Pinnacle Financial Partners Inc (PNFPP) 2013 Q2 法說會逐字稿

Good morning everyone, and welcome to Pinnacle Financial Partners' second-quarter 2013 earnings conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer. He's 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 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 factors 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 foward-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 recently 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 will now like to hand the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Thank you, operator. Before we delve too deeply into today's presentation, I want to take just a minute and try to set our Company in context, given some of the broader forces that are shaping bank performance these days. I believe, personally, that we are probably at another inflection point, as many investors are now looking for banks that, due to the structure of their balance sheet, will have outsized earnings lists as a result of potential rising rates. Most obvious impact for asset-sensitive banks is an acceleration in the growth of net interest income, everything else being equal.

A related impact might be a reduction in fee income due to declining mortgage refinance volumes. Another critical factor for investors is the mountain type of capital required forward, given the Fed's recent guidance on the implementation of Basel III. The impact of the rising cost of regulation on bank expense structures is another critical factor concerning bank stock investors. And I don't want to minimize those kinds of factors in any way. I believe all of those are important things to focus on. So as we walk through today's presentation, we'll try to crystallize those potential impacts on Pinnacle. I believe we're well positioned on each of those points.

But the more important thing, and the thing I really want to make clear today, is that our approach at Pinnacle is to increase shareholder value the old-fashioned way. In other words, to build a firm that has a sustainable competitive advantage and can will that advantage to take clients away from competitors and grow client base revenues even when the market is not advantageous. In other words, grow a net interest income by adding new clients and cross-selling existing ones is likely the best path to yield long-term shareholder value. And that's what we do here at Pinnacle.

We've now grown our net interest income 11 quarters in a row. I expect that to continue for the foreseeable future. In addition, we've grown our fee income -- core fee income 5 quarters in a row. This kind of growth in client and product sales, largely from our existing expense base, is resulting in sustainable earnings growth and excellent operating leverage. And it's my belief that that's how Pinnacle will continue to build long-term shareholder value as we go forward.

Now let me focus on the slides. I believe we began publicly discussing our long-term profitability on our 4Q 2011 earnings call. As you can see on the slide, we've made progress every quarter since then toward the achievement of those targets. They're now operating at the lower end of the target range for ROAA at a 1.10% return. Also, as you can see, for each of the components required to sustain a 1.10% to 1.30% ROAA -- in 2Q 2013, we're now operating better than or within targeted range, except for the net charge-off ratio. Technically, we're one tick above the cap there. But given the commercial nature of our portfolio, charge-offs will be lumpy. But year to date, we're at 30 basis points, well within the target range. Although the non-interest expense to average asset ratio dipped into the target range for the second quarter of 2013, we don't really believe that we've achieved our targeted run rate.

We'll elaborate further on that in today's call. But the key force to drive that number into the targeted range on a permanent basis is to contain expenses while growing assets and revenues, which has been our stated plan for some time and which we continue to do meaningfully in the second quarter of 2013.

As you look under the hood to see how we're achieving growth in profitability and earnings, I think you can see that we're hitting on all cylinders. Net interest income, provision expense, non-interest income, and non-interest expenses -- those are the four basic components of bank earnings, in spite of Harold's caution regarding me comparing that to a four-cylinder engine.

First, as I mentioned at the outset, we continue to grow net interest income largely based on our ability to grow loans and lower our cost of funds. Secondly, we continue to make meaningful progress on asset quality, whether you look at NPLs, NPAs, or virtually any asset-quality metric. Given the relatively high level of our reserves versus the continuing quarterly asset-quality improvements, reserve releases have and should continue to provide relatively lower provision expenses through 2014 than what would otherwise be required for a company growing loans as rapidly as we should.

Third, non-interest income, excluding security gains and losses, is up 15.7% in 2Q 2013. That's versus the same quarter last year. And core non-interest income, which we'll talk about further here in just a moment, is up 23.6% year over year.

And then fourth, consistent with our strategic objective to contain expenses while growing loans and revenues at a rapid pace, our core non-interest expense to asset ratio continued to improve -- it's continued to improve every quarter. Expenses in the second quarter were favorably impacted by an expense credit at $2 million that Harold will discuss further in just a few minutes. But nevertheless, eliminating that and holding everything else constant, our core non-interest expense to asset ratio would have been 2.42% for the quarter. Still outside the targeted range, but continued forward progress during the quarter, and consistent with our plans.

The pretax pre-provision earnings for 2Q 2013 grew by 48.7% over the same quarter last year. Perhaps a slightly more telling indicator of the pace at which we are expanding the core earnings capability of the firm is the adjusted pretax pre-provision earnings for 2Q 2013, which grew by 36.8% over the same quarter last year. You can see on the slide the adjustments we've made to the pretax pre-provision number to best reflect core pretax pre-provision earnings.

