Pinnacle Financial Partners Inc (PNFPP) 2016 Q2 法說會逐字稿

Good morning, everyone, and welcome to Pinnacle Financial Partners' second-quarter 2016 earnings conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer, and Mr. Harold Carpenter, Chief Financial Officer.

Please note, 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 to not put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10-K.

Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation whether as a result of new information, forward events, or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.PNFP.com.

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

Thank you, operator. Good morning. We appreciate you joining us here this morning.

For several years now I've tried to begin every earnings call with a dashboard which is intended to be a quick look at earnings growth, revenue growth, and asset quality, the three metrics that we believe the most highly correlated with share price over time. This quarter we are starting with the GAAP results and we'll talk about results, excluding merger-related charges and other items that we've excluded for the last several quarters, here in just a minute.

Those of you that have been following our firm for any length of time know that one of our primary objectives has been to grow the core earnings capacity of the firm. And so for that reason to eliminate things like gains and losses on security sales and merger-related expenses is really a better way for me to gauge how well we're building that core earnings capacity than just a simplistic review of the GAAP measures.

So, as you see here, we were blessed again with another great quarter. Top line growth continues to be excellent. In second-quarter revenues, excluding securities, gains and losses were up 51.1% year-over-year and up roughly 8% on a linked quarter basis.

Bottom line, our fully diluted EPS and other merger-related charges was $0.75, up 17.2% year-over-year. And excluding merger-related charges, earnings is a function of tangible common equity were 15.64%, that's consistent with last quarter and up from the 15.44% in the same quarter last year.

Moving to the second row of charts, generally focusing on balance sheet growth which for companies like ours is the primary basis for our future revenue and earnings growth. Loans were up $263.5 million in the quarter. That's annualized growth rate of 16.8%.

Core deposits were up $158.7 million in the quarter. That's an annualized growth rate of 9.9%. And with the general target near 20% for a dividend payout ratio we're still growing tangible book value per share 18.2% year over year.

Switching now to asset quality on the bottom row of charts. In first quarter we saw an increase in several of the problem loan and asset quality indicators, but this quarter, in other words second quarter 2016, we saw the NPA and classified asset ratios come right back in line and in the case of net charge-offs we were able to get back inside our targeted range of 20 basis points to 35 basis points, albeit just barely.

The charge offs in the second quarter were again dominated by the nonstandard auto loan portfolio. We continue to expect meaningful improvement there in the second half of 2016 since we reduced the portfolio balances from roughly $57 million last quarter to $43 million here in the second quarter and believe we are now in the position to see stabilization in the remaining portfolio. So, all in, 2Q 2016 was a fabulous quarter for us with year-over-year core earnings growth of 17%, core revenue growth year-over-year of 51%, and key asset quality indicators all back in line.

Sticking with this theme of growing the core earnings capacity of the firm, we always have a number of initiatives that are aimed at accelerating our growth. I think over time the single most impacted growth strategy executed hiring the best bankers and brokers in our markets. To borrow a term from Jim Collins, this is our hedgehog strategy. It's our primary core competence.

We've established a reputation it's been a great place to work. We are able to leverage that to source and recruit and hire and on board and retain the best and most productive revenue producers in our markets. 2015 was a record year for onboarding revenue producers and we are on pace to substantially outperform 2015 in 2016 having already hired a little more than 75% of 2015's number just through June 30.

Over the last 18 months or so we've also been able to effectively leverage our highly valued stock to accelerate growth through acquisitions. We've acquired the most attractive high-growth banks in the urban markets of Tennessee in terms of fit with our firm.

We've now completed system integrations for Magna Bank and CapitalMark Bank and are in a position to realize most of the deal synergies by the end of the third quarter. The system integrations have been near flawless and we didn't lose a soul in Chattanooga.

In Memphis, I believe, we lost three revenue producers but with virtually no client or revenue impact thus far. So, from 30,000 feet the integrations have gone extremely well. Harold will address this further in just a minute, but I do want to expand my comment regarding effectively leveraging our high-valued stock.

