Pinnacle Financial Partners Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.16.13 | About: Pinnacle Financial (PNFP)

Pinnacle Financial Partners (NASDAQ:PNFP)

Q3 2013 Earnings Call

October 16, 2013 9:30 am ET

Executives

M. Terry Turner - Chief Executive Officer, President, Director, Chairman of Executive Committee, Member of Directors Loan Committee, Chief Executive Officer of Pinnacle National Bank, President of Pinnacle National Bank and Director of Pinnacle National Bank

Harold R. Carpenter - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Chief Financial Officer of Pinnacle National Bank and Executive Vice President of Pinnacle National Bank

Analysts

Michael Rose - Raymond James & Associates, Inc., Research Division

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc., Research Division

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

Matt Olney - Stephens Inc., Research Division

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

Peyton N. Green - Sterne Agee & Leach Inc., Research Division

Brian Joseph Martin - FIG Partners, LLC, Research Division

Operator

Good morning, everyone, and welcome to Pinnacle Financial Partners Second Quarter 2013 Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer. He is joined by Harold Carpenter, Chief Financial Officer. Please note, Pinnacle’s earnings release and this morning's presentation are available on the Investor Relations page of their website at www.pnfp.com.

Today's call is being recorded and will be available for replay on Pinnacle’s website for the next 90 days. [Operator Instructions]

Before we begin, Pinnacle does not provide earnings guidance or forecast. During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other facts that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements.

A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10-K. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events or otherwise.

In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial website at www.pnfp.com.

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

M. Terry Turner

Good morning. In the call over the last 7 or 8 quarters, we tried to outline our long-term profitability targets and more specifically, the targets for each growth component of the P&L. Third quarter was another solid quarter of execution continuing to some nice improvement and growing the core earnings capacity of the firm. Third quarter operating highlights included, beginning on the top left and working counterclockwise around that slide, continued asset quality improvements, which free up elevated reserves. Nonperforming assets, total loans and OREO are now just 89 basis points and the adverse of classified asset ratio is now just 20%. Despite intense pricing competition, we set another record for net interest income, to some extent, due to the pricing power we've exhibited on deposits but largely due to our ability to grow loan volumes.

Thirdly, we set another record for core noninterest income with 5.8% linked-quarter growth and 22.4% year-over-year growth. And we continued the trajectory toward our ratio of expenses-assets, which we've targeted at 2.10% to 2.30%.

Looking a little further at the net interest income growth, despite modest contraction in the margin percentage during the quarter, there were really 3 primary contributors to the growth. Number one, continued growth in low-cost funding. Our average DDAs are up 37% year-over-year. Number two, continued reductions in the rates paid on deposits. But thirdly, and most important is our ability to grow loan outstandings. The net result for the third quarter was an 8.9% increase over third quarter of 2012 for net interest income.

Third quarter was below my expectations, frankly, in terms of loan growth. In the period, loans increased by $44 million during the third quarter. That's below the pace of the second quarter, as well as that for the third quarter of 2012. And I'll say that loan demand continues to be spotty. And the lack of increase in loan utilizations also, I think, would signal a less than robust economy. At the risk of degradation, I'll offer that -- I believe the political landscape undermines business owner confidence and continues to weigh on economic growth prospects. But thankfully, we are having great success, continue to have great success moving market share. In fact, Harold will review it in greater detail here in just a few minutes. But you'll see that our loan originations in the third quarter of 2013 were virtually identical to those of the third quarter of 2012. But the volumes of payoffs were significantly higher in third quarter of '13. We also had several loans scheduled to close in the third quarter that were deferred into the fourth quarter, which gives us some optimism about what may happen in the October through December time frame of this year. And I think maybe most importantly, over the planning horizon, I continue to be confident that our associates in the markets that we serve will enable us to achieve the 3-year volume targets that we've been talking about for the last 1.5 years.

Thankfully, again, during the third quarter, we were able to offset some of the loan yield contractions by continuing to lower our cost of funding. We got that done while growing our average deposits by 5.9% during the quarter. We'll talk some more about this later in the call, but I believe our ability to grow this deposit base so substantially while lowering the cost of deposits so substantially is indicative of the differentiation that we continue to build versus our large regional competitors.

When I think about building franchise, nothing is more valuable than the ability to take client share in attractive markets at suitable pricing. So we like to include this chart to illustrate the franchise value that we've built. The red line is the client margin, in other words, the yield on loans less the cost of client deposits. The blue line is the treasury margin, basically, the yield on the securities book less the cost of noncore funding. And the green line is our actual margin, the amalgamation of the two. The goal is not to minimize the importance or impact of the treasury margin at all. But it can be volatile, given: number one, the absolute level of liquidity of the firm; and number two, the absolute level of rates. But we do want to emphasize the customer margin since we believe this is what really drives the absolute growth of the firm, the profitability of the firm in the long-term franchise value. I believe a 4.09% client base margin is extremely valuable, especially for our commercially oriented franchise. So again, it's my belief that this success with clients is what really yields sustainable long-term shareholder value.

Switching now to noninterest income. During in the third quarter, we saw core fee income growth of record level for our firm, up 22.4% over the same quarter last year. We've seen outstanding growth in service charges, brokerage or investment services and trust, well more than enough to offset the declines in our mortgage origination business, which I'll talk further about in just a few minutes. If you think about the long-term profitability targets that we've set for each major element of the P&L statement, so [indiscernible] work is critical that we grow our fee income as fast as we're growing our loans or our balance sheet. And as you can see a 22.4% rate of annual growth over the last 4 quarters, we've obviously been able to go on and do that. I might also point out that we originally established a target for fees to assets of 70 to 90 basis points consistent with the long-term profitability targets. And adjusted for security gains and losses, we were above the target range at 96 basis points for the third quarter.