Again, Harold will cover the $2 million other expense credit that I just mentioned and we noted in the press release last night. And he'll provide a little more color commentary on that in just a minute.

Looking a little further at the growth in net interest income, despite some contraction in the margin percentage, there were three primary contributors. Continued reductions in our cost of funds, continued growth in low-cost funding, and then thirdly and most importantly, our ability to grow loans outstandings. The net result in the second quarter was a 7.9% annualized rate of growth in net interest income.

Second quarter was a great quarter in terms of loan growth. Average loan balances grew 4.4% linked quarter, 17.8% on an annualized basis. Consistent with our previous guidance, loan yields did contract 17 basis points during the quarter. That caused our margins to contract during the quarter, but the margin's still near the midpoint of our long-term target and consistent with our previous guidance. Thankfully, again, during the second quarter, we were able to offset some of the loan yield contraction by continuing to lower our cost of funding. And we got that done while continuing to grow funding. We'll talk some more about this later in the call, but I believe that our ability to grow this deposit base so substantially, while lowering the cost of deposits so substantially, is indicative of the differentiation that we continue to build versus our large regional competitors in these markets.

Consistent with the comments I made at the outset about increasing shareholder value the old-fashioned way, in other words building a firm that has a sustainable competitive advantage and can take clients away from competitors to grow client-based revenues, is further borne out in the makeup of our net-interest margin. On this slide, the blue line is the client margin. In other words, the yield on loans, less the cost of client deposits. The red line is the treasury margin. Basically, the yield on the securities book, less the cost of non-core funding. And then the green line's our actual margin, which is the amalgamation of the two.

And I'm not trying to detract from the treasury margin at all, but it can be volatile, given the absolute level of liquidity in the firm, the absolute level of rates, and the slope of the yield curve. But I do want to emphasize the customer margin because we believe that's what really drives absolute growth and profitability of the firm. I believe a 4.14% client-base margin is extremely valuable. So, again, it's my belief that this success with clients is what really yields sustainable long-term shareholder value.

Switching now to non-interest income during the second quarter, we saw core fee income grow to a record level for our firm of 23.6% over same quarter last year. If you think about the long-term profitability targets that we set for each element of the P&L statement, it's critical that we grow our fee income as fast as we are growing our loans. And so you can see there at 23.6% rate of annual growth over the last four quarters, we've been able to do that.

That's an overview of the second quarter. What we'd like to do now is to focus on our approach to expanding our operating leverage, which I think you know is how we achieve our long-term profitability targets, and specifically the targeted noninterest expense to asset ratio on a sustainable basis. We began focusing on this in our earnings calls in the fourth quarter of 2011. We indicated in that call that we essentially possessed, at that time, the infrastructure to support and the capability to produce meaningful growth. In other words, we felt we could grow revenues significantly while containing incremental expenses. So let me turn it over to Harold to expand that thesis.

Thanks Terry. As Terry mentioned, we are going to switch gears now and eventually discuss operating leverage in a few current topics. But first, a few comments about growth in loans and deposits. We've been highlighting this chart since January 2012 and that it was our belief that our existing relationship managers, plus several new relationship managers that we've hired, had the capacity to produce $1.3 billion in net loan growth over roughly a three-year period of time. In the chart, we are plotting the actual production of the date against the three-year target that we outlined 1.5 years ago. We've always cautioned that you shouldn't expect that we'll produce the loan growth on a straight-line quarterly basis. During 2012, we had a quarterly low of $46.5 million in growth and a quarterly high of $187 million. The round numbers, we're up a net $420 million in 2012, and that's an annual growth rate of 12.8%. We added net growth of $60.2 million in the first quarter of this year and $153 million in the second quarter. That represented a six-quarter CAGR of 12.5%. The required CAGR for loans, in order to hit that $1.3 billion target by the end of 2014, is 11.5%. So to date, we are right on plan.

We've discussed this concept in various forms over the last several quarters. Our communication objective here is to highlight our sales force's efforts in moving market share to our firm in order to produce outsized growth in a slow-growth economy. We surveyed our relationship managers and asked them to determine where the new loans were coming from. A new relationship was determined to be a loan with a tax ID that was not on our records at the end of 2012. And that our loan officers also determined the new tax ID was not an existing relationship. All in, over the first six months, we recorded almost $600 million of new loan volumes excluding any net changes in lines of credit. As the chart indicates, 48% were to existing Pinnacle clients who likely chose to undertake deferred capital expenditures, had growing working capital requirements or perhaps a new venture. While 52% were to new clients.

This capability to capture or move market share is tied to our hiring philosophy of hiring well-known lenders in our market who have the potential to move a large book of clients to Pinnacle. As you can see, and especially if you consider amortization of pay downs of existing loans, without this ability to take share, loan growth would be much more muted.

