Pinnacle Financial Partners Inc (PNFPP) 2012 Q2 法說會逐字稿

Good morning everyone, and welcome to the Pinnacle Financial Partners second 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 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. At this time all participants have been placed in a listen-only mode. The floor will be open to 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 the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements.

Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks are 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 the SEC Regulation G. As 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'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Good morning. For today's conference call, we will obviously review second-quarter performance, but frankly in less detail than we have in recent quarters. Most of the information that has been eliminated from today's call but was contained in the previous quarterly calls is still being provided in the supplemental slides that are included at the end of the presentation. We want you to continue to have all the information, but we really want to shorten the quarterly review on the call in order to leave us a little bit more time to talk in greater detail about our long-term outlook than we typically would on a quarterly conference call.

I thought we would begin by comparing our second-quarter results to the guidance we provided at the conclusion of last quarter's call.

Loans grew during the quarter $106.8 million. That is more than double last quarter's growth and an annualized growth rate of 12.6%. In addition, I might also point out that our lending pipelines going into the third quarter are larger than they were going into the second quarter, so I would expect loan growth to continue in the third quarter as well.

Core deposits grew $117.6 million. Cost of funds continued to decline, down another 8 basis points on a linked quarter basis to 56 basis points.

Net interest income was up $679,000 during the second quarter. That's an annualized growth rate of nearly 7%. And asset quality metrics continued to improve, with an annualized net charge-off rate for the quarter of just 28 basis points and NPAs dipping below 2% of loans and OREO for the first time in quite some time.

Of course the most important metric is EPS. Fully diluted EPS for the second quarter was $0.23. It's important to note that the $0.23 includes a one-time non-cash charge of $1.7 million, or roughly $0.04 for the accelerated accretion of the remaining preferred stock discounting in conjunction with the TARP redemption that occurred during the quarter. So excluding the impact of the nonrecurring charge fully diluted EPS was $0.27, up 29% on a linked quarter basis and 93% compared to the same quarter last year.

Let me also provide some color commentary on a couple of additional important events that occurred during the second quarter, the TARP redemption I just referred to and the application to convert our national bank charter to a state charter.

As it relates to the TARP redemption on June 20, we paid the U.S. Treasury $71.6 million in principal and dividends to fully redeem all remaining TARP preferred securities with no incremental common share count dilution. $21.6 million of the proceeds came from holding company cash, leaving us a cash balance at quarter end of approximately $20 million.

There was a $25 million dividend from the bank to the holding company which was less than the roughly $31 million of dividend capacity we had at the end of the first quarter. And then we borrowed $25 million from US Bank on an unsecured basis. That note has a five-year maturity and a 10-year ammo.

As I mentioned earlier we had a $1.7 million non-cash nonrecurring charge for the accretion of the remaining preferred stock discount. And I might also note that today we anticipate repurchasing the outstanding warrants from the U.S. Treasury for $755,000, which will impact a few of the line items within stockholders' equity in third quarter of '12, but should not impact our P&L results for the third quarter.

The second important event I want to discuss is the application to convert our national BANK charter to a state bank charter. I believe there is a growing trend of high quality community banks opting for state charters -- Frost Bank in Texas, Commerzbank in Missouri, South Carolina Bank and Trust to name a few.

Let me say that my entire 35 year banking career has been spent in the national banking system. I've always enjoyed a great relationship with the OCC. But our board simply felt like in this period of fast-paced regulatory changes those that are associated with Dodd-Frank, with Basel III and any number of other regulatory catalysts that it would be great value in close contact with regulatory decision makers who can meet face-to-face and who understand the nuances of our markets, Nashville and Knoxville.

Specifically, we have applied to be a state nonmember bank. That means that the Federal Reserve will continue to regulate the holding company as it does today, and that the FDIC will become the primary federal regular for the bank. They will work in conjunction with the Tennessee Department of Financial Institutions to supervise the bank.

We chose the FDIC as our federal regulator primarily because we became convinced that the FDIC makes the most significant distinction between the regulatory supervision of community banks and the supervision of the nation's largest commercial and investment banks.

Additionally, and I think this is really important, the Tennessee State Banking Commissioner has a twofold objective. Number one, the safety and soundness of the Tennessee banking system, and number two, the health of the Tennessee economy. That is different than the various federal regulators that focus exclusively on the soundness of the nation's banking system.

I am convinced that this approach of concern for both the soundness of the banking system and the health of the economy is one of the reasons that Tennessee has had so relatively few bank failures and an economy that has rebounded more quickly than that of the nation. And I'm also genuinely convinced that approach to regulation should translate into increased shareholder value through the cycle. This change has virtually no impact on our clients and associates, and should be effective in the next 90 days or so.

Now, throughout 2010, 2011 and 2012 we focused on two primary priorities. One, building the core earnings capacity of the firm, the other aggressively dealing with credit issues. Additionally, two quarters ago we began highlighting an additional area of focus -- growing the balance sheet. Of course growing the balance sheet could be viewed to be a component of building the core earnings, because frankly it is our most important lever to increase both revenues and earnings. But we wanted to break it out given its significant focus.

We continued to march forward on all three of these priorities again this quarter, so as usual we will address our progress on each one during the call.

Let me summarize the asset quality improvements, and specifically the reductions in problem loans. As you can see, we continued to make meaningful progress reducing virtually every important problem asset category this quarter, year-over-year and consecutive sequential quarters for at least the last two years. Net charge-offs were roughly $2.4 million for the quarter. That is down 33.7% from the previous quarter.

OREO expenses of $3.1 million were also down from $4.7 million the prior quarter. So combining those two, our total credit losses were down 33.7% in the second quarter, 55.7% year-over-year and down for the eighth consecutive quarter.

Nonperforming loans shrank by roughly $2 million during the quarter from $43 million to $41 million, a linked quarter reduction of 4.7%. That is the ninth consecutive quarterly reduction there, down nearly 32% from last June. Nonperforming assets, and that is defined as NPLs plus OREO, were down $10.6 million during the quarter. That is roughly 13.8% decline.