In conjunction with the CapitalMark/Magna transactions, revenue per share is up, earnings per share is up, revenue per associate is up, assets per associate are up, and our core efficiency ratio is on the verge of going below 50%. So in my judgment not only have the acquisitions accelerated growth but it is really high-quality growth.

We completed the Avenue merger July 1, just five months after the announcement. This is now the third transaction announced in the last 15 months that were announced in one quarter and in a position to close the next. The technology conversion is currently targeted for September 2016, and it appears to me that the cultural integration with Avenue Associates is going extremely well. Now, the majority of their associates have already been through our new associate orientation process which immerses them in the mission and the vision and the values and the culture of Pinnacle over a three-day period and their feedback and excitement has been outstanding.

Lastly, BHG continues to accelerate our growth. BHG had a fabulous second quarter. You may recall that we increased our ownership from 30% to 49% effective March 1. They contributed $0.06 in EPS in the first quarter and as a result of their growth and our increased ownership, they nearly doubled that to $0.11 in the second quarter.

We continue to believe that BHG will have a record year in 2016 and will grow earnings on a standalone basis even faster than Pinnacle. And so obviously we remain very excited about their growth and contribution to our firm.

So with that as an overview of the quarter and a progress report on our key growth initiatives. Let me turn it over to Harold to review the second quarter in greater detail.

Thanks, Terry. For those of you that have followed us over the years you know that we pay attention to expenses but we focus on revenues and how to grow our top line. It's our belief that top line revenue growers that can leverage growth with increased earnings will be reported with [outside] multiples by the markets.

This chart gives that in some detail. Green bars are fees while the blue bars represent spread income. The dark line on the chart is the critical one as it denotes revenue per share. Growing EPS and tangible book value per share is obviously much more difficult [to this line is] flatter down.

Our trailing four-quarter revenue per share is around $9.55, which is up 26% from the previous trailing four-quarter period. Excluding merger charges, our trailing four-quarter fully diluted EPS is up -- is approximately $2.81 a share, up almost 22% from the previous trailing four quarters. So we believe our firm has performed admirably and transferred revenue growth to bottom-line results. That said, this organization has undergone a lot of change in the last 12 months and there is more change coming, but as it impacts this slide we believe it is all positive and manageable change.

Avenue recorded approximately $9 million in net interest income and $1.1 million in fee revenue in the second quarter. A very simple pro forma analysis would be that Avenue generated $2.70 in revenue per share in the second quarter of 2016 based on the approximately 3.76 million PNFP shares we distributed to their shareholders on July 1. Thus, Avenue should be helpful to our revenue per share metric going forward.

Concerning loans specifically, as the chart indicates, average loans for the quarter were almost $7 billion. Second quarter EOP June 30 loan balances are higher than average balances and our sales pipeline remains strong going into the third quarter 2016. And at this point we continue to expect double-digit loan growth throughout 2016 and 2017.

We grew loans approximately 3.8% in the second quarter which, when annualized, amounts to approximately 16.8% in organic loan growth. Organic loan growth for us in the second quarter was $263 million compared to $185 million same quarter last year. So we continually we can generate earning assets organically at an outsized rate. Avenue recorded $20.7 million in EOP loan growth in the second quarter which amounts to 24% in loan growth over this time last year, which of course is accretive to our growth rate.

As to loan yields, our loan yields increased to 4.53% this quarter. Impacting our loan yields this quarter was purchase accounting accretion which positively impacted loan yields by about 22 basis points. Avenue's loan yields were approximately 4.09% in the same quarter compared to 4.19% in the first quarter of this year.

As to asset sensitivity. We've modified our assumptions around Fed fund rate increases and have delayed any rate increase until December of this year in our forecasting and modeling. Our balance sheet, we believe, is in a solid asset sensitive position upon the first tick of a rate increase.

Our annualized beta factors remain conservative on the positive increases, around 60% of the rate increase being used in additional interest costs on funding even though after the December 15 rate increase the realized increase funding cost was negligible. We've worked our floating rate loans with force down to approximately $625 million as of June 20, 2016, slightly less than 9% of our loan balances. Additionally, approximately 50% of our loan book will participate in the next rate hike if and when it occurs. Coincidentally, Avenue's loan book was approximately 155 -- has approximately $155 million of their $983 million with floors and 41% of their loan balances set to participate in the next rate hike.