We've been providing this as supplemental information for quite some time, but we thought we'd move it to the front and highlight it for you this time. The chart reflects commercial lines of credit, and as you can see we have more than $2 billion of total commitments, of which a little more than half is funded. Again, reflecting our ability to take market share, total commitments were up more than 13% in the last year, and unfunded commitments are up more than 17.5% in the last year. Obviously, this presents us an opportunity for future growth, and hopefully more unfunded commitments will turn into loans over the next several quarters.

This slide is new. We've included it this time because one of our ongoing critical to-do's will be to fund loan growth with quality funding, which is low-cost core deposits or DDA interest checking, customer repos, and money market accounts. The chart on the left depicts our deposit book transition from being predominantly CD-funded to now predominantly transaction and money market account funded. This didn't happen by accident. This was an intentional effort of our entire sales force. More so, traditional bank investors recognize that transactional account deposits are likely to be the most valuable product on any bank's balance sheet, and the more you have the better.

Now to the chart on the right. The question has been how will we fund our loan growth and hit our [1231] 2014 targets? The answer is simple. We'll keep on keeping on. We've seen growth in transaction and money market accounts consistently over the last several years. And for the last 1.5 years, it's approximated 93% of loan growth. Terry and Rob McCabe, our Chairman, will tell you that they seldom talk about loan growth with their sales units. It's all about deposits.

Now we're shifting into four-wheel-drive. We'll pull more with less. As to expenses, as you can see with this slide, our efficiency ratio is now at 52.9%, excluding those items noted on the chart. One of our long-term profitability measures is the ratio of expenses to average assets. That number, again, excluding those items was 2.27% for the second quarter, which puts us in our long-term profitability range of 2.10% to 2.30%. However, during the second quarter, and as we mentioned in the press release last night, we had a $2 million credit to other expenses due to the off-balance-sheet reserve reversal for a line of credit that was funded, and thus the $2 million in reserve reversal was offset by a $2 million increase to provision or loan losses.

We had built the off-balance-sheet reserve for the line of credit over the last 1.5 years. Excluding that event, the efficiency ratio would of been 56.5%, and the expensed average asset rate would've been 2.42%, which remains above our targeted 2.10% to 2.30% range. As a result, we're focused on eliminating any unnecessary expenses, as our senior leaders are looking to find appropriate ways to increase the operating leverage of our firm. However, the primary strategy to decrease and to ultimately achieve our long-term expensed average asset target ratio will be growing the loan portfolio of this firm with the corresponding increase in operating revenues.

Now I want to shift gears again and focus on a number of items that may impact our growth, earnings, and valuations going forward. What I want to do now is begin focus on some items that bank stock investors want to understand regarding how a bank might be impacted by those potential environmental factors that Terry mentioned in his introductory remarks. Several years ago, Terry and I were at a conference, listened to a banker discuss the advantages of their new operation center. And it went on and on.

I leaned over to Terry and told him never discuss a new operation center with investors, because at the end of the day they'd rather you just stick with loans and deposits. So similarly, we are sort of detouring here and spending probably too much time on the bond book and interest rates. But in the last few weeks, we've been reading a lot of analyst reports discussing asset sensitivity and who's on the right road and who might not be. My goal here is to talk some about interest-rate risk but also get the emphasis on the right syllable, which is we are all about gathering customers plain and simple.

Simply stated, we have an investment book to collateralize public fund operating accounts and customer repurchase accounts. We are fortunate to have many great public fund clients to whom we provide a whole host of services. It's a targeted business segment for us. They are a municipality; they are water utilities; they're school districts; so on and so forth. We believe we bank these entities at a fair return. Currently, we are at 32 basis points, which is about two beats over our aggregate cost of funds. That compares to 55 basis points a year ago, which was about eight beats above our cost of funds. Customer repos are at 22 basis points this quarter versus 36 basis points last year same quarter.

We are about 9% pledged, so we don't have a bond book for the sport of it. I'll admit we're not looking for new public fund or repo clients presently until we have a clear perspective on rates. Now, over the years, our investment appetite has been all over the map. Sometimes 22% of assets and now 13%, but today we have a bond book because we needed to collateralize these sort of accounts that technically aren't core but they walk, talk, and act like core deposits.

Another item we've been reading about is premium amortization and how it might impact future profits. We've amortized about $2.5 million in bond premium over the last six months. We should get a break on that going forward as these absolute levels of rates. Additionally, based on current direction, which we should see about 25% of our bond book come back to us in the next 24 months, or mid-2015, which is approximately when economists are projecting the next Fed funds move. When Fed funds moves, that will be much more impactful to us than what's happened over the last six weeks. That said, premium amortization and cash flows from the bond book should help stabilize bond yields going forward.

