PNFP - NASDAQ

Good morning, everyone, and welcome to the Pinnacle Financial Partners Second Quarter 2024 Earnings 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 Financial's web site for the next 90 days. At this time, all participants have been placed on a listen-only mode. The floor will be opened for your questions following the presentation. [Operator Instructions] During this presentation, we may make comments, which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other facts that may cause actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict. And listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's annual report on Form 10-K for the year ended December 31, 2023, and its subsequently filed quarterly reports. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G, a presentation of the most directly comparable GAAP financial measures and the reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's web site at www.pnfp.com. With that, I am now going to turn the presentation over to Mr. Terry Turner, Pinnacle’s President and CEO.

Thank you, Matt. Hopefully, everybody knows we're going to start with this snapshot. Our primary objective here is total shareholder return. And we believe these are the best metrics to ensure we get that done. As always, we begin with the GAAP measures, but for me in quarters like this where there's a lot of noise, the non-GAAP measures are perhaps more revealing. This quarter, our treasury management team here did some extraordinary work, in my opinion, to reposition our securities book, which of course creates a loss on the sale of securities in this period, but provides a meaningful lift to our ongoing revenue and earnings run rates with what we expect to be a slightly better than three year payback. And it increases both tangible book value and risk based capital at the same time, a really elegant and value creating strategy. So looking at the non-GAAP metrics in general, the objective is to have all the balance sheet and P&L metrics moving steadily up and to the right. That's been the case for the better part of our 24 year existence. Unfortunately, as everyone knows, over the last couple of years, earnings for banks have had to recalibrate given the extraordinary impacts of rapidly rising interest rates and an inverted yield curve. Harold tells a story about two campers awakened in the night by big bear. One of the campers stopped to put his tennis shoes on and tie them up. The other camper asked him, do you really think you can outrun that bear? He said, well, I don't know if I can outrun that bear. I just have to outrun you. And so I hate is that this calibration has been required, but I believe that we're outrunning most of our peers. As you look across the top row this quarter, you see an inflection point for revenue, EPS and adjusted PPNR. And you see those lists even as we're attracting record numbers of revenue producers and supporting them with incremental facilities, the truth is, our opportunities to invest in the ongoing growth of our revenue, EPS and PPNR has been even better than we would have projected. Turning to balance sheet growth, I'm very encouraged by the underlying growth going on there. Harold will review the numbers in greater detail, but quickly in a market with prolonged contractions in money supply, many are unable to grow client deposits. But as a result of building important specialty deposit products, we're able to grow client deposits and grow them fast enough to allow us to remix deposit book away from higher cost broker deposits. In the case of loans, our current growth rate is outsized, albeit less than we had originally hoped. Most are aware that we began a strategic reduction of our CRE as a function of risk based capital 18 to 24 months ago. These targets are currently 70% or less of risk based capital allocated to construction and 225% or less allocated to total CRE. We've been traveling pretty fast in the construction bucket. It's now down to 72.5%. So we're rapidly approaching our target there. In dollars, our various categories of CRE loans contracted $76 million during the quarter, which highlights the underlying success we're having among our commercial and industrial clients. So the quarter's numbers have a lot of noise, but the strength in the underlying growth is remarkable. I'd comment across the bottom row, you get a snapshot shot of asset quality. While net charge offs ticked up to 27 basis points in the quarter, we continue to guide to 25 basis points on the year with virtually no problem formation -- problem loan formation at this point. So Harold, let me turn it over to you to let you review the numbers in detail.