As to deposits, again here in the second quarter we were able to maintain our low funding costs with only a slight increase in cost. As to deposit balances, we had a good quarter for deposit growth with deposits up $213 million in the second quarter end point to end point. Our average loan-to-deposit ratio increased to 98.7%. Avenue's average loan to deposit ratio was in the 101% range for the second quarter.

Deposit costs approximated 0.29% compared to Avenue's 0.47% for the second quarter. We continue to believe that effective core deposit growth strategies will be ultimately rewarded by investors. We continue to challenge our revenue producers to seek out more deposits for our franchise as we intend to keep it front and center as we approach the last six months of the year as our loan pipelines appear to be strong.

Switching now to non-interest income. Excluding securities gains, non-interest income for the second quarter increased almost 63% over the same period prior year driven largely by our ownership interest at Bankers Healthcare Group. As you might recall, the first quarter of 2016 we increased our ownership in BHG from 30% to 49%. We continue to believe that EPS accretion as a result of the 19% ownership stake increase for this year should be at least 2% and next year 4% from our pre announcement Street expectations.

We have got an excellent partnership with BHG. They run a remarkable company and we are obviously excited about not only the additional investment but also continue to explore opportunities to expand the partnership into more diverse revenue channels. The numbers they posted in the second quarter provides us great confidence about the opportunities our two firms have together.

Our residential mortgage group had another outstanding quarter in terms of production with approximately $198 million in loan sales this quarter at a yield spread of 3.84%. Yields also increased as a result of the forward rate lock hedge as national, in particular, has a significant amount of residential mortgage activity going on currently. The change in the fair value of the rate lock hedge contributed almost $766,000 to our second-quarter results.

Items included in other [non-interest] income tend to be lumpy and include items such as gains on other investments and loan sales as well as interchange fees. We had a big quarter on loan interest rate swap revenues that we had approximately $107 million in loans booked as fixed rates and swapped to floating rates, generating a gain to us of $1.8 million for the quarter. Other fees are also higher this quarter due to several items impacting our run rates by approximately $1 million. Avenue saw their fee revenue run rate drop from $1.7 million in the first quarter to $1.1 million in the second quarter. This was caused by investments security gains in the first quarter and a drop in their SBA and other loan sales activities.

Now as to operating leverage. Our core efficiency ratio was 50.8%, which is one of our better quarters and compares favorably to peer groups. We continue to believe that we will be able to improve upon these levels of efficiency in 2016.

Our second quarter increase in compensation expense was basically all caused by an increase in our incentive plan accrual. As many of you know, our incentive systems are primarily corporate results win together, lose together kind of system.

In the first quarter our initial forecast for our annual incentive plan in 2016 was less than our target amount. We are accruing our cash incentive plan award at the end of the second quarter at a target award. That adjustment was roughly $2 million of additional expense to not only increase the target award percentage but also to catch up for the first quarter. Thus far this year we've got about $8.7 million accrued for the cash plan.

Marketing expenses up this quarter because various sponsorships that are about to restart here in the latter half of 2016. Other expenses increased in the second quarter due to several expense categories with no one category dominating the net change. Our core expense to asset ratio was 2.37% for the first and second quarters, up slightly from the fourth quarter.

So we obviously are above our operating target again this quarter. The synergy cases for our mergers remain in place which will eventually help us create more operating leverage in future quarters as we fully expect to achieve the targeted EPS accretion targets in 2016 that we spoke about on the various merger conference calls.

As you may know, the technology conversion from CapitalMark was completed in the first quarter and we had approximately 25 positions that rolled off our payrolls at the end of April. Avenue's efficiency ratio was 71.9% in the same quarter, excluding merger-related charges of $545,000, that number reduced to 66.7%. As you might expect, in these type transactions the synergy case was predicated on most of the eliminated jobs rolling off at October 31, but in actuality several individuals have left early and those jobs have not been refilled. We anticipate 57 additional jobs being eliminated by the end of October with approximately 50% to 60% of those jobs being added to the Pinnacle payroll in order to take on the additional volumes.