So as a summary, let me review the performance against the long-term profitability targets. I believe we began probably discussing these long-term profitability targets on our fourth quarter 2011 earnings call. As you can see, we've made substantial progress towards the achievement of those targets, and we're now operating near or at the lower end of the target range for ROAA. Also, as you can see, for each of the components required to sustain a 1.10% to 1.30% ROAA, we're now operating better than or within the targeted range except for the expense to asset ratio. Although the noninterest expense to average asset ratio dipped into our target range for the second quarter 2013, we didn't actually achieve our targeted run rate. In reality, this is a second quarter's accounting treatment for reclassifying loss reserve for all of balance sheet exposure to the loan loss reserve, which we discussed in detail last quarter. In other words, the true expense run rate during the second quarter would have been approximately $2 million higher, but for the reallocation of off-balance sheet reserve to balance [ph] the loan losses. That said, the key for us to continue the trajectory towards that number into the targeted range is to contain expenses while growing assets and revenues, which has been our stated plan for quite some time, in which we continue to make progress on in the third quarter of '13.

So let me turn it over to Harold to review in greater detail our strategies and execution in order to continue the increases in that operating leverage.

Harold R. Carpenter

Thanks, Terry. As Terry mentioned, we're going to switch gears now and eventually discuss operating leverage. But first, a few comments about growth in loans and deposits as loan and deposit growth is the key to achievement of our operating leverage targets.

We've been highlighting this chart since January 2012, and it was our belief that our existing relationship managers, plus several new managers that we hired, have the capacity to produce approximately $1.3 billion in net loan growth over roughly a 3-year period of time. In this chart, we are plotting the actual production to date against the 3-year target that we outlined 1.5 years ago. We've always cautioned that you should expect that we'll produce the loan growth on a straight-line quarterly basis. During 2012, we had a quarterly low of $46.5 million of net growth and a quarterly high of $187 million. For round numbers, we're up a net $420 million in 2012, and we're up $258 million in 2013. In total, since we announced our stated loan growth target of $1.3 billion in January of last year, we've added a total of $678 million in net growth, which equates to a CAGR of 11.3%. Considering the headwinds that, we believe, banks are facing to grow loans and the required figure [ph] to hit the $1.3 billion target of loans by the end of 2014 at 11.5%, we consider that we are essentially on plan.

We introduced this to you last quarter. Our communication objective here is to highlight our sales force's efforts and move the market share to our firm in order to produce outsized growth in a slow-growth economy, which prevails [ph] our relationship management asset and determines where the new loans are coming from.

All in over the first 9 months of this year, we recorded almost $850 million of new loan volumes, including any net changes in the lines of credit. As the chart indicates, 50.2% were the existing Pinnacle clients we likely chose to undertake deferred CapEx, had grown working capital requirements or perhaps a new venture, while 49.8% were the new clients. This capability to capture our move market share is tied to our hiring philosophy of hiring well-known lenders in our market who have the potential to move the large book of clients to Pinnacle. As you can see, without this ability to take share, loan growth would be much more muted.

Now as to the blue bars. Let me discuss new loans, and that we are very pleased with the energy of our sales force, as new loan volumes equate to almost $950 million. As to the green bars, and as we've mentioned in earlier calls, we have many other banks who are experiencing significant levels of payoffs. That is a headwind to loan growth and was again meaningful in the third quarter of 2013. During the third quarter, we recorded payoffs and paydowns of approximately $246 million. As we mentioned in our last quarter conference call, we anticipate that the third quarter to be another quarter of significant loan payoffs. We continue to believe that the acceleration in loan payoffs is largely tied to 3 phenomenon. Number one, the availability of long-term fixed-rate nonrecourse credit for income-producing real estate, net drilling accounts from nonbank providers like insurance companies and REITs. Number two, even though business owners may not be ready to expand operations, they do appear to have confidence to reduce their liquidity and investor loan to part with some of the cash that they have been storing up and reducing debt. That's particularly true, given the fact they can only earn so little for that cash. And then number three, liquidity events for businesses. Since the live owners decided to cash out but still has an unwillingness to risk another business's downturn or are concern about new regulation that are coming out of Wall Street, which may present added risk that these owner operators may not want to deal with. Nevertheless, because of these factors, our expectations that payoffs in the first quarter 2013 will continue to be higher than we would otherwise like to see but, hopefully, less than the third quarter.

The chart reflects commercial lines of credit and as you can see, we have more than $2.1 billion of total commitments of which 54.6% is funded. Line utilization over the past few quarters has remained fairly stable. Again, reflecting our ability to take market share, total commitments are up more than 16.5% in the last year, and unfunded commitments are up more than 21.3% in the last year. The lack of growth in line utilization generally reflects a weak economy, but we believe this presents us an opportunity for future growth and, hopefully, more unfunded commitments were turned into loans as the economy improves.