Thanks, Terry. Good morning, everybody. We will start with loans, which came in a little less than we anticipated. As a result, we're lowering our outlook slightly for loan growth to 79% growth. We believe our growth will still be outsized compared to our peers. We also still believe that we're doing a great job on spreads, particularly for prime and SOFR based credit. New volumes are coming in at essentially the same spread as the existing ones, so we're pleased in this difficult at best to grow loans environment. One of the keys to our financial plan is increasing repricing on our renewal of fixed rate loans. As the slide indicates, we're expecting about $2 billion in cash flows from our fixed rate loan portfolio to come in over the remainder of 2024, with an average yield of around 4.7%. As the fixed rate loans originated in the first half of 2024, our average yields were around 7.25%, so a meaningful increase over prior yields. Our second quarter yields were only 7.08% on new loans, so we have some work to do in the second half of 2024. Our loan growth targets, we believe for the second half of 2024 should show better than the first half. Interest rate cuts will help some, but in the end, we believe it's about borrowers being more confident about the economy, eliminating uncertainties and need to borrow for growth capital. Our competitive advantage is that we have new lenders that are ready to move market share. To that point, approximately 25% of our revenue producers have been with us for less than two years. Accordingly, we have great optimism about Jacksonville, Washington and Atlanta. By the way, Atlanta had another great quarter, both as the loan growth and recruiting as Atlanta brought in some very impressive bankers in the second quarter. And based on what I hear from mainland Atlanta, they should have a great third quarter. We believe we had another strong quarter on deposit growth. Excluding the decrease in broker deposits, we increased client deposits by more than $700 million, the second quarter having essentially the same result as that of the first quarter. We're pleased with that effort as the second quarter is usually our most difficult deposit growth quarter given tax outflows in April. You will also notice that we moved quite a bit of our deposits into the index deposit product category. Almost 40% of our deposits are now indexed to Fed funds. As we prepare for a down rate environment, this should obviously be helpful. As to 2024 deposit growth, we have lowered our deposit volume forecast within a range of mid- to high-single-digits this year. Some of that is due to our reducing the loan volume forecast, thus putting less pressure on deposit growth. We also plan to reduce reliance on the more expensive wholesale deposits this year. That said, our efforts to grow client core deposits remain as energized as ever. What the Fed does will obviously impact our rate projections for the remainder of the year, but more on that in a second. We do believe our deposit beta has serviced well here as we are probably in better shape than most, as we hit into a down rate cycle. As we said before, we continue to like our competitive position as to deposit rates in our markets. Since last June, our weighted average deposit rates have increased only 33 basis points and that includes the impact of the last 25 basis point raise in July of 2023, 12 months ago. In my opinion, our relationship managers have done an amazing job in managing our deposit costs over the last year. As Terry said in the press release last night, we believe we finally experienced an inflection with a meaningful increase in margin in second quarter to 3.14%. We expect more margin expansion to come in the second half of 2024, as the net interest income growth, we are maintaining our growth rate at 8% to 10% for this year. We have kept our interest rate forecast at two cuts, but delayed the first not happening until November. That said, given the volatility of the data, we can see cuts in September or only the Fed could determine that no cuts will occur in this year. We still believe, absent some really unusual actions by the Fed, two rate cuts or no rate cuts, our 2024 margin forecast seems to come in at a fairly higher range from here. The big news from a balance sheet management perspective was the reposition of the bond book, the credit call swaps and all the other actions we’ve discussed pretty early in the press release last night. We've been working on this for quite some time and finally got all the pieces in place to where we can execute and achieve all of the objectives we want to achieve. We have been planned this for several months and a portion of the increased revenues we had planned to achieve from the repositioning was considered in our outlook for net interest income growth last quarter. That's why we've elected to hold our net interest income outlook of 8% to 10% growth consistent. More on this when I get to the outlook slide a little later, but to say we are pleased with how all this turned out would be a great understatement. We continue to work other less impactful initiatives that hopefully will also bolster our revenue run rates. So at June 30 is PNFP ready for a breakdown interest rate cycle. We think our balance sheet is in great shape and well positioned. Our deposit beta was relatively high on the way up we believe will be as strong on the way down. Our sales force is set up to work with clients once these rate cuts begin. As for credit, we're again presenting our traditional credit metrics. We mentioned [$110 million] charge-off of an owner-occupied commercial real estate credit in the press release last night. That situation deteriorated in the second quarter, thus, we accepted the bid for the collateral, even though we've met $10 million in incremental charge-offs. Our special asset group leaders felt doing so was our best play. We're still working with the non-performing credit we mentioned last quarter. Our special asset group officers are still working with that borrower to minimize loss content for that one. As to our outlook for charge-offs, we're maintaining our guidance with the range of 20 basis points to 25 basis points for 2024. We have also included additional guidance around provisioning in relation to average loans with a range of 31 basis points to 36 basis points. Since our loan growth outlook is less, this year results in reduced loan loss provision all else equal. Loan growth is one of the biggest factors impacting our provision and that as we grow loans, we have to build our CECL reserve at greater than 1% of loan growth. So, fewer loans results in less net interest income but also less provision. So after all that where is credit. No real change in what feels like now for several quarters. Our charts for past dues and potential product loans indicate we are offering in near historic lows, which should be a meaningful indicator as to where credit experience should be headed. The outlook for reduced rates on the short end has to be a good sign, particularly for less affluent awards and small businesses that just don't have the balance sheet that perhaps larger borrowers have. More about commercial real estate. And just so you know, we begin to add in more information on credit primarily for non-owner-occupied commercial real estate and construction in the supplemental slides. Our non-owner-occupied and