made that number up.

While you are hunting for that, let me fill the time here and ask, given all of the favorable things that you have developing with the business on multiple fronts, what is it that is troubling you or the biggest factor that you are keeping your eyes wide open for right now?

Well, I believe that there are several things that are long-term issues for our industry. I think the regulatory landscape will get more difficult, not less difficult as we move forward, and you continue to get the regulatory impacts of Dodd-Frank, which honestly have been felt very little by banks our size at this point. But you know the cost acceleration will ultimately impact us there.

I do believe the industry has benefited by a tremendous amount of liquidity. Corporate America has stockpiled a tremendous amount of cash. It is generally warehoused on banks' balance sheets, and so liquidity has been almost no issue matched up against very limited loan demand. But, as loan demand picks up, I believe the principal challenge for the industry will not be producing loans; it will be funding the balance sheet and gathering core deposits. And so those are things that I work on, and we develop initiatives to try to address. They are not burning issues today, but they are going to be burning issues for this Company and for, I think, for all banks in the pretty near future.

Of course, you are always worried about the economy, the impact of election, those kind of things. Those are wildcards. We are not planning for a reversal in the economic condition. But if one were to exist, obviously that would have a tremendous impact on our loss credit -- loss experience that we are forecasting today and so forth. So I don't know if that is helpful, but those would be things I think about.

That is helpful. Thank you.

Bill, on the commercial real estate non-accruals, we had a couple. One was about $4 million. It is an owner-occupied commercial real estate over in East Tennessee. We are working with that borrower, but it seems like we are probably going to have to get more aggressive with that borrower at this point. That is likely to go into some sort of bankruptcy proceeding.

Then there is another one that was about $1.7 million. That is a church that we are working with the people there to figure out the best course of action for that one. So that made up, what, $4.5 million or $5 million of the total inflows into that line item.

Mac Hodgson, SunTrust Robinson Humphrey.

Just a quick follow-up on your expense guidance to be flat for the rest of the year. Are you including OREO costs in that, or is that exclusive of OREO costs in light of your efficiency ratio guidance?

Yes, that is always excluding ORE costs. We would just really rather not get into forecasting ORE costs. It can be pretty volatile. So we are not seeing anything on that ORE side that would cause us to get really apprehensive about needing to talk to you guys about ORE expense for the rest of the year is going to go off the table or anything. So we feel like it is as contained now as it has ever been.

Thank you. This concludes our question and answer session. I would like to turn the conference back to Mr. Terry Turner for any final remarks.

Thank you, operator. I would just say in closing that my own view of the first quarter was it was a great quarter for us. We continued our improvement in asset quality. We also continued to expand core earnings. I think the loan growth in the first quarter was probably lighter than what we expect in future quarters. But with that general exception, our outlook for quarter two is fundamentally the same as what we did in quarter one.

With that, I will wrap it up. Thanks.

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