We've included these charts again as they are one of our ongoing critical to-do's, which is to fund loan growth with quality funding or DDA interest checking and money market accounts. The chart on the left depicts our deposit book transition from being predominantly CD-funded to now predominantly transaction and money market account funded. This did not happen by accident. This was an intentional effort of our entire sales force and their leadership. We believe that transaction account deposits are the most valuable product on any bank's balance sheet. Now the chart on the right, the question has been how can we fund our loan growth and hit our 12/31/14 targets. The answer is simple, we'll keep on. We've seen growth in transaction and money market account consistently over the last several years. And for the last 7 quarters, the growth in these very variable deposit accounts exceeded and represents 111% of loan growth.

Now as to operating leverage. Our core efficiency ratio is at 56.8% excluding those items noted on the chart. You will note then the second quarter, as Terry just mentioned a few minutes ago, we had $2 million of credit to other expenses for an off-balance sheet reserve reversal for our line of credit that was funded in the second quarter and that the $2 million reserve reversal is offset by $2 million increased provision for loan losses. We've built off balance sheet reserve for the line of credit over the prior 1.5 years. Excluding the $2 million allowance reversal, our efficiency ratio would have been approximately 56.5%. Thus, the core efficiency ratio for the third quarter was up slightly from the second quarter.

As you know, one of our long-term profitability measures is the ratio of expenses to average assets. That number again, including those items, was 2.44% for the third quarter, which is disappointing to us as it puts us outside of our long-term profitability range of 2.10% to 2.3%. We are focused on eliminating any unnecessary expenses, as our senior leaders are looking to find appropriate ways to increase operating leverage of our firm. However, the primary strategy to decrease and to ultimately achieve our long-term expense to average asset ratio will be growing the loan portfolio of this firm, with the corresponding increase in operating revenues.

Now I'll turn it back over to Terry to focus on a number of items that may impact our growth earnings and valuations going forward.

M. Terry Turner

Okay. Thanks, Harold. We introduced this slide last quarter, and given the continued market rate volatility, we thought we'd update you again. As you know, we began emphasizing floors in 2008 and 2009. We believe we've been quite successful. The difference between the contract rate and the floor rate provided us meaningful returns over the last several years. Substantially, all of our floors are tied to prime or 30-day LIBOR and 90-day LIBOR. And should those rates change materially, it would take a meaningful rate move to get us to where we'd be earning more money. However, we don't believe those rates are going to change meaningfully in the near term. And in fact, particularly for the Fed's funds rate, based on what we hear, we don't think those rates will change quite some time. So the question we've been debating internally for the last 2 years honestly is when we begin to deemphasize floors but we continue to believe not yet.

You can see from the blue bars, we have about $50 million more in variable rate credit with floors than we had 6 months ago. Secondly, the difference between the average floor rate and the average contract rate has decreased steadily over the last few years and is now at just 87 basis points. There's no real management initiative to make this happen; it's really about market pricing. So we believe that the floor to contract rate difference will continue to decrease primarily because competitively, it's just become more difficult to garner floors of any significant yield above the contract rate. And so I'm quite confident that eventually we'll de-emphasize floors and gradually reposition our loan book when it's more likely the short-term rates will be moving up.

So in summary, I feel good about where our balance sheet is positioned, given where we are in the rates cycle.

With that in mind, I want to comment on our outlook for the net interest margin. Over time, we've made significant progress on our net interest margin even though we saw slippage from 3.77% in 2Q13 back to 3.72% in 3Q13. As we mentioned earlier, there are really 3 factors that should positively impact our margin going forward, as loan growth, continued reduction in cost of funds or rates paid on deposits and growth in low-cost core deposits. But nevertheless, we expect the compression in loan yields will remain a significant factor such that the margins are likely to be flat to down in the fourth quarter of 2013. We still anticipate remaining within the 3.7% to 3.8% range. As I hopefully made clear, despite margin fluctuations, we expect to continue growing net interest income, primarily based on our ability to grow loans in core deposits.

Most banks have enjoyed a robust home mortgage refinance market in terms of the fee income derived from those refinances. Many investors are rightly concerned about the impact of rising long-term rates on bank P&L's as refis become less attractive. We view the risk of Pinnacle’s P&L as refis continue to slow or cease altogether as minimal. In the chart on the left, as you can see, while our mortgage originations have been elevated during this period of heavy refinance, the mortgage origination business is a relatively smaller portion of our fee income compared to our banking and wealth management businesses. And in the third quarter of 2013, our mortgage originations comprise only 2.4% of our total revenues. Furthermore on the right, as you can see that our mortgage units rapidly transitioning back to originating purchase money transactions. Actually, back to pre-recession mix in the third quarter of '13 with refinance comprising just a third of our mortgage origination revenue. Just a credit to the management and mortgage origination group, to some extent, but it's also reflective of the health of the Nashville and Knoxville single-family residential market.

This slide paints a picture of the point that Harold made relative to increased production that we expect from our existing expense base. Our headcount leverage has been significant and, we believe, compares favorably to most peer groups. At roughly $7.1 million in assets and $300,000 in annualized revenue per FTE, we believe our workforce is extremely productive. But based on the capacity of our existing lenders, which Harold reviewed earlier, we still expect to increase the relative productivity of our workforce despite negative trends for the peers. Most of you are familiar with our hiring strategy of hiring the best bankers in the market, asking them to move their books of business. The blue bars in the chart on the left give you a sense of how well our strategy and grow market share by moving the business to our balance sheet, but only modest increases in cost is working. Focusing for moment on the right side chart, $300,000 in revenue per FTE is a metric we're extremely proud of. However, in the third quarter, you saw a little slip, it's there, that's because, in addition to the capacity of our existing workforce, we continue to have opportunity to hire additional capacity, which ensures our ability to grow well into the future.