construction portfolio continues to perform very well. We continue to push for lower exposure for construction. Our target of 70% of total risk-based capital, we believe will be achieved before year-end 2024. Our appetite, as noted by the almost solid rent table on the bottom right is unchanged and we don't anticipate meaningful change this year. That said, we continue to have some interest in high-quality warehouse and some multifamily. But again, let me stress, any new commitments to this space are limited to strategic client relationships only, and no way should anyone perceive more on any sort of offense here. All things considered, we like our commercial real estate book. I know many of you know this, our home limits are very modest. We pride ourselves on a granular book. Our largest ticket sizes for our bank are conservative in comparison to what we hear from other franchises. We just don't seek out the high-profile bulky projects. Now on the fees. And as always, I'll speak to BHG in a few minutes. Excluding BHG and various other non-recurring items, fee revenues were up 6.8% linked quarter. We're pleased to report that our wealth management units had a strong first half and fully expect the efforts of our wealth management professionals will continue through the rest of the year. The fees associated with bank blocking and tackling are also doing quite well. Service charges and interchange both joined linked quarter gains of 8%, 12% respectively. All in, we're again raising guidance for core fee revenues this year, a range of 14% to 17% seems reasonable given the performance of several of our primary business lines in the first half of the year. Second quarter expenses came in about where we thought they would after you back out the expenses connected with our balance sheet repositioning. Importantly, we are increasing our incentive target from 80% to 85% payout for fiscal year 2024. Again, we are raising target points to the fact that we believe 2024 will be better than we thought at the end of last quarter. As you know, the direct linkage between our financial performance and our incentive plan is closely correlated and thus, we can't raise one without believing that the other will move up as well. Additionally, our hiring was really strong in the second quarter with 52 new revenue producers recruited compared to 39% and -- 39 in the first quarter. Going into the third quarter, our recruiting pipelines are very strong across franchise. Terry will speak more to this in a few minutes. With the increase in incentives, strong revenue producer hiring and we call it $4 million impact of loss protection fees from the credit default swaps, we've elected to increase our expense outlook to $960 million to $990 million for the year. Lastly, we presented this slide from time to time. Bringing it back this time because of the bottom book repositioning and just as a reinforcement about how important tangible book value growth is to this firm. Sure, growing earnings is critical but as many bank investors know, keeping a keen focus on compounding tangible book value growth is just as critical. Our tangible book value fared well during the rate up cycle, as we elected to maintain a bond book that minimized our exposure to AOCI hits. Even after we executed a significant repositioning in the second quarter, our tangible book value and common equity Tier 1 ratios expanded along with most of our other capital ratios. Now to BHG. As the slide indicates, originations picked up in the second quarter, which was good news and better results than anticipated. Last quarter, we stated that a higher prolonged rate environment could impact their production assumptions for the year. As a result, BHG believes second half 2024 production will be consistent with the first half, this results in lower production targets for 2024 in the wake of higher for longer and a tighter credit levels. As to placements, total placements were less than originations, which was the opposite from the prior two quarters. This was by design as BHG's total inventory was as standards it's been in approximately three years and BHG's needing to build inventory for larger future orders this year. Also, still great demand for BHG paper both from the auction platform and the institutional buyers. They successfully accomplished an ABS issuance in the first quarter and now thinking the first quarter of 2025 will likely be the next time they fund another such issuance. This is due to competing orders that have been previously negotiated from larger institutional buyers. As to spreads, auction platforms predefined during the second quarter to 8.7%. Balance sheet loan spreads are fairly consistent with the prior quarter. All in BHG believes spreads are holding even in this higher rate environment. BHG still believes when rate decreases do begin, that will be good news to them, not only from a volume perspective but also from a spread perspective. On reserves, BHG did increase reserves in the first quarter for off-balance sheet loans but decreased reserves for on-balance sheet loans. There was a modest uptick in the second quarter credit losses for the off-balance sheet business, which was actual expense related to credit loss for off-balance sheet now at 3.4%. On balance sheet losses were up also to 7.2%. So even though the percentage for on-balance sheet losses increased in the second quarter, the actual dollar amount for on-balance sheet losses decreased. A similar circumstance occurred last quarter, average balances fell faster than actual losses, which is why the percentage loss was higher. BHG believes that they are substantially through the credit issues with respect to the on-balance sheet portfolio. Loans held off-balance sheet by the bank still needs some time, perhaps three to four quarters. Data reflects that 65% of the current losses are attributable to the January '22 through June 2023 vintage credit. The news does keep getting better given BHG's past due continue to approve and hopefully head to pre-COVID levels soon. As to the forward look for origination earnings, and as we mentioned last time, achieving the same level of originations as last year would take great effort in the higher prolonged rate environment, especially given BHG is not interested in adjusting their credit models to achieve volume build. As I mentioned earlier, BHG's second half of 2024 production should approximate first half. So as you look at the chart, it should look a lot like 2021 production levels. As to earnings, BHG is also anticipating that the second half will likely look like the first half. For PNFP that represents a decrease from prior year results of 10% to 15%. BHG always has tactics they can deploy to help their bottom line and increase near-term earnings. They have exited business lines and trimmed their expense base. The second quarter of 2024 did include a loss of approximately $12 million related to exiting our SBA business line. The leadership of BHG has made several strategic decisions concerning their business model aimed at creating a more sustainable business model regardless of the economic climate. The credit pain from the COVID overhang has been real, but I don't think I have ever seen the leadership more optimistic about the near-term and putting all of that behind us. Our partnership with BHG remains as strong as ever. With that, I'll turn it back over to Terry.