We continue to forecast the penalty for exceeding $10 billion to be around $3.5 million to $4.5 million in 2017, most of which is in the last half of 2017 as a result of reduced interchange fees for the Durbin Amendment and $8 million to $9 million in 2018 once the Durbin Amendment is fully absorbed. We have considered these charges when we announced the Avenue merger and continue to believe that the Avenue merger will remain 2% accretive in 2016 and 4% accretive in 2017 inclusive of the $10 billion threshold charges.

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

Okay. Thanks, Harold. So here it is.

We've been attempting to build a $15 billion bank Tennessee's four urban markets. To do that in each market we will most likely be one of the top three banks in terms of FDIC deposits, and we continue to believe that we can do that. But I just want to say that we've now, with Avenue, crossed the $10 billion threshold, and we're in the midst of our annual strategic planning effort which we hope to conclude before our next earnings call.

During this process, think you should expect our Board and Management to review all our accomplishments, explore our opportunities, particularly areas where we believe we have an advantage. Will be looking at our tactics for continued long-term organic growth, our long-term operating metrics which we established several years ago, our expansion plans in Tennessee, and evaluate expansion into other high-growth markets in the southeast. So again, we'll look forward to concluding that planning process between now and next quarter end.

I just want to focus for a second strategically on our sustainable business model. We published that more than three years ago in addition to expressing an ROAA target. We broke down targets for the four critical components that are required to produce a satisfactory ROA. In other words, the margin, the non-interest income to assets -- non-interest expense to assets and net charge-offs.

We've adjusted target ranges for several of the components a couple of times generally to maintain or increase ROA objective. As you can see, we are currently operating in the high end of the ROA target range at 1.36%.

And as Harold hit at earlier, I do think it's an important distinction for our company that what's driving the out performance is really our ability to grow revenue. I personally expect in the case of noninterest expense looking at that non-interest expense to asset ratio that it will come inside the target range next quarter. And so I expect this to continue to operate in the high end of the profitability range for the foreseeable future.

Thinking about the growth tactics we've been over this a little bit here at the introduction. I want to again just put in context as we think about the future of the Company. We mentioned our hedgehog strategy is really hiring revenue producers, the best bankers in the market.

We're hiring at a record pace which again I try to make sure people get this where current expenses without the revenue streams that go with them. And so the idea here is that we build meaningful capacity for future growth. It is how we produce the low- to mid-double digit organic balance sheet growth, fee growth, and EPS growth. So that's really at the core of what we do and we are having great success on that.

We think that we have deployed our shares extremely well in the CapitalMark and Magna acquisitions. The system integrations have been very successful. The brand integrations are complete.

The cost synergies will be fully realized in the third quarter. And we should begin to harvest revenue synergies which we never include in our merger models in terms of what it takes to produce the accretion. And so, again, we are extremely optimistic about beginning to sell our broad product array, particularly focused on wealth management products and the CapitalMark and Magna franchises.

We spent a little time on BHG. Again, just a quick reminder we are now at 49% ownership of the company. We indicated at the time of the 19% increment that we would be at least 2% accretive to 2016, we continue to believe that. And Harold mentioned I am particularly optimistic about ongoing partnership opportunities that we have with BHG, opportunities for them to distribute broader set and produce even greater revenues.

And then in the case of Avenue, again we've been over the financials of that transaction. We were able to complete the merger in July. The technology conversion is slated for release late third quarter of 2016 and so we will begin to realize all our synergies for the year 2017 which we think are handsome.

So, I guess just trying to put all this in a summary format here I'd say we had truly established a competitive extension among the bankers in our markets which is evidenced by our recruiting success. We think we have a competitive distinction between clients which is evidenced by our balance sheet growth. We consistently produced and expect to continue to produce low to mid double-digit organic asset growth.