Classified loans shrank by roughly $4.1 million in the second quarter, a linked quarter reduction of nearly 2.3%. That is also the 8th consecutive quarterly reduction, down 20.2% from last year. Potential problem loans shrank by approximately $6.6 million during the quarter and $37.9 million year-over-year. That is roughly 5.6% versus the first quarter and 25.5% year-over-year decrease.

As you can see, we have now reversed the intentional reduction in our construction and development portfolio. In other words, we produced net growth in that category during the second quarter. I had said last quarter that I believe we'd found the bottom in that category, and consequently it should cease being a significant drag on loan growth going forward. And I would also indicate that we should continue to see a remixing away from residential exposure toward commercial exposure, and as you can see, that is exactly what is occurring.

A quick snapshot of the quarter shows meaningful continued core earnings of momentum. The two most significant levers have been accelerated -- loan volumes, particularly C&I volumes, and expanding the margin. Despite significant headwinds we still managed to grow end of period loans $106.8 million on a linked quarter basis, and C&I plus owner-occupied real estate loans $57.8 million on a linked quarter basis. That translates to roughly 13% annualized rate of growth.

I highlight the C&I growth because as most of you know that is the primary thrust of our firm. Now that we believe we have found the floor on the C&D loans and pace of NPA dispositions is beginning to slow, our loan growth shouldn't be masked going forward to the extent it has been over the last year or so. And consequently it is our expectation that quarterly net loan growth should be strong again in the third quarter.

A further point as it relates to our ability to grow volumes is the average non-interest-bearing deposits were up meaningfully on a linked quarter basis. As you can see, the year-over-year comparison is very strong -- up just over 20%. The net interest margin expanded slightly from 3.74% to 3.76%, primarily aided by decreases in cost of funds quarter over quarter.

Noninterest income exclusive of security gains was up 6.1% while total revenues were up 6.3% on a year-over-year basis. I believe all of these are solid improvements. Nevertheless, I would be quick to say we still have meaningful room to further improve our core earnings as we continue to rid ourselves of problem assets and grow our balance sheet. But as you can see, the second quarter was a great quarter in terms of execution against all of these three priorities.

Let me turn it over to Harold for a more in-depth review.

Thanks, Terry. As you can see, this slide details the quarterly trends of our net interest income and our net interest margin. We're obviously pleased about the steady progress we have made on these measures.

As we mentioned in the press release last night, we're anticipating continued loan growth for the remainder of 2012. The second quarter again demonstrates that we are getting increased traction with our business development efforts. We're also gaining confidence that loan growth will replace reduced funding costs as the primary engine for our net interest income growth in the coming quarters.

As to funding cost, our total funding costs have decreased from [1.09%] for the first quarter of last year to now 57 basis points for the second quarter of this year. We believe that we will make continued progress on funding costs for the remainder of this year, although we believe the pace of this decrease will likely slow. We've also seen NPAs decrease by approximately $46 million over the last 12 months, and we expect continued improvement in coming quarters which will also help lower net interest margin and income in future periods.

We have shown this slide for many quarters, and it highlights the excellent job our relationship managers have done with respect to deposit pricing. As the green line indicates, we have experienced a meaningful decrease in costs of deposits. We remain optimistic that a further reduction, albeit at a slower pace, in cost of funds will occur in the remainder of 2012 as our certificates of deposits re-price, and we focus on reducing specific deposit accounts where we believe the rates are beyond a reasonable premium for those accounts.

A consistent margin improvement opportunity continues to be within our upcoming maturities on CDs. But as we've mentioned, our ability to reduce our pricing is becoming more challenging.

The $135 million represents approximately 20% of our CD book. And as you can see, these CDs are currently priced at approximately 82 basis points, and our target is to re-price them in the sub 60 basis point range going forward.

Our sales force has done a great job managing client interest costs on our money market accounts also. With approximately $215 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 continue to believe a 5 to 10 basis point improvement in money market rates represents a reasonable target over the next quarter or so.

As to loan growth, we're very pleased with where the blue bars are headed. As Terry mentioned, end of period loans are at up an annualized rate of 13% linked quarter. Second-quarter average loans are up an annualized rate of almost 15%. We remain optimistic given our pipelines that loan growth will continue for the remainder of 2012.

Loan yields, however, remain a challenge for our industry. The Federal Reserve noted from a recent survey on business lending that C&I loan yields dropped from the high [2.60%'s] last year at this time to now in the low [2.20%'s], with much of that drop in the most recent quarter.

To be honest, we remain pleased with our yields and where they're holding up currently. Our relationship managers have been well-versed on asset pricing, particularly risk-based pricing, and have been provided various tools to help them get the appropriate yield for their loans. But we've got room to do better, and are working hard to reduce the risk we have to further yield erosion over the next few quarters.

On the positive side, reductions in nonperforming loans will continue to positively impact our future loan yields. That said, loan pricing remains very competitive in Nashville and Knoxville for quality borrowers. Our position has been and will continue to be that in those instances where we believe we are a customer's primary bank, we will do everything in our power to not lose any accounts based on pricing.

I also want to mention the bond book, as it has also been an influencer of our margins. Eighteen months ago we had greater than $1 billion in our bond book. We have personally managed the bond book to now down below $800 million and anticipate continued contraction as we deploy most of the bond book of cash flows into quality lending opportunities.

We are grateful to have loan growth as a viable option for bond book cash flows. For the type of bonds we generally acquire, a five-year average life bond for our portfolio, yields are ranging between 250 basis points and 275 basis points on these new acquisitions, which makes us think we sure like quality loans a lot better.

Bonds represent approximately 16% of our asset base second quarter end. We think that number could be in the high 14%'s to low 15%'s by the end of the year.