Thanks, Harold. Over the last couple of years, we've been through a liquidity crisis as the Fed began right in the money supply compared to a rapidly rising interest rate cycle, an inverted yield curve, increase in credit costs as credit began to normalize with genuine fear about where the credit cost could go in a recessionary environment and a slowing economy, which limits incremental loan demand. That's made it hard on bank stock investors, but I believe Pinnacle offers an extraordinary opportunity for folks that need to own bank stocks. Our well-documented sustainable competitive advantage, which is built on a relentless focus on the work environment in order to attract and retain the best bankers in our markets enables us to leverage our best-in-class service and advice to move their clients from vulnerable competitors. The result is outsized growth through thick and thin with outstanding asset quality. And if we can consistently take share from the market share leaders in our market, we can compound earnings faster and more reliably than peers even in a difficult operating environment. It's how we produce value for shareholders during difficult times and it's a way to realize extraordinary value for shareholders when markets turn bullish and multiples expand. One of the hardest jobs I have is to help investors separate Pinnacle from all the other banks that say they have a great culture, it's unlikely any banker is going to declare their culture is unremarkable. But maybe you can ask them where they rank on Fortune's list of the best companies in America to work for, you can see on the top left, we're number 11, no traditional banks rank higher. Maybe you can ask how many revenue producers they attracted to their firm from their major competitors. On the top right, it looks like we'll have a record setting year even for a long time, prolific higher of revenue producers. But it's not just about how many they were able to hire, perhaps you can see how fast they lose them because turnover is the number one way to demolish service levels and ultimately damage financials. So what's their associate retention rate? You can see on the bottom right, our annual associate retention rate is roughly 95%, and it's that year in and year out. But be critical, some want to carve out various pockets of turnover like people they fired or people whose spouse got transferred or people who retired or died and so forth. For us, it's a simple measurement. If you were on the roster last period and you're not on at this period for whatever reason, that's turnover. You can see here that's very minimal. And it's not just about how many people that they hire. It's not just about how many people they keep. Perhaps you can get them to tell you how their clients view the quality and effectiveness of their client-facing people. And you can see on the lower left, Greenwich Associates, the 4-walls provider market research to banks regarding the commercial marketplace is and our 8-state footprint, businesses with sales from $100 million to $500 million believe our relationship managers are literally the best. For each of those measurements, Pinnacle is the white dot on the range of responses for each of the top 10 competitors in our market. They understand the industry is the best. They understand treasury management is the best and they're the best at proactively providing effective advice. And if they can't give you answers to things like where they rank, recruiting and retention success rates and objective data on how clients review their relationship managers. I'd assume their culture is unremarkable. Answers to questions like these can not only help you separate the wheat and chaff more importantly, to help you understand the likelihood and the reliability of their growth. Of course, simply building a great workplace is not the end game. The goal of creating a world-class place to work of attracting and retaining the best associates is to attract and retain the best clients from other banks. Without this market share-taking strategy, it will be hard to outgrow the market. And as a lot of folks are finding out undifferentiated franchise, undifferentiated franchises are struggling to produce any balance sheet volume at all right now. J.D. Power says of the largest 50 banks in the country, no one, literally no one has been able to create as differentiated as client engaging and experience as we have. I'm obviously excited to have the highest Net Promoter Score among the 50 largest banks in the country. But most important is how we match up against Wells Fargo, Truist and Bank of America shown in red here because those three banks are number 1, 2 and 3 in our markets. In terms of market share, they dominate. Because of our work environment, we routinely attract their best people because of the client experience, we attract their best clients. And this builds like a sustainable competitive advantage for as far as I can see. J.D. Power has quantified the seven metrics that contribute to the Net Promoter Score. They are trustworthiness, the quality of the people, ease of doing business, digital channels, account offerings, saving clients' time or money and resolving problems. What you're looking at here is for the above medium performers among the top 50 largest banks in the country, the scores for each of those seven attributes. As you can see, we're either number 1 or 2 on all, except digital channels where we're number 3 ahead of JPMorgan. So the quality of the work environment and the quality of the client experience we provide is tightly woven into our fabric in a way that would be nearly impossible to unravel. It's why our net interest income grows at a different rate than peers. It's why we produced double-digit fee income growth in our core fee businesses, it's how we afford to invest in the market's best people and support them with incremental facilities in order to propel our ongoing growth when most of our peers are cutting expenses likely damaging their future growth prospects. And so not surprisingly, over the last decade, we provided one of the leading total shareholder returns by rapidly and reliably compounding earnings. In the table below the bar chart, you can see how much the trailing 12 months earnings increased over that decade and how the EPS multiple expanded or contracted. High growth stocks like PNFP have come in and out of favor. That's one of the reasons why our multiple contracted over 40% in the last decade. But even with that outsized multiple contraction, our sustained ability to hire bankers and move their clients, our sustainability to reliably grow balance sheet volumes even with loan demand slack and the Fed's trading liquidity from the system. Our ability to compound earnings growth through thick and thin produce market-leading shareholder value. So we've demonstrated a way to get earnings growth at slack times like we're in now. And beyond that, to be positioned for great value creation when sentiment turns, when it becomes bullish, when bank stock multiples expand and will growth bank stocks trade at premiums. So Harold, let me stop there. I'll turn it over to you to quantify our financial outlook for the remainder of the year.