Lastly, we mentioned this a second ago, transaction accounts are very valuable to bankers, particularly non-interest-bearing checking accounts because they are not impacted by rate moves. And so we can invest those balances into any asset we choose, so long as we think we're going to provide a service equation that keeps that depositor at Pinnacle. We believe we've done that, and we'll keep on doing that. Our consultants tell us we should be proud of our transaction account deposit base -- which is DDAs, interest checking, and customer repos -- because they are sticky and they tend to hang with us regardless if rates move up or down. The consultants tell us our transaction accounts have an average life of seven to eight years, which is not bad given we're a 13-year-old bank. Obviously, we don't know what will happen to these balances when rates go up, but our data tells us that we are in great shape.

Now let's put the emphasis on tangible book value and AOCI. We've been drawing down the bond book in relation to our asset base for the last several quarters. I think at one time, we were at 22%; now we're at 13.5% of assets. That difference represents a lot of earning assets that could have been leveraged on our balance sheet. Conversely, that would've put pressure not only on interest-rate risk management but also funding. The absolute level of the bond book was over $1 billion back in 2010, while today it's at $730 million. The change is even more dramatic you look at the ratio of AFS investments to tangible book, we were at 306% at year-end 2010. Now we're at 153%. So we believe we've de-risked our balance sheet. Now, whether we've done enough or we've done too much, that's debatable. But we feel pretty good about where we are today.

Our advisors tell us our duration is slightly ahead of our small-cap peers, but that difference is not significant and is basically in one class of securities, which we can deal with. If we need to reload on that particular segment of our bond book, then we'll do it as we consider necessary.

Two things we've done recently are worth mentioning. One was that we transferred $40 million of Tennessee municipals to held to maturity. We selected Tennessee municipals because we can place them readily to our Tennessee public fund deposits. And the returns were good, so we basically concluded we'll keep those bonds until they pay off. The impact on 2Q AOCI would've been minimal otherwise, and that these bonds really didn't devalue very much over the last six weeks.

Something that was impactful to tangible book was a cash flow hedge we executed with a forward swap on FHLB borrowings. This swap sheltered about 30% of the AOCI decrease this quarter. We put the swap on during the first part of April prior to the rate move, so it's in the money today. Our job is not to time the market, but we feel pretty good about that particular transaction today.

Lastly, I wanted to briefly touch on loans before we get to Basel III and capital. We've gotten a few questions about our loan floors, and they will surely hurt us when rates begin to increase. We began emphasizing floors in 2008 and 2009, and we believe we've been quite successful. The difference between the contract rate and the floor rate has provided us a meaningful return over the last several years.

Now to the recent rate increases and impact on Pinnacle. First off, substantially all of our floors are tied to prime 30-day LIBOR or 90-day LIBOR. So those rates have not changed significantly. Should those change -- should those rates change materially, it would take a meaningful rate move to get us where we would be earning more money. However, we don't believe those rates are going to change meaningfully. And in fact, particularly for the Fed funds rate, based on what we hear and read, we don't think those rates will change for quite some time. Consequently, the question we've been debating internally for the last two years is when do we begin to deemphasize floors?

Secondly, the difference between the floor rate and the contract rate has decreased steadily over the last 2.5 years and is now at 88 basis points. There's been no real management initiative to make this happen. It's been about market prices. So we have to believe that the floor-to-contract rate difference will continue to decrease because A, competitively it's become more difficult to garner floors of any significant yield above the contract rate; and B, borrowers have become more aware of the rate cycle and thus are willing to take more interest rate risk on their own balance sheets. I am quite confident that eventually we will deemphasize floors and gradually reposition our loan book, but we need to see a few more cards.

What I've tried to communicate to you is that we feel pretty good about where we are in the rate cycle and where our balance sheet is positioned. The recent rate moves were somewhat surprising as to their absolute level of increase. Now, if the rate moves were in fact due to an improving economy, then great. Let's get on with it. Because over the long-term, we all will win. Whether it's the economy that caused the rate increases or whether it's not, we will just keep on emphasizing what we do best, and that is gather clients.

Now to Basel III and capital. I won't spend too much time on Basel III, but basically we are feeling that the final regulations came out better than we all expected, at least on the three topics noted. There was enough chatter leading up to the announcement of the final rules that the impact, at least to community banks like ours, had gotten to a point of optimism. We were also very pleased that the regulators put the rule out when they did, because we were reading that it might not be issued until late summer or early fall. So getting the information when we did was helpful, thus we can get on with our capital plan.

One question investors may have regarding the new rules is what will Pinnacle do about AOCI for the bond book, and are we likely to continue to exclude it from our regulatory capital calculations? I'll just say this. Because we don't know for sure, but leaving it in the calculations creates a degree of volatility to our regulatory capital that we'd just as soon not have to deal with, and given our public fund deposit books, we need bonds to collateralize those deposits. So if we were to consider AOCI and capital, we might have to think again about whether we should be in the public fund business.