We've made significant progress on our net interest margin from its low of 2.72% in March of '09 to 3.76% last quarter. That is the seventh consecutive quarterly expansion. We have discussed our margin opportunities with you for many quarters, and we believe we've been very open about our margin opportunities as well as any threats.

Obviously we believe we continue to have opportunities to increase our margins based on the strength of our current loan pipeline and the ongoing reductions in our cost of funds. However, we anticipate that much, if not all of these margin gains, may be required to offset general economic trends on loan and bond yields. Thus our margin growth opportunity at these absolute low loan interest rate levels from this point appears somewhat challenging to us currently.

However, we do believe that loan growth will facilitate increased core revenues over the next several quarters and offset the impact of these anticipated lower loan yields.

As Terry noted, total credit costs continue to trend downward. We traditionally define total credit costs from our firm as the [sale of] loan charge-offs and ORE expense. This bar graph shows that the sum of these two numbers has been decreasing, and decreasing steadily for the past six quarters. As to charge-offs, we recorded a $2.4 million in charge-offs in the second quarter in 2012, down from $3.6 million in the first quarter.

Provision expense for the second quarter was $634,000, down $400,000 from the first quarter due to reduced charge-offs, and as Terry mentioned, our continued improvement in the credit quality of our portfolio, offset by the additional reserves needed to account for net new loan growth.

We continue to believe that barring any national or international economic event that could find its way to Nashville and impact us, our credit quality metrics will experience improvement for the remainder of the year. This improvement will continue to impact the absolute level of our loan reserves, but will be offset by our second belief that we should experience consistent loan growth for the remainder of this year.

We continue to have a sense of urgency regarding troubled asset disposition. Last year we mentioned that we believe our nonperforming asset disposition result would range between $75 million and $100 million for 2012, compared to $131 million in 2011. Year-to-date we are at $48 million in disposition, so we feel like we should achieve our earlier projection for 2012.

As Terry mentioned, inflows dropped from $14 million to $12 million this quarter, and we anticipate continued reductions this year.

Our ORE book stands at $25.4 million at quarter end, down from almost $40 million at year-end. Based on our review of potential third quarter foreclosures, our ORE portfolio should approximate $25 million to $30 million next quarter. That said, we believe our anticipated reduction in NPLs should produce a net negative number for NPAs in the third quarter.

Expenses associated with managing and disposing these properties should also trend downward. So we're 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 continue to anticipate a meaningful decrease in ORE expense this year. Not including ORE expenses are some of the ancillary costs associated with troubled asset dispositions. We are very pleased with the efforts of our Special Asset 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, who were now at 19 and intend to reduce that number to approximately 12 by the end of this year.

Now looking at our P&L trends, our adjusted pretax pre-provision increased from $16.5 million in the second quarter of last year to $19.2 million in the second quarter of 2012 a year,-over-year increase of 16.5%. We expect to see growth in our pretax pre-provision profits based primarily on revenue growth for the remainder of this year. After 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 any increase due to additional new relationship managers, which could occur throughout 2012.

As many of you know, we have largely completed our branch buildout in Nashville, but continue to believe we need an increased presence in Knoxville. We're penciling in a new branch location in Knoxville towards the end of this year which will impact our expenses more so next year. With that, I will turn it back over to Terry to wrap up.

Okay. As I mentioned at the outset, I want to invest a little bit more time today giving my outlook for the future of the firm. It is my sense that we are at an inflection point, transitioning away from a primary focus of problem loan rehabilitation -- which we have had for the last two or three years -- to season the significant growth opportunities that we now see in front of us. In other words, returning to the high quality organic growth we produced in Phase 1.

So, I'd like to take the bulk of our remaining time to try to put our outlook for the future in the context of our history to date.

As most of you know, during the first eight years of our existence we were reliable organic growers; literally one of the fastest-growing banks in the United States. We focused primarily on the relationship managed segments -- the commercial and the fluent consumer markets. We hired the best bankers in the market and asked them to move their best clients.

We were primarily C&I lenders. You can see at the top chart there the persistent growth in loans and deposits, quarter in and quarter out. We were aided in achieving that by a very healthy market in Nashville, Tennessee.

But in my judgment, by far the more important ingredient in that growth success was the vulnerability of the large regional banks who dominated our market. In other words, the competitive landscape was more impactful than the economic landscape. Regions, SunTrust and Bank of America and their predecessor companies gave up a combined market share of roughly 25% during our first decade of existence.

Now, in addition to the organic growth that you see in the top chart, growth was also impacted by two acquisitions -- one in the first quarter of '06 and one in the fourth quarter of '07. But even following those acquisition-related jumps the persistent organic growth continued.

You'll almost never hear me talk about the kind of growth that we just talked about without also talking about asset quality. The goal is not to make loans, but to make good loans. And this is really important for somebody who may be newer to our story.

You can see on the chart at the bottom that we not only grew loans and deposit volumes rapidly and reliably, we produced extraordinary loan quality as well. Net charge offs for the life of the firm through 2008 were just 5 basis points and the largest annualized net charge-off rate for any quarter during that eight-year period was roughly 27 basis points.

In my judgment, we were above to do that because we were hiring only experienced lenders in our markets. They were bringing only their best clients, and they were leaving bad credits behind. It's the soundest way I know to grow a quality loan book.

I mentioned the acquisitions that occurred in 2006 and 2007. As you can see, they had a significant impact on our low mix. They created a meaningful shift in our loan mix away from C&I, which is the wheelhouse of this firm, toward residential construction and development.

And let me be clear about this. My belief about the acquisitions is that they were good targets, that they were well integrated, that the operational integrations were essentially flawless. We kept all of the employees. We kept all of the clients. We got the targeted operational synergies.

The only substantial issue with acquisitions was that we ended up with a concentration in residential construction and development loans, and other loans related primarily to that industry, just in time for the collapse of the residential housing markets in 2008. Having that concentration is not the fault of the acquired banks. It is nobody's fault but mine.

