2023-10-19 12:42:09 ET
Summary
- Pinnacle Financial Partners is focusing on hiring established revenue-producers from rival banks to continue growing its business, despite the challenging environment for loan growth and profitability.
- The bank's third-quarter results were relatively strong compared to other banks, with revenue and margins beating expectations and loan growth significantly outperforming the overall banking sector.
- Pinnacle's strategy of recruiting experienced loan officers and prioritizing customer satisfaction has helped it gain market share and outcompete weaker competitors, and they're doubling down.
- Higher operating costs are likely to contribute to a year-over-year decline in core profits in 2024, but high single-digit growth over the long term is still attainable and supports an attractive return.
In an environment where loan growth is harder and harder to come by, credit costs are rising, and spread pressures remain significant for many banks due to rising funding costs, operating leverage is the Street’s current obsession, and investors didn’t like the fact that Pinnacle Financial Partners (PNFP) isn’t catering to that. Instead, management is pursuing it’s already-proven strategy of hiring away established revenue-producers from rival banks to continue growing the business.
I consider the ability (and willingness) to continue growing while others are hunkering down in their bunkers to be a positive attribute, and I continue to believe that Pinnacle is an attractive multiyear growth story as it continues to grab business away from larger, less-nimble rivals. I don’t consider long-term core earnings growth in the high single-digits conservative, but I think Pinnacle can do it, and I think the shares remain undervalued even after modestly outperforming regional banks since my last update (in this case meaning “the shares aren’t down as much”).
A Good Set of Results, Relatively Speaking
Pinnacle’s third quarter results weren’t exactly something you’d frame for future reference, but the bank still did rather well on a relative basis at a time when many banks are struggling for growth and having to focus more time and attention on deposit or capital management.
Revenue rose 2% year over year and 1% quarter over quarter on a core basis, beating expectations by around $0.05 to $0.06/share. Net interest income (on an FTE basis) rose 4% yoy and a little less than 1% qoq, missing by about $0.02. The miss was driven by spread pressure, as the bank continued to pay up for deposits to maintain its customer base – net interest margin declined 14bp qoq to 3.06% - but earning asset growth was better than expected at around 4%.
Core fee-based income fell 4% yoy and rose more than 2% sequentially, beating by around $0.08. The BHG business saw a 7% qoq decline as this specialty lender continues to pull back on lending (originations down 5% qoq) and boost reserves. Loan sales to other banks declined 17% qoq and loans to private investors declined 1% qoq.
Operating expenses increased 7% yoy and 1% qoq, but still came in lower than expected (adding $0.04/share), and Pinnacle continues to compare well to similarly-sized banks on efficiency ratio. Pre-provision profits fell 3% yoy and rose 1% qoq, beating by about $0.09/share. Tangible book value per share declined slightly from the prior quarter.
Strong Loan Growth On Share Gains, But Funding Costs Are Still Pinching
Pinnacle reported over 15% yoy and 2.5% qoq growth in loans, growing well above the overall banking sector in the period (all-bank lending was up about 4% yoy in the third quarter), and likewise significantly outgrowing rivals in C&I, CRE, multi-family, and mortgage lending (up 16%, 16%, 43%, and 12% respectively). Construction lending was also up double-digits (up 11%), but slowed to 1% sequential growth as management is getting a little more conservative here.
Loan yields improved 20bp qoq, pretty much average, to 6.5%, and Pinnacle will continue to benefit from loans repricing higher for several quarters.
While loans are repricing higher, so too are deposits and other funding sources. Deposit costs rose 40bp qoq to 2.92% and interest-bearing-deposit costs rose 46bp to 3.76%, with new interest-bearing checking accounts coming on at about 3.8% interest rates. At almost 70%, Pinnacle’s cumulative interest-bearing deposit beta is among the highest out there, and the 22% ratio of non-interest-bearing deposits to regular deposits is not great.
To a large extent this is pretty much literally the cost of doing business. Pinnacle’s focus on commercial lending (and aggressive growth) translates into a weaker NIB deposit position. At the same time, Pinnacle is making the choice to stay ahead of deposit pricing in a market where many rivals have been aggressive on pricing to lure in deposits. I believe this is likely a smart choice over the longer term, as it maintains higher customer satisfaction and loyalty. Deposit pricing should start easing up, but I do still see some risk here.
On the credit side, the company had a sizable loss tied to its part in a syndicated loan to the now-bankrupt Mount Express , but a 0.23% charge-off ratio (up from 0.13% in the prior quarter) still isn’t that bad, and management is not concerned about credit quality in general.
Leveraging The Model
I’d strongly suggest that readers make the time to listen to Pinnacle’s latest earnings conference call. At a minimum, I would say it’s a good example of a management team explaining how “we’re whoopin’ their butts” in gentlemanly terms.
Pinnacle is pretty obsessive when it comes to customer satisfaction, and not surprisingly customers appreciate that. Likewise, a core competitive advantage here is a roster of experienced loan officers who not only have long-standing relationships across a range of industry verticals, but also have deep industry experience. The better you understand an industry, the better your underwriting can be, and Pinnacle simply out-competes a lot of its rivals who apply more of a “one size fits all” philosophy to underwriting. Underlining this point, management pointed to the shares gains it has achieved in the Nashville market, while referring to Regions (RF), Truist (TFC), and Bank of America (BAC) as “weaker competitors”.
Pinnacle has thrived in no small part by recruiting productive loan officers from these larger rivals, and management sees the current environment as harvest time. Given the weaker loan production from many banks, not to mention the substantial restructurings underway at PNC (PNC) and Truist (including headcount reductions), I think this is a sound strategy. The “but” is that it will drive increased opex at a time when the Street is obsessed with cost-driven operating leverage – I consider this a trade-off of short-term pain for long-term gain, and it’s a trade I’d be happy to make.
The Outlook
Pinnacle isn’t immune to the overall macro environment, and even if management is right that NIM is close to bottoming out, I think 2024 will see a year-over-year decline in core operating earnings. For a lot of growth stock investors, that’s just not acceptable and that takes the shares off their lists for a time. I think this is just a blip, though, and I expect high single-digit core earnings growth over the next five and 10 years as Pinnacle continues to take share in attractive Southeast and Mid-Atlantic markets.
Discounting those earnings back, I get a fair value in the high-$70’s, and I get a range of $75.50 to $81 based on my ROTCE-driven P/TBV approach and my P/E approach (using a lower-than-normal 11.5x multiple on my ’24 EPS estimate).
Of course there are risks here. The Southeast is seeing a surge in competition as larger banks (including Fifth Third (FITB), Toronto-Dominion (TD), and U.S. Bancorp (USB)) move into the area, attracted by the favorable demographic and economic trends. Maintaining good loan pricing and continuing to gain share in such an environment won’t be easy. I do also see some “key man” risk here, as Pinnacle is still a founder-led bank and it can be difficult to maintain a culture when management transitions. Last and not least, I see elevated business risk – as First Republic and Silicon Valley Bank amply demonstrated, managing growth isn’t always easy.
The Bottom Line
I do think concerns about operating costs and operating leverage could dull some of the shine on Pinnacle for a little while, but I think opportunistic investors should look at this as the company reinvesting in its own future and taking advantage of the fact that many of its rivals need to cut costs (and personnel) to make their own models work in the near term… even if that means that they ultimately lose share over the longer term as productive employees go elsewhere. With above-average growth at a reasonable price, this is definitely a name to consider as a multiyear opportunity.
For further details see:
Look Past A Short-Sighted Street: Pinnacle Financial Partners Is Doing The Right Things