You know the information we've talked about is compelling. We're blessed to be in two of the best banking markets in the United States. Of course, job growth is the key to the health of any CD. And as you can see on the bottom left, Knoxville is fully recovered and just above that. Nashville is really on the move, well above its the prerecession peak. Nashville ranks second in job growth in the U.S. last year.

On the right at the top, consistent with my comments on the volume of purchase money transactions earlier, you can see that Nashville residential real estate market is very healthy, expressed in terms of median home prices, number of closings or months of inventory.

As you might expect, the unemployment in both markets is better than the national numbers. We said a number of times, our success in Pinnacle's contingent on producing rapid growth while containing operating cost. And it would appear to me that our markets do provide an environment which should enable us to do that.

Not only that, but we've now got a proven track record for being able to capitalize on the vulnerabilities at the larger regional and national franchises that once dominated this market. Here, you're looking at Greenwich Research for Nashville, Tennessee among businesses with sales from $100 million to $500 million in annual sales volume. That's essential in the entire commercial market in Nashville. The y-axis is plotting market share. So you can see, we're beginning to open up a pretty commanding lead in terms of the percentage of businesses that declare Pinnacle to be their primary bank. The x-axis is plotting the Net Promoter Score. According to Greenwich, the promoters of those clients score 9 or a 10 on a 10 point scale, in response to the question: How likely are you to specifically recommend your lead bank to a friend or colleague? So the Net Promoter Score is the total number of promoters. Those that rated their likeliness to recommend you as a 9 or 10, minus detractors, those that rated you 0 to 6. And as you can see, our Net Promoter Score is almost off-the- meaningfully higher than all of those I mean, we'd target in terms of moving market share. So not only have we generated the largest lead bank share, we've been engendered the loyalty among our clients and as Cousin Eddy would say, that's the gift that keeps on giving.

I'm sure all of you are aware that yesterday, our board announced an initiation of quarterly dividend. Several quarters ago, we began discussing in these quarterly earnings calls that we believe we could see our way to continue to grow our company and potentially pay a dividend. So last night, our board declared an $0.08 dividend to common shareholders. That's a big event in the life of our company. We feel fortunate that we are in a position to pay a modest dividend to our shareholders, and at the same time, continue to grow our firm at the pace we set out to grow and maintained internal capital to support that growth.

Factors that argued for a sustainable dividend strategy included that it shouldn't limit our growth prospects. In other words, we believe we can continue the double-digit organic loan growth that we've sustained for the last 2 years. It should increase demand for the stock among yield-oriented investors for PNFP. And it appears to me, based on a number of studies that we looked at, that the market does assign a premium to dividend payers, in other words, has the potential to enhance our evaluation. The factors that argued against a sustainable dividend strategy included a figure that it would cost investors to draw wrong conclusion regarding our outlook for future growth. And then secondly, once it started, it would likely be a considerable negative for the stock to unwind it or reduce it. So candidly, the principal concern in all of this was will the marketplace misinterpret this as a signal that we're backing up on our growth objectives, let me assure you that I'm still optimistic about our growth prospects, the capacity of our existing salesforce to deliver our targets, our ability to continue hiring the best bankers in the market and the vitality of our markets in general. So simply said, I believe we can continue the current plan rate of growth and pay the dividend.

We believe for quite some time that there's an operating leverage that we now have, we could support a modest dividend and grow the bank rapidly. This slide shows that, for the first 6 months of the year, we grew net loans approximately $257 million or 7%. Those loans when risk weighted based on current guidelines and based on the composition of our loan portfolio at December 31 and September 30, would require capital to support $192.6 million of risk weighted loans. And so our risk weighted loans have increased by 5.5%. Interestingly, tier 1 common tangible equity and tier 1 risk-based capital since you're in and grew by more than $47.5 million. Total risk base capital grew by more than $51.5 million or approximately 9.3%. So just looking at loan growth and this relationship, capital growth in the period of pretty rapid loan growth, capital growth meaningfully exceeded the loan growth. We believe that the level of capital growth should continue to support the double-digit growth that we've been experiencing in loans over the last couple of years.

I want to comment on the payout ratio. The payout ratio was started with on a pro forma basis; approximately, it's 20.4%. As you can see, we're well beneath the peer median on that measure as we pay approximately 22.5%. Depending on the stock price, our dividend yield is a modest 1% to 2% compared to peers, which yield approximately 2.5%. So as we mentioned earlier, we believe the deposit is for initiating a dividend outweigh the negatives for us. And we believe our shareholders are likely to hold the same view.

So now, in conclusion, hopefully, we've covered the key performance metrics for the third quarter. We flashed out our approach to expanding operating leverage by rapidly growing loans and deposits and fees while containing expenses and provided the loan return outlook for things that may influence our growth earnings and valuation. Down and all the way back to what we're going to focus on in the fourth quarter 2013, the path forward continues to be very simple in my judgment. The principal profit improvement leveraged loans and revenue growth produced by existing infrastructure expense base. And we also expect continue to have some nice improvements as well.

Operator, with that, we'll stop and be glad to respond to any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Michael Rose from Raymond James.