We certainly understood we had a concentration. I simply underestimated the consequence of taking that risk at that time. So, unfortunately, our problem loans during this recession were much impacted by that choice and we spent the better part of three years our balance sheet.

But with that said, I am proud of the discipline and workmanlike approach our associates have taken in that rehabilitation. As most of you know, in Nashville and Knoxville we compete with four large regional banks -- Regions, SunTrust, Bank of America and First Horizon or First Tennessee, as they're known in this market. This data is the SNL data for each of our companies.

First of all, on the left it seems that apparent that our portfolio even with the C&D concentration substantially outperformed our end market competitors. Our losses through the cycle -- that is Q1 2008 through Q1 2012 -- have been markedly less, less than half of the losses incurred by most of our competitors. And secondly, ours has not been a kick the can down the road approach, evidenced by the chart on the right.

The fact is that we truly entered the cycle later and exited sooner than our competitors, which I think suggests something about the relative quality of our borrowers. So, if past is prologue, that brings us to the inflation point I mentioned earlier, the third phase, where we are now transitioning from balance sheet rehabilitation to high performance and season the rapid organic growth opportunities that we now believe exist for us. Essentially a return to the high quality organic growth that we saw in the first eight years of our existence.

From our inception, we have always maintained the strategic framework with all of the meaningful board-approved longer-term performance targets for our firm. We shied away from publishing those heretofore.

But I know most of you follow a good number of banks, all the different opportunities and aspirations. I'm particularly sympathetic with the difficulty of trying to understand the true earnings potential and the likely timing of that earnings, given the uncertainty surrounding regulatory costs, the varying health of local economies, the varying competitive landscapes in which we operate, and the fact that some are further along than others in the rehabilitation process.

I believe Pinnacle's opportunities are different and distinctive versus most of our peers, and so we have decided to go ahead and give you several of our key long-term performance targets in an effort to at least clarify where we intend to take the firm.

So, here they are -- an ROAA of between 1.10% and 1.30%, a NIM of 3.70% to 3.90%, net charge-offs of 25 to 35 basis points, noninterest fees to total average assets of 70 to 90 basis points, and expenses to total average assets of 2.10% to 2.30%. In the interest of time, I don't think I will spend much time on the NIM, net charge-offs and fees since as you can see we're already operating inside those ranges very close to the midpoint.

Perhaps the one item on the chart that deserves the most discussion is expenses. I recognize that from this chart our current actual level of expenses to assets looks a long way away from the target. But let me say that the 2.10% to 2.30% range is indeed the normalized run rate for this firm. In fact, our noninterest expense to average assets fell within that range from 2003 through 2008, and even in 2009 it was just 2.31%, just a tick away.

So, knowing we consistently operated there for seven consecutive years, the question is how are we going to return. Let me say first of all we do have some modest opportunities to cut operating expenses, and secondly that we expect the substantially elevated expenses associated with the credit environment we have been through to normalize within the next 12 months.

But a huge contributor to the ratio escalating was not just the fact that the expenses went up, but the fact that assets came down. Assets peaked at $5.1 billion in Q4 '09. As a part of the asset rehabilitation focus that we have had, assets declined by a roughly $300 million.

Not only did we make a strategic choice not to cut expenses as assets dropped in the rehabilitation, which I believe now serves us well as we make this transition, but we have actually increased our cadre of relationship managers by an additional 10% in the last nine months. We believe that the strategic choices we've made should enable us to capture the market share we believe is available to us.

We've talked before and we will talk more in a moment about the $1.3 billion asset growth capacity that our existing relationship managers have. But the point I want to make clear is that in broad and general terms, $1.3 billion of assets on this expense base transforms the profitability and the noninterest expense to asset ratio substantially. So, in terms of ROAA, if we were to hit the midpoint for each of the components that are listed on the slide, that would likely produce a 1.20% ROAA, right at the midpoint of the ROAA range.

The loan growth targets I just mentioned simply anticipate an economy that gets no worse. Most of you have heard me say this before. I'm 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 an update for the 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 creating jobs, the net number of jobs still appears to be 3.6% less than peak employment at the end of 2007. In other words, less than half of the lost jobs have been recovered on a national basis.

You can compare that trend to Nashville and Knoxville in the charts on the right. Nashville has nearly recovered all of the jobs that were lost since peak employment in the second half of 2007, and Knoxville has literally recovered all of the jobs lost, so our markets to appear to be recovering more quickly.

I'm not the only one who expects our two markets to outperform the nation. I won't rattle down through all the various accolades and rankings here. But I would specifically highlight the Kiplinger's listing where Nashville is forecasted to be one of the eight best cities in the United States for job growth going forward.

In addition to the strong and healthy markets that we serve, another factor that argues for our ability to grow the balance sheet volumes and therefore achieve our long-term performance targets is our current growth trends, given the outlook for a slow or no-growth economy, to hit our targets we have to gain market share. This slide details the strong and generally consistent growth we have experienced in average non-interest-bearing DDAs, even through the recession. Generally speaking if you've got a checking account you've gain marketshare. If you gain marketshare, you grow revenues.

Similarly, continuing to focus on current volume growth trends, this slide details the quarterly growth we have experienced in loans. I want to remind you this growth momentum has been established in the face of, number one, the large and rapid run down in the residential real estate portfolio which has now bottomed, and number two, a reduction in problem loans and the resulting problem loan dispositions which occur with elevated levels of problem assets.

But even with these significant headwinds, second-quarter loan growth annualized was roughly 13%. So with little or no help from the economy, it appears our focused organic growth strategies are working.

The third factor arguing for our ability to produce the balance sheet growth targets that are essential to achieving our long term performance targets, and frankly the most important factor, is our track record for taking market share. Those of you that are regulars on the call have heard me say a number of times that given the relatively bleak outlook for real economic growth, the only banks that will be able to produce meaningful balance sheet growth will be those that can take market share.