Lastly, as to the estimated impact to Pinnacle, we think it will increase our 2015 risk-weighted assets by 3% to 5%, which we believe is manageable.

Now moving to something more interesting. Several quarters ago, we mentioned that we believe we could continue to grow our Company and potentially look at some capital planning transactions primarily concerning dividends. Given the final Basel III rules issuance, we felt like we should update that conversation with you, as Basel III was one of the more significant cards we needed to see before we moved forward. We are still evaluating the final rules of Basel III, so we're not all the way through it. And additionally, we're not in a position to conclude that a dividend strategy is something we should pursue due to many factors. But we wanted to revisit the topic with you, and that it's a matter for this firm to consider for its shareholders currently.

The slide shows that for the first six months of the year, we grew loans approximately $213 million. Those loans, when risk-weighted, were under current guidelines. And based on the composition of our loan portfolio at December 31 and June 30, would require capital of sufficient size to support $178 million of risk-weighted assets. So the question is, from a regulatory risk-weighting perspective, how much capital is required to support $178 million in loan growth? Interestingly, tier 1 capital grew by more than $30 million, and total risk-based capital grew by more than $34 million. So just looking at capital growth and its relationship to loan growth, capital growth represented 17% and 19% of loan growth. We believe that level of capital growth was significant and more than required to support our loan growth. But the key measure impacting capital is going to be, for us, loan growth. As I mentioned, we're not in a position to move forward on a dividend strategy today, but we need to continue to consider our loan and funding growth prospects, and the associated capital requirements as providing capital for growth is by far, in our opinion, our best use of capital. But on the surface, it would appear that we could potentially support double-digit growth and deploy a dividend strategy. With that, I'll turn it over to Terry to wrap up.

Okay. Thanks Harold. We need to comment on our outlook for net interest margin. We made significant progress on our net interest margin from its low of 2.72% in March 2009 to its peak of 3.90% last quarter, and now back to 3.77% in 2Q 2013.

There are really three factors that should positively impact our margin going forward. Loan growth, continued reduction in cost of funds, and growth in low-cost core deposits. But frankly, we expect the compression in load yields to exceed those factors such that the margin is likely to contract a little further in the third and fourth quarters of 2013. For that reason, we're likely to see margins decrease for the remainder of the year. But we anticipate remaining within the 3.70% to 3.80% range noted on the slide for the whole of 2013.

As I hope we've made clear, despite the contracting margin, we do expect to continue growing net interest income primarily based on our ability to grow loans and core deposits.

Most banks have enjoyed a robust home mortgage refinance market in terms of the fee income derived from those refinances. Many investors are concerned about the impact of rising long-term rates on bank P&Ls as refis become less attractive. We view the risk to Pinnacle's P&L an event refi slow or even seesawed together is minimal. In the chart on the left, as you can see, while our mortgage originations have grown during this period of heavy refinance, the mortgage origination business is a relatively smaller portion of our fee income compared to our banking and wealth management businesses.

And furthermore, on the right, you can see that our mortgage unit is rapidly transitioning back to originating purchase-money transactions, nearly back to the refi boom levels in -- here in the second quarter of 2013 at 49%. It's a credit to the management of our mortgage origination group to some extent, but it's also reflective of the health of the national single-family residential market.

This slide paints a picture of the point that Harold has made a couple of times, relative to the increased operating leverage and the increased production we expect from our existing expense base. Our headcount leverage has been significant and, we believe, compares favorably to virtually any peer group. At roughly $7.1 million in assets and $300,000 in revenue per FTE, we believe our workforce is extremely productive. But based on the capacity of our existing lenders, which Harold reviewed earlier, we expect to do even better.

Most of you are familiar with our hiring strategy of hiring the best bankers in the market and asking them to move their books of business to us. The blue bars give you a sense of how well our strategy of growing market share by moving business to our balance sheet with only modest increases in cost is working.

Focusing on -- just a moment on the green line there, $300,000 in revenue per FTE, that's a metric we are extremely proud of. I will say, in the second quarter you see a little slippage of verses the highs in the previous two quarters. That's because, in addition to the capacity of our existing workforce, we continue to have the opportunity to hire additional capacity, which of course ensures our ability to continue to grow and take market share well into the future.

And then finally, there is an old adage among bank investors that great markets make great bankers. So if none of the other information we reviewed is compelling, even if we are not great bankers, we are blessed to be in two of the best banking markets in the United States. Of course, job growth is really the key to the health of any city. And as you can see on the left, Knoxville is fully recovered and Nashville is booming, now, nearly 6% above the 2007 peak for jobs.