I mentioned $15 billion asset level that we believe we can produce in our existing markets, in other words markets that we currently operate in. At the 1.2 to 1.4 ROA target -- I think the target is generally high versus our peers. We consistently perform there in the top end of the range.

Similarly, for the last 23 quarters when you adjust for extraordinary items we've had double-digit EPS growth and we expect that to continue. And I think importantly at a 15.64% level we continue to produce top quartile ROTCE and that is in a very high-performing peer group.

I think the last point, which I believe is really important here, is that we've got an advantaged stock more than that is rationally deployed. We're fundamentally organic growers at heart. That's what we think about, that's what we love to do. But we do have an advantaged stock and that puts us in a position to create even more operating leverage and even more EPS growth which we believe we have done with CapitalMark, with Magna, with Avenue, and with BHG.

I think Harold did a nice job talking about the revenue per share, the growth in EPS per share that we've been able to create via mergers and acquisitions. Even though we're not out here aggressively or recklessly deploying our shares, I'm confident that we will have a number of other opportunities over time similar to the opportunities that we've had the last year or two to create even more shareholder value and turbo charge our growth rate. So, in simple terms that's really how I think how we think about our organic growth in our growth in EPS and producing shareholder value over time.

Operator, I'll stop there and we will be glad to take questions.

Thank you, Mr. Turner.

(Operator instructions)

Stephen Scouten with Sandler O'Neill.

Hey, good morning, guys. How you doing?

Good. How are you, Stephen?

Doing well. Thanks. Hey, I just wanted to follow up with one quick question on the indirect auto sub prime portfolio there. It sounds like you wouldn't expect any more elevated charge-offs like we've seen the last two quarters, but I just want to -- I was kind of that viewpoint last quarter as well. I think, Harold, you had mentioned last quarter there was about $1 million in 90-day delinquent loans at the end of the quarter yet we saw about $4.1 million in charge-offs. So I guess how can we think about future charge-offs from that remaining $43 million and what that might look like in the next couple quarters?

Yes, I think what we are modeling, Stephen, is that the charge-off rate on that book ought to come down maybe as much as half for the rest of the year, maybe 60% of what we've seen here in the first part of the year. We changed some policies with respect to charge-offs and got more aggressive on some of those, some of that paper that we acquired. So, again, I think we're going to be looking at 50% to 60% of what we've seen in the first half of the year being charged off in the second half of the year.

Okay. That's helpful. And then, Terry, I know you said you felt pretty good about getting to that [230] expense-to-average-asset threshold maybe as soon as next quarter. Can you give me a thought on expenses and what's really going to drive that obviously because the Avenue cost saves are not really going to show up until 4Q. So is that just growing revenues faster than expenses or could (technical difficulty) actually come down since you have the cash bonuses here in the current quarter?

Yes, to be clear let me go back on the cash bonuses just to make sure you get that. That accrual is a function of what our projections are versus targets that are set before the year begins, and so we accrue that incentive over the course of the year in order to be in a position to pay it out in January. And so in the case of the first quarter our forecast was that we would be below the targets that were set for 100% payout on that plan which may tell you something about the level of those targets, but in the second quarter we believe that we are in a position to hit the targeted payouts.

And so what you have there in the second quarter is not only a 25% increment to the incentive accrual for the quarter but also the catch-up for the first quarter, and so you have got outsized growth there on that expense line item which would likely more resemble the targeted payout in the third and fourth quarter. So again, just trying to get clear with you on how that expense accrual works on incentives.

I think as it relates to what causes the expense-to-asset ratio to come back in line, as you know, we try to hit that all the time. We have a fabulous expense run rate here as a company. We operate at 220 or so, 230, call it 235 versus peers. That's a very effective expense ratio but our focus is not to manage expense as it is to drive the top line which we drive the top line largely for balance sheet growth. And so again just to get down to what causes that to come back in line is primarily the speed of the asset growth and the revenue growth that is associated with that. And again you might think in terms of an efficiency ratio even though the expense ratio to assets was high, the efficiency ratio continued to decline which again I think is indicative that we have operating leverage and grow the revenues faster than the expenses.