What you're looking at here is third-party market research from Greenwich and Associates, a market research firm that does this research for all of the top 50 banks in the United States plus roughly 700 more. The specific data that is included here as all of the businesses in Nashville, Tennessee with annual sales from $1 million to $500 million and that is virtually every business in the MSA. It compares Pinnacle's market share to the four largest regional or national franchises that dominated this market when we started our firm in 2000.

There are several key points here. Number one, as you can see, the blue bar at the top left, 24% of all of those businesses have a relationship with Pinnacle. That is a number one share position and it is a huge market share movement that has occurred in roughly the last 11 years.

Number two, looking at the blue bar on the top right, 19% of businesses say Pinnacle is the lead or primary bank. Again that is the number one share position. And then number three, for both the general share on the left and the lead share on the right, comparing the red and blue bars you can see the year-over-year share trends for all the major banks in Nashville. All are losing share except Pinnacle, which is rapidly taking share.

Occasionally I hear a comment like at some point you won't be able to continue taking share, and I'm sure that is true. But this chart would lead me to belief that that is not anytime in the near future.

Of course the real question is how much share -- the real question is not how much share we moved in the first 11 years or even in the last year, but what is the likelihood we will continue to take share going forward. Again, this is Greenwich data as described a minute ago. It shows our net promoter scores for virtually every aspect of our reputation with clients.

For those of you unfamiliar with a net promoter score or a net performance score, you take the sum of the percentages of respondents for the topmost positive client ratings, meaning excellent or above average, and net out the two most negative client ratings -- below average and poor. So as an example, for any of the reputation attributes let's assume an even distribution -- 20% excellent, 20% above average, 20% neutral, 20% below and 20% poor. The net performance score would be zero. That is calculated by adding the 20% excellent to the 20% above average and subtracting the 20% below average and the 20% poor.

So, here, you can see minute Pinnacle's extraordinary reputation with clients. Of course you can see the absolute value of the net performance score for each reputational attribute. If the box is green, it means we're in the top three in the market. And on the far right you can see the direction year-over-year plus or minus.

To come out of the tail end of the credit cycle with this kind of reputation among clients I think bodes extremely well for our ability to continue consolidating share from those large regional and national franchises that have long-standing negative share trends.

And the last key factor influencing our ability to achieve long-term performance targets is the fact that we not only maintained our infrastructure and capacity for growth as assets shrank, but we have actually increased our relationship managers by roughly 10% in the last nine months. Meaningful investments to seize the growth in market share movement opportunities that we now see.

Several quarters ago, I highlighted my belief that our existing relationship managers plus an additional 11 relationship managers that we intended to hire had the capacity to produce approximately $1.3 billion in net loan growth over roughly a three-year period of time if you assume straight-line growth, say $400 million per year for 2012, 2013, 2014. In previous calls I've walked through the algebra that supports that capacity, so I won't rehash that here today. But by way of update, all 11 of those relationship managers have been hired and are on board.

In this chart we are plotting actual production in 2012 against the capacity. Round numbers, let's say we grew $50 million in quarter one, $105 million in quarter two. A very modest lift from this quarter's $105 million of growth to $120 million for quarters three and four would be $400 million in growth, net loan growth for 2012.

So our second-quarter production level indicates to me that we are operating near the quarterly production levels required to fill out current capacity by 2014. So, that is an attempt to kind of lay out my belief about the future opportunities for our firm.

You know, I think filling out the loan capacity is one of the most critical ingredients to achieving our long-term performance target. It seems to me we're well-positioned to do that based on the strong, healthy markets we serve, our current and historical performance trends, our track record and our reputation for taking market share, and the fact that we are already paying for the bulk of the capacity that is required to produce the loan growth.

One final comment on achieving long-term targets, none of the items on this slide are specifically included in the plants and targets we have just discussed. But we do have lots of additional opportunities to enhance shareholder value. We are and always have been an urban community bank.

We like urban markets dominated by large regional banks. There are two of those in Tennessee that resemble Nashville and Knoxville. They are Memphis and Chattanooga. If we could do a large lift out and start in those markets on a de novo basis like we have in Nashville and Knoxville, we would consider that.

We get questions consistently concerning our appetite toward acquisitions. If we had a chance to make end market acquisitions of healthy banks that would either produce significant cost synergies or with respect to Knoxville accelerate the distribution we're building, those would be opportunities we would have to consider. But we are not likely to consider troubled banks or FDIC-assisted transactions at all.

Additionally, we have several lines of business that are really important to us from a client acquisition standpoint. But they are only marginally profitable. If we found bite-sized acquisition targets that could enhance scale and profitability, we would consider those.

But let me hasten to say that the list of potential acquisitions we would consider is a very short list, quite honestly because I don't want anything to detract from the substantial organic growth opportunities that I just outlined to you. So, that is our plan for long-term performance.

Let me dial it back to third quarter of 2012. It is my expectation that we will continue to make meaningful reductions in credit costs and problem loan levels. But beyond that I expect the principal profit improvement lever to be loan growth, which should result in net interest income growth, and therefore growth in revenue and earnings.

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

(Operator Instructions) Michael Rose, Raymond James.

Just a question on the loan growth capacity chart on page 29 that you just went over, I just want to be clear. Is that your expectation for what you believe you will achieve through 2014?

Yes, I think that is a fair statement. It's the capacity or the expectation that we have for the existing relationship managers now existing, some of them recently hired, by the end of 2014.

Okay, and just following up on that, how should we think about the opportunity in Knoxville? I mean clearly it is a market on deposits at least that's about one-third of the size of Nashville, but your market share is only a little over 2%, where in Nashville you are over 8%. How should we think about the contribution from Knoxville relating to that guidance?

You know, that is a great question. I think what we've tried to highlight in the press release was that, round numbers, about one-third of the loan growth this quarter came from the Knoxville market. Of course they don't represent one-third of the Company, but they are producing one-third of the growth.