In May, the Bureau of Labor Statistics revised the job growth numbers for 2012. Nashville led the nation at 3.9%, better than markets like Houston and Austin, Texas. And in 2013, Forbes recently ranked Nashville as the second best city for jobs, behind San Francisco. On the right, at the top, consistent with my comments on the volume of purchase money transactions just a minute ago, you can see that the Nashville real estate market is very healthy. As you would expect, given the dramatic growth in jobs. And also as you'd expect, I think unemployment in both markets continues to be better than the national numbers.

In all seriousness, our success at Pinnacle is really contingent on producing rapid growth while containing operating costs. And it would appear to me that our markets do provide an environment which should enable us to do that.

So now, in conclusion, hopefully, number one, we've covered the key performance metrics for the second quarter. Two, we've fleshed out our approach to the expanding operating leverage by rapidly growing loans, deposits, and fees while containing expenses. And three, we've provided a longer-term outlook for things that may influence our growth, earnings, and valuations.

Dialing it all the way back to the third quarter of 2013, the path forward, to me, continues to be very simple. The principal profit improvement lever is loan and revenue growth, produced by our existing infrastructure or expense base. We expect continued reductions in NPAs. And we will continue refinement of our capital planning alternatives in light of the recent Fed guidance on Basel III capital standards. So operator, with that, we'll stop and respond to any questions there might be.

(operator instructions). Michael Rose, Raymond James.

I just wanted to get a little context and color on the margin going into 2014. With everything you laid out, your expectations for rates remaining low, the use of the floors which I expect are -- would continue to fall from here, given the competitive nature of your markets, is it plausible that the margin over a period of time during these low interest rate dynamic that we are in, that you could dip below your longer-term range? And can you kind of walk us through how that could play out, assuming rates stay where they are? Thanks.

Yeah. Michael, we've been looking at that over the last several months and whether or not we'll go below our long-term sustainable targets. Right now, we're not anticipating that of any significant amount. We think we can keep these rates or keep our margin within the target range. But I think we'll be very much at the low end. So to say that I've got a bias that will be above the 3.70%, but I think there is a distinct probability when you go through our modeling that we could fall into the 3.60% for sure.

Mike, I might just add to Harold's comment. While it would appear to us that we'll operate in the margin on an annual basis, it would be more conceivable you might miss it on a quarterly basis here and there.

Understood. And then, I don't think you touched on this, Terry, but any other thoughts on expanding into other markets, as you talked about in prior calls?

Michael, I don't think I can say anything that's additive to what's already been said. As you know, we look at those markets. We believe they may represent opportunity for us, and if we find the right group we'll proceed to those markets and commence on a de novo basis, when and if we find them. If we don't find them, we won't go there. I don't really have any update on that.

Okay. And just one more, if I could. You know, as it relates to the growth this quarter, which was really nice, how much of that came from, I guess, more recent hires? The hires that you brought over that kind of lead us to this $1.3 billion in capacity over the 12-quarter period?

Michael, I don't know the number exactly, but I would estimate $20 million to $25 million came from new hires.

Okay. Thanks for taking my questions.

Jefferson Harralson, KBW.

I wanted to ask you about pricing on new loans. Has it increased for you guys and competition with rates going up, or is it still -- is it relatively unchanged?

I think loan pricing is relatively unchanged. Jefferson. I think what we tried to communicate, I think, through press releases and here today is that you got -- theoretically with longer-term rates moving, you think the associated or comparable loan yields would move similarly. I think the overriding factor is the competitive landscape. And so honestly, I don't look for any easing in loan pricing myself.

Okay. On the margin, if rates go up, I guess if I'm just trying to put everything together that you guys said, should I expect the margin to go down initially as rates go up because of the floors not giving you some increase, while you might have an increase in your cost of funds?

Yes Jefferson, I think that's correct. We've got to get through the floors. So if rates were to go up today, we are 88 basis points floor-to-contract rate difference on the loans with floors. So we'd have to get through that in order to see some revenue lift on that book of business.

Okay. And lastly, you talk about the swap. Could you just give us the details on what the swap is? And does it help earnings every quarter, or is it just kind of hedge book value?

Yes, it's a forward hedge, so there's not really any current impact on earnings. It just -- it does impact tangible book. It's a forward start three years out. It's about $200 million in federal home loan bank borrowings that are at various rates. I think I've got tranches built over a three- to six-year period. So that's the swap.

All right. Thanks guys.

Matt Olney, Stephens.

Terry, in previous quarters, you've talked about the payoff and paydowns being a little bit elevated. How would you characterize the payoffs and paydowns of some of your loans in 2Q? And what's your outlook for this going forward?

I think I would generally characterize payoffs as slightly slower than the peak levels that we saw. But we still are running a relatively high level -- at a higher than normal level, I would say, of accelerated payoffs. I hope that's clear. I'm trying to say it's a little better than it's been, but it's still an elevated level.

And it sounds like you're expecting that to continue the next few quarters. Is that fair, Terry?

I don't have any reason to think it will not.