Thanks, Terry. Now to the traditional slide on our outlook for 2024. As I mentioned earlier, we've lowered our expectations in some cases and raised our expectations in others. Just to recap, for net interest income, we're maintaining the guidance even though we lowered loan growth. We also have a meaningful increase in run rate on the balance sheet repositioning. We're maintaining our charge-off outlook. Our outlook for provision is less this quarter given we think loan production will be less. Core fee income, we believe, will expand and we have increased our confidence levels, which will serve to offset much of the reduction from BHG. Expenses will be slightly higher, primarily due to the increase in incentives or loss protection fee and better than we previously thought hiring success. In the end, we feel more confident about our 2024 outlook given our strong performance in the second quarter, the success of the balance sheet initiatives. And although the macro environment still has some definite uncertainties, it feels like there is some ways to believe that some positive inflection has occurred there as well. With all of that, we concluded that our overall outlook for 2024 is a bit better than last quarter. All of this has to be a good sign for 2025. We're about to start our annual planning effort for next year. Our financial goals will be the same, top quartile revenue and top quartile earnings growth. The investments we've made in our new markets and our hiring success, even with all the uncertainties over the past few years are building blocks we will lean into as we build our 2025 plan. So with that Matt, let's open it up for Q&A.

[Operator Instructions] Your first question is coming from Brett Rabatin from Hovde Group.

Great quarter from you on the growth in the core loan portfolio. I wanted to ask, if I look at the slides on the legacy markets on 28 and 43, the legacy markets are not growing and the deposit growth this quarter in legacy markets was lower than 1Q. How much of that is the repositioning of the loan portfolio? And is there some slowing of growth in legacy markets kind of due to either pricing selectivity? Or just you kind of already penetrated those markets and further penetration is more difficult?

We do think that over time, as lenders are with us for an extended period of time, their growth begins to contract from a percentage perspective. That said, they always -- we always believe they will at least be able to keep up with the broader economy and how that's working. So we don't lower our expectations for our legacy markets, but we do have, as you might expect, so very high expectations for the newer markets as they start from a lower base. I don't think we've got concerns about where we are with our legacy markets and the growth we've got there. As you know, we're in some pretty spectacular markets and we're still looking to hire people. But that will -- as we hire in these legacy markets as we're going to get this growth.

And then the increase in the incentive target from 80% to 85%. Obviously, your outlook is a little better. Let's just say in the back half of the year, either the margin NII ends up being better than what you've adjusted the target for to 85%. Is there a relationship we can think about if the NII is $1 better? How much of that might get taken out or taken reduced by the incentive increase, if you get to 100%?

I don't want to get too specific here, but there is a definite grid that's produced and we'll close it in next year's proxy. So you'd be able to work through that. There's a lot of art here as well as science. I think what's driven our -- first I'll talk about the uptick for this quarter. We've just got a lot more confidence in where we think we'll be for this year. So that's why we felt like we needed to increase the incentive accrual. As for the rest of the year, should like another dollar revenue show up or another dollar of earnings show up is probably going to be somewhere around $0.20 to $0.25 will end up in that incentive accrual but give me some leeway on that because things do move around as we approach year-end. And in the past, we have on occasion kind of taken the named executive officers and adjusted theirs downward in order to make sure we fund everybody else's. So I'm talking about gross numbers here with the 85%. But sometimes we do -- we work with the compensation committee of the Board to adjust it.

Your next question is coming from Steven Alexopoulos from JPMorgan.

I want to start. So on loan growth, the second quarter was a little bit softer, and you guys are taking the full year guide down a bit. I know most of the growth has come from newer bankers moving books of business over the CRE runoff is a factor two. But has the pace of movement from new bankers moving business to you guys, has that slowed a bit here? Is that a factor?

Steve, I don't think that it really is. We work hard to try to quantify things, show the math of things, help people get underneath the numbers and all those kinds of things. The truth is sort of irrespective of how things are quantified, I rely a lot on just what my sense of where people are and those kinds of things. So many times in the quarter, there are things that will cause your loan number to be down. You get a few payoffs you didn't expect a couple of loans you thought were going to close this quarter, close next quarter. All those kinds of things move things back and forth. Just to cut through it, at the bottom, my belief about our pipelines going into the third quarter and fourth quarter feel much stronger, much more vibrant than they would have, say, in the second quarter. And so anyway, I don't know if that's particularly helpful to you, but just trying to get you through. No, I don't think we're seeing a slowdown in anybody's ability to move business. I just think there are odds and ends there, but it feels like to me what gets closed in quarter three and four will be meaningfully better than what got closed in quarters one and two.

I'm just wondering everybody is focused on loan growth. And I was wondering if peers are doing a better job of defending share from some of the bankers they lost, but it doesn't sound that way from your response.

It doesn't feel like that to me.

Okay. And then, Harold, on the securities repositioning, I don't know if you said this earlier, but when did that happen in the quarter? And can you help us think about the NIM impact -- net interest margin impact from that in the third quarter? Like how much should that benefit the NIM?

Well, I'll just put it to you this way. I think we gave enough information in the press release to get you to like a 3% kind of spread differential on the one point call it, $4 billion we reinvested. I think if you plough that into the NIM, you'll get some. We experienced some of that in the second quarter because we reinvested -- we started reinvesting towards the end of the second quarter. And that gave us a little bit of push on our NIM for -- our yields on investment securities, which ended up impacting our NIM.

Okay. But it was back-end loaded in terms of when you did this?

Yes. We have to make sure we had all the counterparty was in good shape. All the attorneys are on the same page, all of that. And so that happened towards the, call it, mid- to late June.

And final question on BHG. So this a pretty notable change in the outlook, right? You went from up mid-single digit for the year, now you're down 10% to 15%. Could you zoom out 30,000 feet and talk about what's really driving the change in the expectations for net income from them?