The reason for that, and I think frankly the reason we wanted to highlight that is because I view Knoxville to be in a steeper part of the S-shaped growth curve than Nashville. So, relative to the percent of the balance sheet it should be an outsize contributor to the growth going forward for both loans and deposits.

Okay. And then on a separate topic, Hal, this one I guess would be for you. With the change in the charter, would you expect that you might be able to run off or lower your reserve ratio more quickly since the state regulator in theory should understand your markets -- your loan customers and just the markets in general better?

Michael, I wouldn't make that assumption at all. We're not anticipating anything like that. We believe that our reserves will continue to I guess contract as these credit quality metrics improve.

So that would be the only reason we think we would have any kind of reduction in the reserves. And we're anxious for the charter change to occur. We believe that it will be an enhancement to this firm to have a local regulator here that we can go talk to and discuss issues with.

Okay, and how should we think about normalized reserve levels? You guys are 2.02% at the end of the quarter. You have historically been in the low 1%'s. How should we think about kind of a normalized level for you? Thanks.

Yes, that is the big question of the day, is to how low can that reserve go. We don't know the answer to that question. We have run models to kind of project where it might could go. But I doubt that any regulator will let that reserve get down to where it once was in maybe the low 1.10%'s or 1.05% range.

Okay, thanks for taking my question.

We're not expecting it, anyway.

Kevin Fitzsimmons, Sandler O'Neill.

Good morning everyone. Terry, I was just hoping if you could give a little more color on the drivers of the loan growth. I know you spent a lot of time on the taking of market share, and that seems to be a long-term game plan for you all that you are seeing results from.

But what about just from the market in general? You are saying that the market remains healthy, but what are you seeing in terms of new utilization of credit? And you know, are you seeing anything there? Or is virtually all of the loan pick-up taking market share? Thanks.

I think -- and Kevin I can't -- I don't have numbers in front of me that would let me give you an exact breakdown of the loan growth, how much of it specifically came from market share movement and how much of it came from existing clients, which would theoretically be some sort of economic growth. But if I had to give you a guess at that today, and it would just be a guess, I would say it is about half and half; about half market share movement and about half economic growth.

I think the economic growth -- when I talk about economic growth, what that is for the most part is people that have had deferred capital expenditures that they are now prepared to wade in and invest in. I would say we see very little -- that is always Phase 1. Working capital expansion is Phase 2.

I would say our line utilization is flat at best, which would say to me that we are not getting a lot of expansion of working capital, working capital working assets. And then of course I would say there is near zero on pure expansion where people are adding plants and shifts and those sorts of things. So, we are clearly in a better zone than we have been two or three years ago.

In terms of economic loan demand, I would describe the vast majority of it as deferred capital expenditures. But clearly a big piece of the loan growth would be market share movement.

Kevin this is Harold. A lot of people asking questions about commitment levels and where fundings are and all of that stuff, and Terry is absolutely right. Overall, we remain about 58% funded to commitments on our loan book. The biggest component of that is C&I lines of credit and those are about 50%. So -- and that hasn't changed at all probably within the last year and a half or so.

Okay, great. If I could ask just a quick follow-on on the margin outlook, you're seeing 3.70% to 3.90% long term. The low end of that is just really modestly below where you were in the second quarter, and I guess I'm just trying to get comfortable with that.

If, going forward, you are saying it's getting a little more challenging to offset the pressure on loan yields and we stay in this persistently low rate environment for some time, is there a possibility that that low end of that range goes even lower? Or are you assuming in that long-term target an increase in rates from here? Thanks.

Our modeling would have rate increases in 2014, so -- and we continually push those out, as has everybody else over the last two or three years. The near-term guidance as far as the 3.73% to 3.79% is just based on current trends we're seeing over the last, say, two to four to five weeks. So that is the basis for those two different assertions.

Okay, great. Thank you.

Matt Olney, Stephens.

Hi, good morning everybody. I want to circle back on the long-term targets you guys put out there. And as far as the assumption for expenses as a percent of average assets and how this will move down from historical levels, it seems interesting because it seems like most of the industry is saying they will be less profitable in the future compared to historical, because expenses will just by and large be higher than historical levels.

So I guess within your assumptions of your expense outlook, does this include things like de novo branching, additional hires for commercial lenders, additional staff, or regulatory expenses and things like that?

Yes, I think that -- two or three things I guess to capture what you are talking about there. The -- it would assume that we're going to continue to build out distribution in Knoxville, meaning an office a year for the foreseeable future. We have three offices there. We believe seven or eight offices is probably a good size distribution system for us, so that assumption would include that.

And, it would include what I would call routine hires. If we -- in the chart at the close, we tried to list a bunch of things that are not included like doing de novo expansions. So if we're trying to do large lift-outs in other markets or those kinds of things, that wouldn't be included in the numbers that we talked about in any way, the expense run rate or the asset lift that would be generated.

I think -- I guess one thing that I personally believe about the regulatory expenses, I can't imagine there will be less over time. But at the same time, I'm interested in all of the hand-wringing that goes on there. I think regulatory expenses will clearly be higher.

But if you look at what percentage regulatory expenses are as a function of your total expense base, if they went up by 50% or something, it is just not that big a number. And so, again, I believe that for us -- as I said, I think we have opportunities TO -- just from a standing start, we have some opportunities to cut our expenses. We will seize those.

We have elevated expenses which are meaningful that are associated with OREO and other credit work-out expenses. Harold mentioned the number of people that we have working in a Special Assets Group that is still yet to be cut in half and those kinds of things. So we have some expense opportunity.

But again I think what we're trying to communicate, Matt, is that we didn't cut the expenses as assets shrank. We have already invested on the front end for the folks to create the rest of the lift that is required, so you don't get a meaningful increase in expense level. But you get a big increase in assets, and so I think that is the basic thesis of the plan.

Okay, Terry, that is helpful. And then just a follow-up if I may, when you guys typically hire seasoned commercial lenders, what is the typical lag time before they become accretive to the bottom line?