Michael Rose - Raymond James & Associates, Inc., Research Division

Just wanted to get some context on Slide 16 where you talked about the floor volumes, looks like they've gone up the past 2 quarters. And I wanted to -- just to understand how you're getting floors at this point in the cycle, and most are finding it pretty difficult, and kind of balance that with the ongoing paydowns that you're experiencing. If you could just kind of talk to that. That would be helpful.

M. Terry Turner

Okay. I'll start, and Harold, you feel free to jump in. Let me talk about -- start with the last part of the question in reference to the environment paydown. As Harold talked about the environment paydowns, we don't believe that payoffs are related to market share movement to competitor banks. And I think that's an important thing when you think about pricing. In other words, what we believe is influence in the paydowns, really, has to do with fact that there are significant and good alternatives for commercial real estate. The insurance markets are wide-open. The REIT markets, they are variety of alternatives for commercial real estate financing that are long-term nature, long-term fixed-rate. And nonrecourse is the appropriate home for a lot of that financing. And so much of the many firms thought financing that we and most banks do is being refinanced out of those markets. And then, as Harold mentioned, there's a deleveraging going on. In other words, there are a good number of companies that have been sitting on cash that now have the confidence to turn loose on that cash and pay of debt. So again you're getting paydowns but not market share movement from that.

And then, I think the third component that Harold mentioned in his comments for the pay downs really has to do with a lot of liquidity, a lot of money in the marketplace, looking for a home. And when I say that, I'm talking about specifically private equity money, venture money and the like. And you have a lot of business owners who are looking at this as an opportunity to cash out. I think I had breakfast yesterday with one of the better-known estate attorneys here in Nashville, and he was talking about the fact that he's encountering that among a lot of his wealthy clients. And his observation was, look, we've got the aging of baby boomers, a lot of these guys are retirement age. They've not been in a position to cash their companies out over the last 5 years, but there is significant money today, chasing those businesses. And so it's a good opportunity for them to exit, particularly given a poor outlook for a slow growth economy with a difficult regulatory environment. And so again, I don't want to go on too long about that, but just want to sort of be clear about the paydowns and where they're coming from. We don't find those to be somebody taking our clients as much as those 3 phenomena that I just mentioned. I think on the ability to get floors, I would say that our ability to get floors is less good. You say, "Well, your volumes are up." Yes, they are. But the difference between the contract and floor rate is shrinking, and the last couple of years is down 50 basis points, which is meaningful. And as we've commented during the conference call, that's not because we're trying to lower that differential, it is just because of competitive pressures required. So I think you're on the right point that the competitive pressures will continue to shrink the amount, both the amount and the difference of -- between the contract -- the amount of floors that we get and the difference between the contract rate and the floor that we get. That will continue to shrink as we move forward due to competitive pricing. And as I mentioned, we're now at 87 basis points. You ought to expect it to continue to shrink. And when we get to a point where we feel like short-term rates are closer to movement, we'll probably go away from that technique. But I don't know, Harold, do you want to offer anything?

Harold R. Carpenter

Well, the -- Michael, I don't really have any data in front of me to support what I'm about to tell you, but I think most of the payoffs, as Terry mentioned, would probably fall into the C&I category. We've seen a lot of good growth this year in C&I, and I think that's where most of the floors would likely find themselves. So I think a lot of it just has to do with the type of portfolio that we are lending into. The second thing too, would probably be in construction. We're back in the construction business in a measured way. We're up on commercial construction, and I think many of those credits, too, have floors attached to them.

Michael Rose - Raymond James & Associates, Inc., Research Division

Okay. That's really helpful. And just as a kind of a follow-up, it seems like this quarter's growth was impacted by some timing issues. Any sense for the loans that you expected to close this quarter? Like what was the -- how many loans was it? What was the size? And then obviously, you've given this loan growth guidance a while ago, how many lenders have you hired since then? And kind of are the lenders that you had in place, when you established this guidance, are they kind of generally tracking what you had originally expected?

M. Terry Turner

Yes. I'm not sure, Michael, that I understood the first part of the question on loan growth, but let me deal with the second part. Harold, if you know the first part of the question, you can answer. But I think, as it relates to the production from the existing salesforce and our ability to continue to hire new lenders, we are getting elevated production out of our existing salesforce. Again, I think you see that in some of the charts, where we're trying to highlight the growth in assets or loan volume to the FTE count. So we are getting increased leverage out of the existing salesforce. We are also continuing to hire people. Michael, I'm going to refrain from trying to get into exactly how many people are hired, not because I'm trying to be coy, but it just gets too confusing to keep updating and saying now as that includes the ones that were included last time or the ones included the time before and those kinds of things. So we just sort of like to stick with the target that we've laid out. We continue to be confident that we'll hit that. As I mentioned earlier in the call, we are continuing to hire people. That ought to suggest that we could beat that. But again, I don't want to get into trying to quantify an update on each call how many more have been hired.

Operator

Our next question comes from Jefferson Harralson from KBW.

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc., Research Division

I'll follow-up real quick with the floor question. Is there -- Harold may have already answered it. Strategically, with this amount of floors, is there something to do to take some of this, I guess, risk off the table where the rates go up? Or it's just -- it's a feeling of that short-term rate increases are far enough away that we're getting the benefit and let's just keep it going for a while?