Yes Matt. We had, based on some data I'm looking at, we had about $100 million in amortization in paydowns. So that's about consistent with what it was in the first quarter.

And then piggybacking on Michael's question before on new lenders, did you make any new hires in the second quarter? And how would you characterize the pipeline for new hires today?

We did make hires in the first quarter. And in the second quarter. And I expect we'll make hires in the third quarter and fourth quarter.

Okay, thanks guys.

Kevin Fitzsimmons, Sandler O'Neill.

Just real quick on some of the capital planning issues you talked about. I hear you on the dividend, that it kind of depends on the loan growth. So if I hear that right, is it almost that we would need almost a pullback in this pace of loan growth before you'd feel comfortable going forward with the dividend? Or it sounds like you're saying you're comfortable, you can do both, but you want to watch it for a while. And is it almost that if the pace pulls back, then you're more comfortable stepping forward with the dividend? Thanks.

I wouldn't say that if the pace pulls back, we are more comfortable. I think, based on what we've talked about and our targets for 2014, we still think we can do both. Now as to the timing of when we might want to start a dividend program, or if we start dividend program, we're unsure of that. But we believe that, based on what we've been able to do with loan growth here over the last, say, six quarters, we think a dividend could be affordable.

Okay. And a quick follow-up. Terry, I know M&A has never been a big part of the strategy here, and it sounds like you still have a lot of organic loan growth opportunity. But you're sitting with a very nice multiple on tangible book compared to a lot of banks. And we've seen some transactions where the buyers' stock actually reacts very positively, and there's more reception to the accretion that comes from some of these deals. How do you -- how would you characterize how constructive you're looking at those kind of opportunities these days?

Kevin, I would say that if we could find in-market bank deals in Nashville or Knoxville, those would be very attractive to us. I guess we are interested in and, you know, have dialogue and pursue internally those kinds of things. I guess in order to be candid, though, I would need to say that's a relatively short list of possibilities. And so, I think you're right. The currency is attractive. We like our distribution in Nashville. We ought to produce outside synergies if we could do an in-market deal. All those kinds of things. But again, I just want to be clear it's not like there's a list of 43 banks we're going to go out here and take a look at. I mean, it's a pretty short list.

Knoxville, the rationale is a little different. I'd like to accelerate distribution. I've only got, now, four offices in Knoxville with a little better than a $600 million asset base over there. And so I need more distribution. So the rationale would be different for the two markets. But if we could find in-market deals, we would certainly do those. And we also continue to bang around on, I guess, generally what we refer to as wealth management businesses. If we could find things that would build our trust asset base or augment our P&C insurance, those things have appealed to us as well.

And I guess based on your answer from earlier about entering new markets, you definitely have a preference for hiring a team, as opposed to going and buying your way into a new market.

We definitely do. I know everybody likes their company, but we do think our brand is distinctive. Our reputation is distinctive and so forth. And so we just have a bias that to go in and buy somebody else's brand, particularly if it's not a particularly high performing company, it's just hard to convince anybody that it's a great company just because you change the signs out front, you know.

Okay. Thank you.

Peyton Green, Sterne, Agee.

Good morning. Congratulations on a great quarter. I was just wondering maybe, Terry, if you could comment a little bit about the loan pipeline. Certainly, the loan growth in the quarter was very good. And I know it was maybe a little short of where was in the fourth quarter, which was a very extraordinary loan growth quarter for you all. But maybe just talk about to what degree the pipeline refilled in the quarter and how you would feel about loan growth going forward.

Well, I think -- Peyton, I don't want to give you a cheap answer here, but let me give you this and see if this tells you what you need. I'll be glad to try again if it doesn't. But we are sort of -- we've been pretty transparent about what our loan growth targets are. You know, round numbers. If you do $1.2 billion to $1.3 billion over a three-year period, you've got to grow a little better than $400 million a year. And we are about $200 million into 2013 at the halfway point. My belief is we'll hit or exceed our loan growth target for the year. So does that tell you what you need to know?

Yes. I guess if I heard the number right, you mentioned that only about $20 million to $25 million of the volume was from new hires, which I guess, in a way, would lead me to believe that the existing capacity may be greater than you may have set a year and a half or so ago, when you put out the $1.3 billion in terms of capacity. I guess I'm just trying to kind of rationalize those two statements.

Yes. I think -- you know, I guess I would say I like -- if you will, I like the commitment that we have on the table, and we'll deliver against that.

Okay. I'll ask maybe a different way. A couple of quarters ago, you indicated -- maybe three quarters ago, maybe even a year ago now, you mentioned that this was the point in the cycle where you started to gain an advantage in terms of hiring bankers and also in pulling customers away from other banks, just given that all of the above had been through the credit cycle and were feeling better about their own businesses and maybe their own opportunities going forward. How would you feel about that today compared to last June?