Yes. I think they've upped their credit out or I think credit will be the most significant change for the second half of the year from what they thought originally. And I think that's primarily attributable to the off-balance sheet, the auction platform loans that are out there. The pace of those banks submitting for substitution has begun to accelerate. And so they're just anticipating more of those losses coming in over the second half of the year.

Your next question is coming from Jared Shaw from Barclays Capital.

Maybe just going back to the discussion around the expansion markets, but looking more on the deposit side, is there a noticeable difference in the cost of deposits in those expansion markets? Are you using pricing to -- on the deposits to really drive some of that? And is that also, I guess, include ECR in that discussion as well as sort of overall interest expense?

Yes. I think -- I would say generally the answer to your question on, are we using pricing to move the clients? I don't think that we are. There's no doubt if you're moving a client from another bank, you're probably not going to get them to come over and accept a substantially lower interest rates. So to the extent you're moving at a high point in the cycle, it might be a higher rate than what your average funding rate is. But just in terms of matching off the rates for the marginal production and market extensions versus regular markets, I don't think you would find much difference there. I think another thing, Jared, that I think is kind of important. When you go to the Greenwich data, in our -- across our whole footprint, all in, roughly 80% of our clients view us to be their lead bank. And so I'm only making that point to say it is the same in these market extensions. Our relationship managers are moving their clients and those clients are switching their lead bank from somewhere else to us. So anyway, the -- I would say that the marginal production would be similar, of course, the growth rates higher, but at least as it relates to pricing, I would say, it'd be similar to the marginal production even in legacy markets.

So, just to give you a little fact. We keep up with new account pricing on the deposit side, obviously. New accounts came in at about 390 in the second quarter. And that's all of them. Every new account that went over the deposit system. And that's about 10 basis points to 15 basis points higher than what was in the first quarter. So it was a significant kind of uptick for new accounts. I appreciate the deposit book behaves a lot differently than the loan book. The deposit book has a lot more kind of fluidity in it. So you've got old accounts that are also repricing and -- but the new accounts that we had to attract to our balance sheet came in at 390.

Okay. And then -- when we look at the CRE book and you're letting that slowly run down with payoffs. Once you hit your target of the 225% capital. Do you expect to continue to see that go lower from there? Or at that point, you would re-evaluate the appetite and we could expect to see growth in loans to maintain that 225%?

Yes. No, I think the simple answer to your question is we would expect to reengage and target the allocation at 225%. Our belief about that is that asset class will continue to be a really important asset class for our firm. We just felt like it needed to be a smaller allocation in terms of what it meant to our risk-based capital. I felt like that was appropriate, both because of the economic conditions and just because of how we desire to run our balance sheet going forward, we desire not to be -- have an outsized concentration in CRE for all the reasons that you know and understand. But yes, we haven't done a RIF. All the people still here. We have clients that continue to be a dialogue with us about subsequent requests, all those kinds of things. And so a long-winded way to say, yes, we expect the growth to pick up.

Your next question is coming from Brandon King from Truist.

So you mentioned in [December] that the fixed rate lending has been challenged by the rate environment. So could you give us some context as far as how you're trying to navigate that? And also, how does that inform how you think about loan yields going forward?

Yes. In the second quarter, we were down at $708 million on new fixed rate originations, but they were only about 15%. So I think what I need to do is reengage with the market leaders and figure out what's going on. I'm sure there is rate pressure from the markets, but we still need to, I think, do better. So I think it's more about sales emphasis and getting those yields back up to where they're closer to that, call it, $725 million, $750 million. Our target is $750 million on the low side. So we're going to continue to hang that out there for our relationship managers to see that. That’s what we want to get, we get it sometimes but more times than not, like the averages indicate we don't. But we're going to keep applying pressure there and try to achieve that. The spreads on floating and SOFR based credit their handles are higher at the current time because we believe a lot of borrowers are opting to go to that channel as have a lot of our fixed rate loans, they've moved into blooming and SOFR based because they believe the rate decreases are coming, and they're going to try to take advantage of that. So what we try to do in treasury is make sure we manage that effectively so that we don't get out of whack from a balance sheet perspective and right now, we feel really good about where we are. Did I get to your question, Brandon?

Yes, that answers it. And then in regards to the shift from deposits to index deposits, is that move complete? Or are you planning to do more of that in the coming quarters?

I think it's pretty much done. We've kind of hit where we bought our threshold ought to be for that. Obviously, there's a lot of larger clients that moved in that direction. We were pleased that the overall yields and the deposit yields didn’t go up a lot as a result of that. And so any time you engage with a client about their deposit rates, you're always going to be faced with, well, you need to pay me more. But we are really pleased that our relationship managers held at and check the way they do.

Your next question is coming from Catherine Mealor from KBW.

Maybe just following up on some of the margin outlook. Just maybe first on the securities deals. I know you mentioned, Harold that most of this bond restructure happened in the back half of the quarter, but you still saw a pretty big increase in your bond yields this quarter. And so just trying to think about if you can give us kind of an indication of where you think maybe bond yields will maybe start third quarter once this is all put together?