Harold R. Carpenter

Yes, Jefferson, I think what Bill was saying is pigs get fat and hogs get slaughtered. We -- like Terry said, we've been in a cost to debate over the last 2 years as to when we deemphasize these floors, and I think he said not yet. And we are there, but our sense is that probably, over the next 2 to 3 quarters, we'll begin to negotiate with these borrowers to potentially reduce this -- the blue bars on Slide 16 down to something that's a little bit more manageable. That said, though, we're not that far away from being asset-sensitive. So we believe that our balance sheet is in pretty good shape right now. We like where we are, but we've got some -- maybe some tactical issues that we can deploy over the next 2 to 3 quarters to help reduce the duration risk in our balance sheet.

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc., Research Division

Right. And my follow-up is on the fees. You had -- it looks like you had about $700,000 of other fee income growth X the GAMP sale to loan. And similarly, on the expenses, it looks like you had $700,000 of increases and other expenses, excluding the unusual items of the last quarter. Can you talk about what drove those 2 items?

Harold R. Carpenter

Well, first off, on the gain, we had a government guaranteed loan. A buyer came into us during the quarter and offered us a price for that loan that we reviewed and said, "we ought to take that gain." So we had about $270,000, I think, last year, of similar gains. The lender that's in that business has some more loans on his docket that we hope to materialize over the next 2 to 3 quarters. On the expense side, we had some growth in the benefit line, primarily because the deductibles for our associates, they're beginning to run through those deductibles. So we're picking up more of the health insurance costs there. We also had some increased legal expenses this quarter, more or less tied to one matter that we feel like we're totally covered now so that we shouldn't see any repeat on that in the fourth quarter.

Operator

Our next question comes from Kevin Fitzsimmons of Sandler O'Neill.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

Just wanted to touch on your margin outlook. You guys have stayed consistent with your margin range for full year 2013 of $3.70 to $3.80. Looking beyond that though, with the margin now pretty close to the low end of that range and everything you alluded to in your comments about the pricing competition that's out there, and I would assume the ability to lower funding costs is still there but it's probably getting smaller, that ability, do you feel that -- it just seems like we're probably going to dip below that low end for much of 2014 if we stay in this rate environment. Is that a fair way to look at it?

M. Terry Turner

Kevin, I'm not sure it is. When I say -- I'm not sure it is. I think your statement that we're likely to dip below that for much of 2014, that wouldn't be our outlook. I would say that we would certainly operate at the low part of that range, low end of that range during the bulk of 2014. But I wouldn't look to drop below it for the bulk of 2014.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

With loan growth being the main driver for that?

M. Terry Turner

Yes. We -- I think our belief is, yes, loan growth helps us in the margins. And secondarily, we do believe, and I think if you look at our loan yield numbers, we are seeing a decline, in other words, the rate of decline in loan yields is slowing. And so we expect that phenomenon also to continue. So as -- I think as we tried to comment in the call, we expect the rate of decrease for both loans and deposits to slow going forward.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

Okay. Great. Just one quick follow-up. On the bond portfolio, you all mentioned the sale after quarter end of, I believe, $22 million. Should we expect, looking at point-to-point, the bond portfolio, all things being equal, to be roughly $20 million lower? Or is that being replaced and going to be more stable?

M. Terry Turner

Yes. I think -- it's hard to say if we'll reduce the absolute size of the bond book. We'll probably need those funds to collateralize, but we are trying to do some things to reduce our duration risk in the bond book going forward. We did some things early in the year. We put a hedge on with some Federal Home Loan Bank borrowings that we've talked about before. But we are off -- we are trying to actively manage it to reduce the asset -- the liability sensitivity, I guess, of the bond book. So...

Operator

Our next question is from Matt Olney from Stephens.

Matt Olney - Stephens Inc., Research Division

Terry, going back to the board's decision to pay that cash dividends, it seems like in the past, you've also discussed M&A as a potential way to kind of augment your growth strategy. So can you talk more about this -- the board's decision and what that means for your M&A outlook?

M. Terry Turner

It would not have bearing on our M&A outlook. I think -- so let me kind of talk about what our M&A outlook is. We've tried to be clear that we believe we have an advantage stock, and that provides us some opportunity to theoretically provide some opportunity to participate in acquisitions. We have a number of acquisitions that have appeal to us. It's not a long list. It's a short list. Generally, they are in market transactions in Nashville or in Knoxville. In the case of Nashville, because we ought to produce outsize cost synergies, we like our distribution. In the case of Knoxville, it would be an opportunity for us to accelerate distribution. Right now, our current plan are we continue to de novo an office a year in Knoxville. And so we could accelerate that through acquisition. That would be a motivation there. We, I think, have talked about, we additionally like Chattanooga and Memphis. And we have a preference to go there by de novo expansion as opposed to true acquisition. Our preference is that because we believe our image and culture and reputation and model are distinctive, and it's just hard to go into a market with -- to acquire some distinctly different franchise and convince the market that it's now a great company. And so we have a preference for going on to a de novo basis and doing lift-outs just like we did in Nashville and just like we did in Knoxville. I would say that in both of those markets, there are a very limited number of franchises who, I think, would say that we're trying to execute the Pinnacle model. And so their model of doing business and their culture would be more in line with ours and might provide some opportunity there. But again, generally, we would have a preference to go on a de novo basis. So, yes, I rambled through all that to say we do have an advantage stock. We do have some likelihood that we might find mergers, but it's -- mergers and acquisitions, but it's a really short list. And that's what our outlook is. But we believe that we can manage both M&A and organic growth and pay the dividend.

Matt Olney - Stephens Inc., Research Division

And as a follow-up, Terry, how would you classify the M&A chatter of some of those potential sellers that you just talked about in your target markets?