Yes, absolutely and that makes sense. And maybe one last one for me. One of your industry peers had a call just before you, is talking down their growth. You seem to be pretty confident in your release about the rate of growth that you can consistently deliver and any pushback from regulators given your CRE exposure and maybe C&D exposure in particular which has been growing over the last few quarters? Any comments or clarity you can give there?

Well, I just might go at it this way, Stephen. As you know, we are not permitted to talk about whatever conversation we have with regulators specifically, but I just say this. The two principal thresholds that people look at are the 100% threshold and the 300% threshold for construction and for total CRE. As you know we are inside those parameters today and I think broadly you should expect that we will continue to operate around those thresholds. I do not want to say that there will never be a day it wouldn't tick above that, but just fundamentally we intend to operate near the 100% and 300% guidelines.

That said, and I think you know this, those are not regulatory [caps] or guidelines and what regulators expect is if you exceed those guidelines that you have some elevated level of risk management, some elevated level and ability to monitor and stress test cash flows, vacancies, and those kinds of things in those books. And I believe that we have elevated risk management procedures that would be satisfactory where we operate above the 100% to 300% thresholds. But, again, I think you ought to just expect over time we will operate right there in that range.

Perfect. Thanks for all the color and congrats on another good hiring quarter as well.

All right. Thanks, Steven.

Jennifer Demba with SunTrust.

Thank you. Good morning. Two questions. On the hiring you did in the second quarter, can you give us a little more detail on how many and what types of hires they were? And then my second question relates to BHG. Just, Terry, wondering if you can elaborate on the growth opportunities you see in different product areas that could possibly be pursued in the future?

Okay. I'll comment quickly on the hiring, Jennifer. I don't have a breakdown here in front of me so I will just give you a broad color without specifics here. We are hiring across all key revenue producers, meaning that in the quarter the largest concentration of hires would've been financial advisors or maybe the term you would use is relationship managers. And they are probably concentrated within that category probably concentrated in middle-market commercial relationship managers. In addition to that, we continue to hire mortgage originators. We've hired folks in the wealth management line for trust and brokerage, and so it's pretty broad-based hiring and we are having success in each of the four markets, but I would say generally we are having our greatest success in Nashville right now.

Jennifer, I'll just follow up with Terry on that. What we talk about are the revenue producers which were the 29 folks or -- there's probably another 40 or so that are in non-revenue positions that have also been hired in the first half of the year. So I just want to make sure everybody understands that we try to go in there and get -- and just talk about or disclose those guys and those women that are going to be bringing revenues to the firm.

Jennifer, I hope that gets -- you can feel free to follow up and ask further questions, but that is the color on the hiring success in the second quarter. In the case of ongoing opportunities with BHG, and I think you know this, we currently have an arrangement with them where they distribute our credit card as an affinity card to their client set. I want to say that over the last 12 to 15 months they've generated something on the order of $150 million in commitments and $60 million to $65 million I think in outstanding balances, and so that's an example of the kind of thing we're talking about where we can take some product that's useful and helpful to their client set and push it down through their sales distribution and be either the direct beneficiaries, which we are in the case of the credit cards, or the indirect beneficiaries as we are in the case of the other loans they generate produce gain on sale and we share in the revenue stream.

In terms of the other kinds of things that we talk about, we believe we have opportunities to perhaps distribute insurance products down to the doctors' practices that -- again I'm not telling you we're going to do that. I'm just trying to give you some sense of the kinds of things that are being talked about and that we are researching. So we believe there might be an opportunity there. And then the thing that's most exciting to me personally is if we can figure out how to distribute operating accounts. In other words, control the checking accounts, operating accounts at doctors' practices across the 44 state franchise. That would be a powerful thing as well and so we are having dialogue about that kind of thing, too.

So again, Jennifer, I want to be clear with you I'm not trying to oversell the future capabilities. I love what we have and if it continues like this it will be a fabulous investment, but I do get excited by the incremental opportunities that we hopefully can produce.

Thanks very much.

Tyler Stafford with Stephens Inc.

Hey. Good morning, guys.