Yes. I think we all see an increase in bond yields that will be part of the increase in the margin going forward. The first quarter bond yields were down. We had some cash that we're sitting in some investments that were under yielding. So we believe we'll see this uptick going into the second quarter -- third quarter, I'm sorry, yes.

Okay. So it's fair to say, I mean, if we’re not only just bond yields, one, to calculate the impact of the bond restructure, but the $1.5 billion at 3% better spread, but then add in there was also an increase in just kind of core bond yields in the second quarter, like more relative to what we saw in the first quarter?

I think that's an accurate assumption.

And then on loan yields, is it fair to also think that with the $2 billion repricing, maybe you get a little bit of a better fixed rate new origination levels and then maybe a little bit better growth in the second half of the year that we could see a higher kind of per quarter increase in loan yields in the back half of the year than what we saw in the first half of the year?

Our research would indicate we fully expect to see fixed rate loan yields in the third and fourth quarter to increase on renewals and originations from what we experienced in the second quarter. We ought to be more -- we ought to get closer to those targets.

And then maybe just one more off of the margin. On BHG, you mentioned that you probably won't see another securitization until the first quarter of next year. And so, what do you think BHG's preference is for placements? Do you think you'll see more kind of auction movement or more of those one-on-one negotiated transactions with PE firms?

For lack of a better word, they've got orders from various firms for loan volumes that are pretty much in BHG's option as to when. So talking to BHG, they will manage their production or they'll manage their placements between the auction platform and these large institutional buyers to try to make sure that they -- because they get gain on sale treatment with the auction platform. That's what they're going to try to manage to. So you'll probably see more loans going to the auction platform here in '24 than what happened in '23.

Your next question is coming from Timur Braziler from Wells Fargo.

Maybe just following up on Catherine's last question there on BHG. Just looking at the placements this quarter, kind of the link quarter decline and then the bank buyers and the funding network that unique buyer kind of declined in the quarter as well. Is that any indication for broader demand for the product? Or is there something else going on there as to why placements maybe slowed quarter-on-quarter?

Yes. I think, first of all, I think the market on the origination side has -- like we talked about these originations are going to be fairly consistent for the rest of the year, which I think are down from two or three or four years ago, and that's all because of where the interest rate cycle is and tightening the credit box. So obviously, if they loosened up on the credit box or if the interest rate cycle began to turn down, their production numbers would go up. The demand for their product on the bank side and on the institutional buyer side is as strong as it's ever been. They could probably sell 2x loans into their networks, but it's making sure that the loans that come into the firm are consistent with their credit underwriting -- so that's where the -- I guess there might be a limitation as far as growth rate. Does that make sense, Timur?

Yes. That's helpful. Maybe switching over to margin and a nuance question just on your guidance. So the current guidance is for margin up in 3Q. The previous year-on-year guide for margin is flat to slightly up. Does the current guidance kind of supersede that or year-on-year margin? Are you still expecting that flat to slightly up for the year?

I think it will be flat to slightly up. I have to go back and revisit that assertion, but I think it will be flat to slightly up for the year.

And then, just last for me, maybe revisiting Brett's first question on incentives. If I remember correctly, I think on the fourth quarter call, there was some comment made that in order to hit 100% of incentives, earnings would need to grow year-on-year. Is that still the right way to think about it if earnings don't grow, the incentive rate should be somewhere lower than 100%?

Generally, what we do is we'll put target at a certain level that we believe is fair to everybody. And I think for this year, full target payout was around, call it, somewhere in that neighbourhood. I'll say it that way.

Your next question is coming from Stephen Scouten from Piper Sandler.

I guess I had one question around the reduction in asset sensitivity that shows in your disclosure quarter-over-quarter. Is a lot of that coming from the move in the negotiated rate to index deposits? And if so, should we see a near-term spike in kind of the costs related to that migration?

No, I don't think there's -- as far as the absolute cost of interest expense, I don't think you'll see a big increase at all. And I think our relationship managers we're able to negotiate that pricing within a pretty thin, call it, range between what they -- between the negotiated price and what they're paying today. But that is contributing to where that interest rate risk sensitivity table that neutrality that where we are today is probably -- we're probably as neutral as we've ever been.

And that was the biggest quarter-over-quarter shift there. Was that transition?

Yes. That's right.

And then just kind of thinking about the CRE concentration and the guide at these 225 % and such, I mean, obviously, they're a lot lower than maybe stated regulatory concern level. So I'm wondering -- and I know, Terry, you commented on this some already, but is there any part of this that creates or is intended to create optionality if an M&A opportunity ever were to occur? Because to me, like the last time you guys really got elevated was when you bought BNC and so I'm just wondering if, starting at this low level in any way, increases optionality to be able to buy something that might be more concentrated.

I think just on the underlying assumption, Steve, on M&A, I don't think we're spending any time and energy trying to figure out how to acquire bank. I think the case is that where our ability to attract people and move books business is so dramatically good. It's just hard to figure out why you would want to acquire something. So I guess, said simply, I don't think that's a motive at all. The motivation, I think there are two motivations for taking it out. I think one is we have had a belief that the market was sort of peaking and it was probably a time to have less capital allocated to it just in terms of general risk management. But equally important in terms of the profile from an investor perspective, it was our desire to get off the screens for people that are highly concentrated in CRE. As I said a little bit ago, I mean, that's an important asset class to us and we're going to always be in that business. But we just felt like it would be wiser to get more to the middle of the pack in terms of what the level of concentration was just, as you know, a lot of people are screening for CRE concentrations and we'd just rather be in the middle of the pack.