I would say it was accurate then, and I think it's still accurate today. As I mentioned, we continue to hire people. We have hired a number of revenue producers in the first quarter and the second quarter. I believe we'll hire more in the third quarter. We are in discussions with a number of people that I believe will get hired in the third and the fourth quarter this year. So, again, I think we are taking people.

And if you look at that market share chart that Harold showed really dividing the production through the first six months, you know, more than half of that growth is market share movement. And so, again, I think that -- and I believe our pipelines will continue to look like that for an extended period of time as the folks that had been on our payroll when we said we could produce it -- you know our company well, Peyton. All of those people came from somewhere else. And so the folks that they know and are moving are from other banks. And of course the new hires that we are hiring will be moving largely from other banks. So I expect our ability to hire people from other banks to continue to be strong, and I expect their ability to consolidate their books from those other banks to continue to be strong for the foreseeable future.

Okay. And then maybe one other question. On the line utilization, I think you all have had a slide in the deck that indicated that it went up fairly noticeably, I guess. Was that because the utilization rate was higher on the new volume, or was it a combination of existing and new volume?

Peyton, I've got to say I don't know the answer to that. I just know what the overall utilization rate is, but I can't break it apart for you.

Okay. Great. Thank you very much for taking my questions.

Andy Stapp, Merrion Capital Group.

Peyton just touched on my last question. Thank you.

Brian Martin, FIG Partners.

See, my question was answered. But I guess really the other point was, Terry, your thought as far as that targeted loan growth, if you will, over a three-year period -- you know, if you are talking about the capacity from the new people you're adding. And I guess it's kind of fair to say that we should be thinking about that maybe as being somewhat conservative, as that target was back from a couple of years ago with all the people you've been adding. I guess kind of in line with Peyton's question, does that seem as a fair way to look at it?

Well, I guess, again, Brian the thing I'm hesitant about -- obviously to the extent we hire more people, that ought to propel our growth into the future. And so that's a true statement. And, you know, as a general rule of thumb, when we hire, say, middle-market commercial relationship managers or private banking relationship managers, generally it takes about three years for them to consolidate their book of business from their previous bank to here. And so, I guess, you know, I -- we've sort of put a target out that makes sense. It drives the profitability of the Company to a targeted level, and we are excited and pleased about that. I tend to view the hiring as my path to the future beyond what we've talked about. So, to the extent I keep hiring people, I can continue a rapid growth in market share, capture gain for an extended period of time. I guess, again, yes, hiring more people and their ability to produce loans will be additive to what we had originally said. But I just don't want to get into having to put out new targets and then talk about the old targets and the new targets and all that sort of stuff. I'd rather just sort of say, conceptually, hiring more people ought to be additive to capacity.

Understood. Okay. Thanks very much.

Bill Dezellem, Tieton Capital Management.

I'd actually like to continue on the path with the loan officers for a moment. How many did you hire -- new ones in the Q1, and how many in the Q2? And then how does that first-half higher number compare to the first half of 2012?

We hired three in the first quarter and four in the second. That's the -- those are relationship managers. Again, there would be other hiring that might go on the Company to support new branch openings and other things. But in terms of relationship managers, three in the first quarter, four in the fourth. And what was the second part of the question?

How does that seven for the first half of 2013 compare to the first half of 2012?

In 2012, I think -- actually when we communicated our capacity, I think we said included in that capacity was that we would hire 11 people during 2012. And we did hire those people in 2012. And I would say they were concentrated in the first half, but I couldn't go back and tell you how many got hired in Q1, Q2, Q3, Q4 of 2012. But, so I would say it's a similar number, would probably be a fair thing to say.

Thank you. And then a remedial question for you. The difference in contract rates versus your floors, why has that decreased over the last 2.5 years from that, what, I think it was 133 basis points to 88 or so?

Yes Bill. I think there's two things going on, as we talked about. The first is, and maybe more importantly, the borrowers, I think, are more keenly aware of where we are in the rate cycle and where rates -- when the Fed funds rate may actually get increased and all that sort of stuff. So they are taking a little more interest rate risk on their own balance sheet. So they are willing to play a float -- maybe get a floating-rate loan or something like that on their own balance sheet. And then secondly is that, competitively, it's getting more difficult to get a significant lift in the floor rate over the contract rate.

That's helpful. Thank you both.

Thank you. I'm showing no further questions at this time. I'd like to hand the conference back over for any closing remarks.

Yes. I would just say hopefully what we've tried to do is highlight our performance in the second quarter, which we view to be very strong. And at the same time, give some information, continue to expand this thesis of operating leverage, producing revenue growth more rapidly than expense growth. And then thirdly, to try to give some insight into things that we think are likely to influence our ongoing growth capabilities valuations and so forth. Thank you for joining us.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect, and have a wonderful day.