Hey, Tyler.

Hey, I wanted to start on BHG coming at it from a credit perspective. Harold, I know in the past you've talked about these loans being nonrecourse but can you talk about the put-back risk to BHG from the purchasing banks and walk through any kind of hurdles that have to be met in order for them to put those loans back to BHG?

Sure. Well, first and foremost management of BHG and the Board of BHG has to approve any kind of substitution that may go on there, but basically let me just start at the top. The documents are real clear. BHG sells those loans without recourse, but what they do in order to create good business with the funding side or the Community Bank Network is they will substitute a loan for a loan that may look to be deteriorating in credit quality, and BHG has certain processes and procedures they follow with respect to that and if the Community Bank follows those procedures then BHG, if they believe that Community Bank is in good stead with BHG, they will go through the substitution process.

I think in May or June, I can't remember the month, there was about $1 million in substitutions. I think in one month there was maybe $600,000 that I saw, but all of those have to be approved by the Board and again the bank that is asking for the substitution has to follow procedures with respect to is it within five days of it being 90 days past due and all of those sort of things. BHG does that only because they want to keep that Community Bank funding network active and so -- I don't know if that gets at it Tyler --?

No, that's helpful. What are the typical reserves that BHG has on those credits and remind us what I guess the loss rates were prior cycle?

Thus far -- well, I'll just say this. Thus far this year they're running about a 2% loss rate. They keep about 3% reserves. Well, there is a 3% cash reserve that they maintain for every loan that is sold to a community bank and then there's another allowance for loan loss reserves they keep on their own balance sheet to cover any losses as a result of the substitution process. They also have other products with various banks where they share the credit risk on some but that's probably about 5% to 10% of their business volume. So it's not a big component.

Got it. Okay. And then maybe just BHG for the quarter. Do you have what those originations were? And any change, material change, in their gain on sale margins?

No. The spread is still running about 8% to 10%. The business flows, and I've got it somewhere here, Tyler, and I'll get it to you, but last year they did $450 some odd million in originated credit. If they hit their numbers this year, they will see a nice little increase in that number. So, so far so good this year. It looks to be they'll outpace last year.

Okay. And then last one for me just on the margin. Can you hit the accretion impacts this quarter and last quarter? And then I guess high level -- are you still thinking kind of a 2 to 5 bps margin dilution from Avenue next quarter? And I'll hop out. Thanks.

Yes, I think revenue it's probably going to be that. We don't have all the purchase accounting issues wrapped up on Avenue yet, so we still think there's going to be to a 2 to 5 basis point dilution to the margin. First quarter we had 20 basis points or so in purchase accounting accretion on the margin, same thing in the second quarter. So with CapitalMark and Magna's numbers coming down, those numbers will come down too. We've still got I think about $18 million worth of purchase discounts with respect to Magna and CapitalMark, of which about $15 million of that is accretable into the yield. So there's still quite a bit left to go with respect to CapitalMark and Magna. We think Avenue is going to end up being $10 million to $12 million in purchase accounting adjustments as well.

Maybe one more followup then. Do you have how much you've recognized so far from CapitalMark and Magna?

It's been about $10 million.

Okay. Great. Thanks, guys. Very helpful.

Jefferson Harralson with KBW.

Hey, guys. Thanks. I'll ask a BHG one as well. We saw a lot of buildup throughout the year of seasonality in BHG but we had such a big increase. Once you hit Q2 this quarter -- this year, should we see a similar seasonal increase as we go throughout the year? Should we expect originations and sales to increase throughout the year?

Yes were not expecting them to throw a third quarter at us at the same growth rate 2Q over 1Q. I think they're going to be pretty steady here out for the rest of the year. We think they'll outgrow us in 2016 compared to 2015. So I think their pipelines look good. I think they hired some people on the front line, so it's going to be a good year for BHG.

Okay. So what I hear from that is maybe higher but not the same growth rate most likely?

No, you won't see the same growth rate between 2Q and 1Q.

All right, thanks a lot.

And I'm showing no further questions at this time. Thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a nice day.