Your next question is coming from Russell Gunther from Stephens.

Just one for me at this point. The release referenced commercial loan categories where you were able to put enhanced control processes in place and reduce related RWA, just would be helpful to get some increased color as to what portfolios were impacted and if there's the potential for similar actions going forward?

I'll answer it this way. We didn't disclose the portfolio primarily around privacy issues. It's a fairly narrow band of loans. It's a meaningful amount of our credit. And so obviously, concerns are why we didn't want to talk more about what portfolio it was and so on and so forth. But what we did want to talk about was that we've enhanced our control structure and those enhancements are meaningful, they're expensive and they're ongoing to be able to get that recharacterization, I'll say it that way. But we've elected not to do that, but there will be future opportunities in that portfolio to continue to do this with new credit. I apologize for not being able to tell you more about it, Russell but the -- that business line is pretty important to us and it's a pretty sensitive kind of group of people. I'll put it that way.

I appreciate what you're able to share. And the rest of my questions have been asked and answered.

Your next question is coming from

Just a quick one for me on the deposit front. You guys have been able to keep non-interest bearing deposits flat pretty much since year end. Just kind of curious how that fits into your overall deposit guide? Is there any point where you guys are starting to think that you can win back those interest bearing deposits? Any color you can give there would be helpful.

Yes, our guide would include consistent performance in our non-interest bearing volumes. Right now, we believe we're hopefully at the bottom and we'll be able to grow non-interest bearing from here. We've had quite a bit, call it, 15% of our new account growth is non-interest bearing. So there are new accounts coming in. And we're hopeful that a lot of new account growth, even though it's at 15% at that seed money put into non-interest bearing that will grow over time. So call us optimistic, but we believe we'll see that number perhaps expand. But right now, our planning assumption is that it's going to be fairly consistent for the rest of the year.

Your next question is coming from Brian Martin from Janney.

Just a couple of small ones for me. Just the tax rate, Harold, going forward, what's -- I know you mentioned something in the release, but just as far as how we should think about that going forward where that lands?

We believe the capital optimization, bond repositioning all that, that we'll go back to kind of a more consistent tax rate going forward than we have probably in the first quarter, fourth quarter, that kind of thing. So we feel like we'll be back at those levels.

Like a 4Q level, okay. And then just on the fee income, was there anything kind of on not sustainable on the run rate when you look at this quarter without focusing on individual line? I mean, it felt pretty good. It was strong across the board, but anything unusual in there that might not be sustainable as you look going forward?

No, I don't really think so. I think there's two -- well, there's one area and that in the valuation of some of these unconsolidated investments that we have, but I don't think there is anything -- I don't think there's anything unusual there. So we didn't feel like we need to call out anything this quarter. Last quarter, we had that mortgage servicing right income. And so that's why the decrease in that line item.

And then just last two is maybe on the loan growth for Terry, just the optimism on the loan growth in the second half versus first half, any -- I mean, the key driver of that, Terry, I guess what would you point to there just given you seem a lot more optimistic than the first half?

Well, I think it just has to do with what the pipelines look like. And as you would guess, and as all the numbers have indicated for a number of quarters, the principal provider of the growth is new hires. So as we continue to hire people, they continue to move books. And Brian, you know how that works. I mean some people move them open a day, some it takes a month or two or a quarter or two or whatever to get it done. But it just feels like, as I say, in pipeline discussions that we're in a stronger position today than we would have been 90 days ago.

And then just the last one on the margin. I guess given the repositioning, I guess, if you think about the margin in the back half of the year, it would seem that the third quarter margin expansion is greater than the fourth quarter margin given the full quarter impact. So, just kind of wanted to confirm that and just kind of the puts and takes there. And then just remind us the impact of in a down rate environment, the sensitivity of the balance sheet and how that would perform?

I think from a margin perspective, we're pretty tight on whether or not there's any rate decreases or increases from here. We obviously don't think there's any more rate increases. But we should see continued margin positive moves there going into the third quarter and begin into the fourth quarter, particularly if we can hold on the non-interest bearing deposit assumption and we can get repricing on these fixed rate loans and all of our spreads on all this new -- on this new loan volumes. I just want to reemphasize because I don't know if we've gotten this out very much about these relationship managers that we've hired over the last couple of years. We've got a lot of them out there and they're all in these new markets. A lot of them are in these new markets. So we have reasonably optimistic that we'll see this loan growth pick up here in the second half.

And then just the thought on the margin. Harold with the linked quarter change in 3Q versus 4Q, would that kind of make sense as far as the pickup you could see in 3Q being greater than the 4Q, just given a full quarter impact of the optimization. Is that the right way to look at that?

Well, there will be some -- there's some money in cash at the end of the second quarter from the optimization that will get reinvested in the third quarter and maybe some higher yielding assets. So it could happen. I don't know if there will be a meaningful amount of uptick or not, but it could happen.