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2: EX-3.1 Articles of Incorporation/Organization or Bylaws HTML 135K
3: EX-31.1 Certification -- §302 - SOA'02 HTML 27K
4: EX-31.2 Certification -- §302 - SOA'02 HTML 27K
5: EX-32.1 Certification -- §906 - SOA'02 HTML 24K
6: EX-32.2 Certification -- §906 - SOA'02 HTML 24K
13: R1 Document and Entity Information HTML 84K
14: R2 Consolidated Balance Sheets (Unaudited) HTML 131K
15: R3 Consolidated Balance Sheets (Unaudited) HTML 48K
(Parenthetical)
16: R4 Consolidated Statements of Income (Unaudited) HTML 133K
17: R5 Consolidated Statements of Comprehensive Income HTML 52K
(Unaudited)
18: R6 Consolidated Statements of Stockholders' Equity HTML 120K
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19: R7 Consolidated Statements of Cash Flows (Unaudited) HTML 158K
20: R8 Summary of Significant Accounting Policies HTML 121K
21: R9 Equity method investment HTML 49K
22: R10 Securities HTML 226K
23: R11 Loans and Allowance for Credit Losses HTML 881K
24: R12 Income Taxes HTML 30K
25: R13 Commitments and Contingent Liabilities HTML 31K
26: R14 Stock Options and Restricted Shares HTML 128K
27: R15 Derivative Instruments HTML 161K
28: R16 Fair Value of Financial Instruments HTML 321K
29: R17 Regulatory Matters HTML 131K
30: R18 Other borrowings HTML 84K
31: R19 Summary of Significant Accounting Policies HTML 117K
(Policies)
32: R20 Summary of Significant Accounting Policies HTML 82K
(Tables)
33: R21 Equity method investment (Tables) HTML 47K
34: R22 Securities (Tables) HTML 218K
35: R23 Loans and Allowance for Loan Losses (Tables) HTML 873K
36: R24 Stock Options and Restricted Shares (Tables) HTML 129K
37: R25 Derivative Instruments (Tables) HTML 164K
38: R26 Fair Value of Financial Instruments (Tables) HTML 315K
39: R27 Regulatory Matters (Tables) HTML 121K
40: R28 Other borrowings (Tables) HTML 85K
41: R29 Summary of Significant Accounting Policies - HTML 58K
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42: R30 Summary of Significant Accounting Policies - HTML 47K
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43: R31 Summary of Significant Accounting Policies - Basic HTML 57K
and Diluted Net Income Per Share Calculations
(Details)
44: R32 Equity method investment - Financial Position and HTML 58K
Results of Operations (Details)
45: R33 Equity method investment - Narrative (Details) HTML 39K
46: R34 Securities Securities - Narrative (Details) HTML 50K
47: R35 Securities - Amortized Cost and Fair Value of HTML 152K
Securities (Details)
48: R36 Securities- Unrealized Losses (Details) HTML 62K
49: R37 Loans and Allowance for Credit Losses - Narrative HTML 48K
(Details)
50: R38 Loans and Allowance for Credit Losses (Details) HTML 44K
51: R39 Loans and Allowance for Credit Losses - Loan HTML 230K
Classification by Risk Rating Category (Details)
52: R40 Loans and Allowance for Credit Losses - Financing HTML 75K
Receivables Past Due (Details)
53: R41 Loans and Allowance for Credit Losses - Allowance HTML 72K
for Credit Losses (Details)
54: R42 Loans and Allowance for Credit Losses - Details on HTML 138K
Allowance for Loan Losses and Recorded Investment
by Loan Classification and Impairment Evaluation
Method (Details)
55: R43 Loans and Allowance for Credit Losses - Nonaccrual HTML 47K
and Past Due Greater than 90 Days (Details)
56: R44 Loans and Allowance for Credit Losses - Recorded HTML 88K
Investment, Principal Balance and Related
Allowance (Details)
57: R45 Loans and Allowance for Credit Losses - HTML 55K
Rollforward of Purchase Credit Impaired Loans
(Details)
58: R46 Loans and Allowance for Credit Losses - Troubled HTML 59K
Debt Restructurings (Details)
59: R47 Loans and Allowance for Credit Losses - Industry HTML 38K
Classification System (Details)
60: R48 Income Taxes - Narrative (Details) HTML 37K
61: R49 Commitments and Contingent Liabilities (Details) HTML 36K
62: R50 Stock Options and Restricted Shares - Narrative HTML 45K
(Details)
63: R51 Stock Options and Restricted Shares - Common Stock HTML 59K