I'm sorry, I do see in other question in queue. We now have Tyler Agee with Hilliard Lyons. Your line is now open.

Good morning, guys.

Hello, Tyler.

Sorry about getting there at the end. I just had some questions on the linked quarter decline in securities yield and given the flattening of the yield curve, what are your thoughts regarding purchase of securities?

Yes, we're only going to maintain that bond book, Tyler, just to kind of keep up with collateral for public fund deposits. You should not expect us to grow our bond book at all. We'll have some incremental impact because of Avenue. They'll come on -- those bonds will come on to ours, but I think we're in the process today of doing several transactions to restructure and get their bonds or kind of make the portfolio look a lot like ours today, so there's some things we can do to enhance yields from that.

Okay. All right. That's all I had.

Our next question Brian Martin with FIG Partners.

Hello, guys.

Hello, Brian.

Hey, just one follow-up, Harold, and then a separate question. Just on the accretion income this quarter. Just a dollar amount of the accretion income. I think last quarter you said it was about $2.5 million. This quarter was that a similar amount or can you quantify that amount? Did I miss that?

This quarter is about $4 million.

Okay. So this quarter was $4 million. Okay. Just the other fees in the quarter. When you look at fee income in total, when you just drill down the other line item, kind of the catch all, that was pretty significant on a linked quarter basis. Did you guys kind of cover was in there? Was there anything unusual? Was it pretty sustainable? You talked about the swap fees, but just the other line item in particular.

No, I think there's about $1 million in there. You might call it in a recurring/nonrecurring bucket. A couple of transactions hit in there that were helpful.

Okay. And then just maybe the last thing, just maybe if Terry can just give a little color about the national market in general as far as the commercial real estate, just kind of the temperature of that market? Is it getting overheated? Is it still at a pretty nice level? Any commentary just in general about the national market would be helpful?

Yes, I don't think there's any doubt that national has been a hot market for some period of time and there continues to be a lot going on in the market. I think if you sort of begin to break down categories and think about well, what drives the growth and so is it credible? Does it still have legs and so forth? My own judgment would be that it still has -- the market still has pretty good legs and here's why. One, a broad category of CRE is hospitality. We are adding a lot of hospitality rooms and so you might look at a glance and say my goodness, they're bringing on a lot of rooms. What would cause that? Is that going to work over time?

The reason for that is or the catalyst for that is we have a new convention center here which has been extraordinarily successful and frankly has only been limited by the unavailability of hotel rooms. So tourism is running at a record pace here and so again obviously for me, hospitality would be an area within commercial real estate that would require the greatest caution any day, any time, but again I'm just trying to say that there is a catalyst that underlies that incremental capacity and seems to make sense. Again, I think folks who have been into this market to specifically evaluate that have generally left with the same feeling I'm describing. In other words, it's rational expansion.

Then when you start looking at the other broad categories there, whether you're talking about office space or warehouse space, any of those kinds of things, the vacancy rates here in Nashville for office are 5.5% or something like that, so you know there's room for more there.

And so again when you get behind it so what causes that, what's the growth? Frankly, it's the growth in jobs and as you know my own belief, and Brian you and I have talked about this over a long period of time, Tennessee is an in-migrator of jobs and has been for quite some time. It is that for a number of reasons but most importantly is the fact that there is no state income tax, it's a low business tax state. It's a business friendly state. It's a right to work state, all those kinds of things, and so we continue to migrate jobs and even headquarters out of markets like Illinois and California and my belief is that will continue for the foreseeable future.

And then middle Tennessee is particularly a beneficiary of that in-migration. In other words, we get growth throughout the state of Tennessee but it is more dramatic here in middle Tennessee. So, anyway, that's just sort of a long-winded way to say we continue to add space at a pretty dramatic pace, but there are underlying reasons for it. In the case of hospitality, it's driven by the Music City Center which is a huge convention center with extraordinary success. And in the case of the other income-producing categories, generally it is driven by job growth in the area.

Okay. I appreciate the color. Thanks, Terry, and nice quarter, guys.

All right. Thanks, Brian.

And I'm showing no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.