It varies. I think in general we look at the database that we hire in I would say three broad categories. Either they are focused on the fluent consumer segment generally, they are focused on small businesses, generally companies with sales less than $5 million, or they're focused on middle market companies. And so the economics of those three segments are different and therefore our expectations are different.

But generally our approach to hiring is we -- as you know we're generally trying to hire experienced people who control large books of business. We have detailed discussions with them about that book and how much of it they can move and those sorts of things. I would say as a general rule of thumb, people are generally able to move about 80% of their previous book. And it generally takes them about three years to get it done.

Okay, thanks.

Brady Gailey, KBW.

So, TARP is gone. Credit is getting better. I got double-digit lung growth, so your focus is back towards growth. I'm sure you guys will hire where it makes sense, but I guess two things.

Number one, how serious are you about contemplating a move into Memphis and Chattanooga? And number two, on acquisitions, I haven't heard you all talk about acquisitions in years until today. I guess are there healthier banks that are possibilities within your markets? And if so, how large of a deal would you feel comfortable doing?

Okay. Let me talk about why the slide is there that lists those things. The point of it is that we have laid out what our fundamental plan is, fundamentally what we intend to do over a three-year period of time. And -- but we, as I think you know, have always been an opportunistic Company. If we find other good opportunities we will seize those.

And so we simply tried to outline, hey, these are some kinds of opportunities that we get asked about that we consider from time to time. And so let us just put them on the page and help you understand what we would consider, what we wouldn't consider and make sure you know that those things are not included in the plans that we outlined. So that is the purpose of putting it there.

It's not intended to send some different signal. It's just trying to be clear, as those items aren't included in the performance targets that we laid out there.

Specifically as it relates into Memphis and Chattanooga, I don't think you ought to interpret those as being anything meaningfully different than what we have talked about. I think if you go back maybe to the original prospectus on the Company we referred to ourselves as an urban community bank, and probably talked about urban markets in Nashville being Memphis, Knoxville and Nashville. And we have had discussions and included in investor presentations over the years that we have some interest in Memphis.

We view it to be an opportunistic thing. It's not like we're dying to get to Memphis. It is simply if we could do a large lift-out over there, that would be a good opportunity.

We feel like both Memphis and Chattanooga represent good opportunities where markets are dominated by large regional banks, specifically the large regional banks from whom we're taking lots of share in Nashville and Knoxville. And so if we could seize that same sort of opportunity in those other markets, we would.

I would say in the case of Chattanooga I've generally not included Chattanooga on the list. We've always included Memphis on the list, but I think Chattanooga is a high-growth city. It's got a lot of great stuff going on in it, and it is about halfway between here and Knoxville and so we've gone ahead and put that on the list.

But again, Brady, I don't know if this is helpful. I'm not trying to send a signal that we're working on those and trying to get there. I'm just trying to give you a list of things that are always on our list of opportunities that aren't included in the planned targets that we listed.

I think in the case of acquisitions, I'd make a similar comment. We're not trying to particularly send a signal that we are an acquisitive Company. Every time I've been asked that question probably in the last decade, I have said I think of our Company primarily as an organic grower. That is still how I think about our Company and that is really what the whole focus of the long-range plan that we laid out there is, is organic growth.

But I would imagine that over some period of time, we will have opportunities to make acquisitions. I've tried to say, hey, we are not in the market to do FDIC-assisted transactions. We're not interested in doing market extensions through acquisitions. What we would do is in-market healthy banks.

Brady, you run the scans just like I do. Once you get down to that list right there, that is a pretty short list in and of itself. And then we have these fee businesses that are really important to us. They're helpful to us in terms of gathering clients and so forth.

We don't make as much money as I would like to make. Scale would be helpful. So, again, if we could find P&C agencies or some wealth management firms that would be bite-size transactions, it would enhance our profitability, those are things we would consider.

But, again, I guess want to -- I appreciate you asking the question because I do think it is important to get in context. The goal of that slide is not to give you a laundry list of things we're trying to make happen. The goal of that slide is to say those things aren't included in the plan we just talked about, but we always keep those things on the list as opportunities if something good came up.

Okay, great. Thanks for the color.

Kevin Reynolds, Wunderlich Securities.

Thank you. Good morning Terry and Harold. Terry, how could you not be dying to get to Memphis? That hurts my feelings. (laughter)

I though (multiple speakers) was going to meet you here in Nashville.

Well, okay. We can do that too. A quick question for you; I want to sort of get a little focus on Phase 3 here. Great quarter by the way.

But when you talk about the limited capacity that you have because you brought on 11 or 12 people, and that is just looking at the next few years, you are very well known in middle Tennessee. I would presume that now being there longer than a decade, you probably cherry-picked most of the people that fit the Pinnacle model over there, at least at this point.

How many more do think you could add? Or how many more top-tier lenders are there in Nashville today, if you look out there, that you could add on top of this Phase 3 as you go forward? And then what does that opportunity set look like as you sit here right now, say in Knoxville, Chattanooga and Memphis just in terms of numbers of lenders that you might have that you would be interested in talking to?

Well, let's break apart Nashville from other markets, because I think you are right. They really are different. And I guess the first point, to be clear, the $1.275 billion is the existing capacity if we don't hire anymore people, so any additional hires would provide additional capacity to that.

I would say we certainly have hired and I think built the largest cadre of well-known bankers in the market. I don't think there's any doubt about that. But keep in mind one of our important hiring criteria was hiring people that have been at it 10 years or more in this market.

We've now been in business 12 years. There are people that worked, as an example, at Regions Bank and have been at it for 12 years that I didn't ever hear of when I worked at First American. So I just say that to say I think some people think, well, you must have hired all the people. But there are a lot of bankers in this market.