M. Terry Turner

Chatter among the bankers or the chatter among the investors?

Matt Olney - Stephens Inc., Research Division

The bankers.

M. Terry Turner

I would say that there's a growing -- there's a slightly growing interest in willingness to sell some of the small franchises because of all the headwinds that you well know. But that said, I think there's still a fairly meaningful gap between bids and asks. I mean, I don't think the market is on fire to do something.

Operator

Our next question comes from Kevin Raynolds from Wunderlich Securities.

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

Gentlemen, most of my questions have been answered, but a few of them and maybe a slightly different way to ask them. First is you talked about, in your press release and your commentary earlier, about the loan pipeline. It looks like it might be strengthening in the fourth quarter. What are the factors that would cause you to expect maybe loan growth to pick up in the fourth quarter other than the -- some resolution of the macro uncertainty in Washington? Is there anything specific that you could point to that might cause businesses to be a little bit more active at the local level?

M. Terry Turner

Yes. Let me say, and maybe make a slight distinction between businesses being active and our loan demand, to some extent, as I mentioned, we had several deals that were originally expected to close in the third quarter. They'll close in the fourth quarter. And so that phenomenon has the impact of reducing what we booked in the third quarter, an increase in what we booked in the fourth quarter. I don't think it signals any particular elevated activity, it's just a timing difference between what showed up in the third quarter and what's expected to show up in the fourth quarter. So that's one thing. I do think -- the second thing is, there is a natural rhythm for a lot of business owners to get transactions done and closed out for year end. People are motivated to address balance sheets and finish their P&L year, most of which have calendar fiscal years. And there's always a natural rhythm in the fourth quarter, I would say, over the last good number of years. Our fourth quarter loan growth has been higher than our third quarter loan growth.

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

Okay. And then a couple more questions. You talked about not wanting to put numbers of recruits, or numbers of new hires out there, and I appreciate that. But just kind of from a little bit higher level, as I recall in the pipeline of loan growth that you have today, that you -- the set 3-year pipeline was the result of hiring something like 10 to 12 senior lenders. What does your pipeline look like, your sort of -- your courtship pipeline right now as you look forward? How many people might you be talking to at any point in time? And how much longer do you think that sort of refilling of the pipeline can continue in a marketplace like Middle Tennessee? I mean, at some point, one might think that perhaps you've gotten every senior loan officer that you'd want out there, and there might not be anymore recruit [indiscernible]?

M. Terry Turner

Right. Right. Yes. Okay. Let's talk about the fact that the marketplace is going to run out of bankers for us to hire. We showed a market share chart, which I laughingly told Harold before the call, that my favorite chart in the whole slide is that Greenwich chart that shows what our market share is and what our Net Promoter Score is. But that said, it's still 18% share. I mean, that means 82% shares somewhere else, so they're bankers that are banking 82% of this market out here that don't work for Pinnacle. And so again, I guess I always want to put that perspective. It's a true thing. I'm not going to get 100%, but I have been in this market at a large regional bank that had roughly 2x the market share that we have here. And so again, that would give you some way to think about it. It's not likely that we're near in the end of our ability to hire people in terms of the fact that there's no supply. And then secondarily, what's our ability to tap into that market? What's our ability to hire that market? I do believe -- and I think the Greenwich data would show this. I also think the various work environment studies that have been conducted would demonstrate this. This is one of the best companies in America to work for. It's clearly the best company in Nashville to work for. We've won the award 10 years in a row. And so there's a broad reputation among bankers that it would be a good thing to have the opportunity to work at Pinnacle. And so I guess, again, as long as we, I think -- well, said this way, I think as long as we continue to manage our workforce appropriately and build a reputation that we have for our work environment, and as long as we continue to focus in a systematic way on recruiting the best bankers in the market, I don't really see anything that's going to slow our ability to hire people down in the very near term.

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

And then my last question is related to the statement that you'd sort of selectively gotten back into the residential construction. The housing market over here is clearly strong and doing very, very well. The question though, is, are you -- can you comment on where you might feel more comfortable engaging in the construction business? Sort of is it Davidson County, Williamson County, other areas? And are there sort of pockets of strength? Or is it broader than that?

M. Terry Turner

That's a good question. I would say, Kevin, you're here and sort of have a chance to feel it. I would say, the whole Middle Tennessee market is relatively stronger than it was and is reasonably strong. As you know, there are some pockets that are absolutely on fire. There are some markets where we're just about out of land, there are no lots available. And so clearly, it's not even in terms of how strong the markets are, but I would say that they're all strong. I think the comment that I would make though about our growth is, we made the decision that it was time to move back toward a growth stance in the construction business. I'll comment that we're not growing the development business. We're growing the construction business. And in that vein, what we did was sit down and make a list of the folks that we wanted to target, most of whom already bank with us on the deposit side. And so I -- we're going to focus on this group of builders because they weathered the storm and done well through the cycle. And so those are the folks that we're attracting and growing our outstandings in.

Operator

Our next question comes from Peyton Green of Sterne Agee.

Peyton N. Green - Sterne Agee & Leach Inc., Research Division

Just a question on the residential mortgage originations. I was wondering -- I think you all had a slide in here that mentioned that the home sales were up about 18%; the prices, up about 12%. I was just wondering, when do you think you've passed through the point where you get to take advantage of the fact that sales are up so strong and the price is up so strong and that the origination volumes starts to go up again?