If you are looking at -- even looking at the Greenwich data, if you've got primary market share down there say at 19%, there is 80% of the businesses out there that bank somewhere else. And they're being banked by other bankers. Again, I can't give you the number, but I guess I would encourage you not to assume that there's nobody left. There is I think -- again, somebody is handling 80% of the market. And so I think there is more opportunity than many might guess.

I think in the case of these other markets like Memphis and Chattanooga, again, we don't -- the approach there is different than what we do in Nashville. Meaning we've already built this franchise, so we are adding one relationship manager at a time in Nashville and in Knoxville at this point. If we were to go to Memphis or Chattanooga, we wouldn't want to go those markets.

Memphis, you would want to believe you could build a $750 million bank. In Chattanooga you would want to believe you could build a $750 million bank, Memphis probably a $1 billion bank. And so the approach there is to try to lift out a large group of people like we did in Nashville.

You know, I think in Nashville, if I remember right, we had 37 people when we opened the doors. I think in Knoxville if I remember right, they had about 18 people right at the get-go, so we did a pretty large lift-out there. And so that would be the approach in those other markets, is to find a good-sized group of people that we feel like would ultimately have the capacity to be our large banks in those markets.

I will say, Kevin, I think you have heard me say this before. I can tell you I have no interest in going to those markets and building $100 million or $200 million or $300 million bank. I mean, that just wouldn't have any appeal to me at all.

Right. Well, certainly here, it shouldn't be hard to exceed that and sort of hit your targets with the right team. I guess in those new markets in Memphis, I know you said you're not signaling to us that you are actively -- or that you are going there immediately.

But do you think the lenders in the markets there are sort of fully aware of you and your potential entry into the markets down there? Are they contacting you and saying come on over? Or is it still more of a much longer-term proposition right now?

We do have feelers from, I would say, relationship managers in particular; maybe department heads. I guess, Kevin, that is generally just not what -- that wouldn't be a catalyst for me, that I had a handful of relationship managers that want to do that.

I see some banks whose expansion strategy -- and I'm not saying it's not a good strategy, it's just not mine -- who will go to some faraway city and try to hire some high-profile commercial banker and build loan production office, and then turn that into a full-service banking operation and so forth. That is not our strategy.

And so, what I'm trying to get to is the fact that I have a handful of commercial relationship managers wouldn't be enough of a catalyst. What I need is somebody that can build a $1 billion bank. And so that is the catalyst for me, is who can build a big bank, not can I hire a handful of commercial bankers.

Okay, got you. Thanks a lot, and thanks a lot for all of the updates on the business plan.

Christopher Marinac, FIG Partners.

Thanks. Just wanted to drill down a little bit more on the loan yield thoughts you had given earlier in the slides and in your comments, other examples where customers are not necessarily looking for the cheapest loan yield, and to what extent do you have flexibility within customers to not be the bargain basement pricing?

That is a great question. As we look at our commercial loan yields versus our major bank competitors -- Regions, SunTrust and Bank of America -- our commercial loan yields are higher than theirs. As you know, it is a little hard to compartmentalize all that and make sure you are matching off in Nashville against Nashville and that kind of thing. You can't really get to that granularity, or at least I don't know how to get to that granularity.

But just comparing franchise to franchise, loan yield for commercial loans, we do in fact get a premium versus those major banks with whom we compete. Chris, am I answering your question?

Yes, definitely. And I guess is there any reason we would think any specific shift in terms of mix that is likely? I'm expecting no, but I just want to ask.

Yes, no, I don't think so. I think what we -- the big shift mix that we've been trying to orchestrate over the last three years is to bid down our exposure to residential construction and development. And as I've said a couple of times, I think our C&D book is at a good relative size in our portfolio. I think it's about 8% or maybe 9% of the loan book, and that is a good level for us going forward.

So, we will do some remixing within the C&D category away from residential to commercial. But in terms of -- if you are looking for a mix shift away from C&I or owner-occupied C&I or any of those kinds of things, no. That is where we will continue to play.

Great, thanks very much.

Bill Dezellem, Titan Capital Management.

Thank you. Would you please discuss what has changed in Chattanooga that prompts you to put them on the list and now be willing to look at them, whereas before not so much?

Yes, I think there are two or three things. You know, when we started this Company I want to guess that Chattanooga probably had a population base of 400,000 people or something like that. It's meaningfully above that. The growth outlook for the city is different today than it was in early stages of the Company.

There have been a handful of things going on. I've seen the praises of Sen. Corker, who is the mayor of the city, did an awesome job in downtown redevelopment, reinvesting in the city. They have done -- and probably outperformed the other three markets in terms of just their investment and rehabilitation of their downtown market.

And I think probably the biggest catalyst for change has been the Volkswagen plant that was built there, and all of the attendant suppliers to that plant. And so they've done an extraordinary job on economic development as well. So, it's not one thing. It would be a whole series of things that have escalated -- the population growth and the quality of the business market, the size of it and the health of it.

Thank you.

Zachary Wollam, Sterne, Agee.

Zachary, before you go, let me comment on Bill's thing one more time. I want to reiterate that what is on that chart is a list of stuff that is not included in our plan, and I wouldn't want somebody to walk away and say, hey, those guys are going to Chattanooga. That is not the point of the slide.

The point is that the plan we laid out doesn't include Chattanooga. So let me just to be clear about that. Sorry to interrupt there, Zach.

No problem, good morning. I just had a couple of questions. First, could you give me the unfunded commitment number at the end of the second quarter?

Total unfunded commitments are about $950 million.

Okay, great. And just one more, looking at the slide on the largest NPLs, could you talk about maybe why there is so many consumer, large consumer NPLs? And could you give me some color on the nature of those, like loan to value?

I know we have one large family residence in there. I think it is about a $1.4 million house. And there is a lot of residential in there as well, so -- plus the residential land development piece is still in there.

Okay.

As far as loan to value, I think we are at less than 80% on all of those properties.

Okay. That's all I had. Thank you.

I show no further questions in the queue. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect at this time.