M. Terry Turner

I mean, Peyton, that's a great question. I think I would just be honest and say, I don't know the answer to that yet. I'm out -- I haven't really worked on that. I would -- I do not have an expectation in the near term, meaning the next couple of quarters, that the -- that our mortgage origination volumes will accelerate. I don't look for them to decelerate either. But I don't look for much acceleration on mortgage originations for some time, probably on out to next spring.

Peyton N. Green - Sterne Agee & Leach Inc., Research Division

Okay. And then kind of with regard -- Harold, I think you touched on this earlier, about the interest rate risk sensitivity of the company. I mean, maybe if you could give a little bit of color on where you think you are in September 30. And just kind of looking at the overall deposit growth, it was about $500 million over the past year on average in the third quarter, and you had loan growth of about $440 million, but about 60% of that deposit growth was non-interest bearing, and I just wonder, is there a portion of that non-interest bearing that you would expect to migrate in an up 200- or 300-type rate environment? Or do you think this is more core relationship growth as opposed to share of wallet growth?

Harold R. Carpenter

Peyton, yes. We have -- you basically answered my question for me on that first part. The growth in non-interest bearing deposits has been phenomenal in my view. We are very pleased with where that number is, and we don't sense that there's any kind of slowdown that we need to anticipate there. We've looked at -- we look at that DDA book. As you might expect, we've got some fairly large depositors in there that are some of the most well respected and well known middle market businesses in Middle Tennessee. So we ask our financial advisors to analyze those deposit accounts, tell me if there look to be a little shaky or if they appear to be maybe a little frothy, that some of that money is going to move out eventually. And we've got some, but we're not expecting any big dilution. As you might expect, regulators ask us similar questions. They were nervous that when the TAG program went away, that our DDA balances would leave, and they actually grew. So we're cautiously optimistic that this level of growth that we've had in non-interest bearing deposits, that it's really sticky, and that we'll continue to see that number go up. We've engaged third-party consultants to come in and review our deposit book, compare to other firms, and they'd come back with some pretty pleasing results on what they see in the characteristics of our accounts. So that -- we talk -- we spent a lot of time talking about floors on loans. We spent a lot of time talking about where the bond book is and how that's going to detract from our asset sensitivity push when the time comes. But at the end of the day, this deposit book has really made a lot of difference in our balance sheet positioning.

Peyton N. Green - Sterne Agee & Leach Inc., Research Division

Okay. And then I guess just -- I mean, do you have any idea, plus or minus, where you think the asset or liability sensitivity is as of September 30?

Harold R. Carpenter

Well, just to give you kind of a very elementary kind of number, if I had $200 million in floating rate assets, I'd be asset sensitive on the spot.

Peyton N. Green - Sterne Agee & Leach Inc., Research Division

Okay, great. And then going forward -- I mean, the client growth seems great. I mean, would you expect deposit growth to continue to be a little bit stronger than loan growth? Or -- I know that's probably a tough, tough question to answer, but I would have guessed, a year ago, we probably would have been surprised if deposit growth would have bid stronger than loan growth, particularly with the mix. How do you feel about it going forward maybe?

M. Terry Turner

Well, we expect it to be more balanced because we expect the loan growth to be better than it was, say, in this quarter and frankly, last quarter as well. So we expect it to be more balanced. But again, that's on the shoulders of improved loan volume, not decreased deposit volume.

Peyton N. Green - Sterne Agee & Leach Inc., Research Division

Okay, okay. No, I was just trying to take your comment about the private equity conditions and -- that, that would seem to create more deposit liquidity for you.

M. Terry Turner

I think that is -- I think that's a true phenomenon. Again, we're not concerned about our ability to continue growing deposits at a rapid pace. But again, the difference in the comparison of deposits to loan is more about an ability to produce greater loan volumes going forward than previously.

Operator

Our last question is from Brian Martin from FIG.

Brian Joseph Martin - FIG Partners, LLC, Research Division

Most of my questions are answered, and maybe you even covered this one, Terry, I'm not sure. I got cut off for a minute. But the -- you had a credit leverage going forward. I guess -- I mean, do you guys still feel like there's -- it looks like there is still a fair amount of room for ongoing credit leverage, kind of in the way of the provision, the reserves. And kind of leading that number down, I guess, does that seem like a fair assessment as you guys look forward?

M. Terry Turner

I believe it is a fair assessment, Brian. I think that the -- I guess there are a couple of factors that are important. One, you see the asset quality numbers. We continue to show improvement in levels of non-performing loans, the classified asset ratio now at 20%. I mean, those are pretty strong numbers, and we expect continued forward progress on those numbers, running charge off levels at 20, 21, 22 basis points, those kinds of things. And so that has the phenomenon of elevating your coverage, your problem assets. And again, we try to make that point just to help people get that there's probably ongoing credit leverage. I do think the other phenomenon that is at least interesting and on the discussion, is being likely discussed in the industry and in our company, you run a reserve methodology where you're trying to ensure that the allowance of coverage, you're likely losses based on historical performance. And so you look at that over some reasonably current history, say, 5 years. And so the point of that is that as we move further away from the 2007, 2008 time frame when losses started rolling up, your historical track record improves, which requires even less loan loss allowance. And so again, I just gave you those 2 factors that over time would suggest that there ought to be continued credit leverage.

Operator

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.

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Pinnacle Financial (PNFP): Q3 EPS of $0.42 misses by $0.01.(PR)