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64: R52 Stock Options and Restricted Shares - Unvested HTML 49K
Restricted Awards (Details)
65: R53 Stock Options and Restricted Shares - Restricted HTML 48K
Shares Awarded (Details)
66: R54 Stock Options and Restricted Shares - Restricted HTML 92K
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67: R55 Derivative Instruments - Non-hedge Derivatives HTML 41K
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68: R56 Derivative Instruments - Hedge Derivatives HTML 92K
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69: R57 Fair Value of Financial Instruments (Details) HTML 91K
70: R58 Fair Value of Financial Instruments - Rollforward HTML 51K
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71: R59 Fair Value of Financial Instruments - Carrying HTML 74K
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72: R60 Regulatory Matters (Details) HTML 121K
73: R61 Other borrowings (Details) HTML 145K
75: XML IDEA XML File -- Filing Summary XML 137K
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(Registrant's
telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changes since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒ No ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the registrant was required to submit such files). iYes☒ No ☐
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
iLarge Accelerated Filer ☒Accelerated Filer ☐
Non-accelerated Filer ☐Smaller
reporting company i☐
(do not check if you are a smaller reporting company) Emerging growth company i☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes i☐ No ☒
Securities
registered pursuant to Section 12(b) of the Exchange Act:
Title of Each Class
Trading Symbol
Name of Exchange on which Registered
iCommon Stock, par value $1.00
iPNFP
iThe
Nasdaq Stock Market LLC
iDepositary Shares (each representing 1/40th interest in a share of 6.75% Fixed-Rate Non-Cumulative Perpetual Preferred Stock, Series B)
iPNFPP
iThe
Nasdaq Stock Market LLC
As of July 31, 2020 there were i75,844,238 shares of common stock, $1.00 par value per share, issued and outstanding.
All statements, other than statements of historical fact, included in this report, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words "expect,""anticipate,""intend,""may,""aims,""should,""plan,""believe,""seek,""estimate" and similar expressions are intended to identify such forward-looking statements, but other statements not based on historical information may also be considered forward-looking statements. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from the statements,
including, but not limited to: (i) further deterioration in the financial condition of borrowers of Pinnacle Bank and its subsidiaries or Bankers Healthcare Group, LLC (BHG) resulting in significant increases in loan losses and provisions for those losses and, in the case of BHG, substitutions; (ii) the further effects of the emergence of widespread health emergencies or pandemics, including the magnitude and duration of the COVID-19 pandemic and its impact on general economic and financial market conditions and on Pinnacle Financial's and its customers' business, results of operations, asset quality and financial condition; (iii) the ability to grow and retain low-cost core deposits and retain large, uninsured deposits, including during times when Pinnacle Bank is seeking to lower rates it pays on deposits; (iv) the inability of Pinnacle Financial, or entities in which it has
significant investments, like BHG, to maintain the historical growth rate of its, or such entities', loan portfolio; (v) changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; (vi) effectiveness of Pinnacle Financial's asset management activities in improving, resolving or liquidating lower-quality assets; (vii) the impact of competition with other financial institutions, including pricing pressures and the resulting impact on Pinnacle Financial’s results, including as a result of compression to net interest margin; (viii) adverse conditions in the national or local economies including in Pinnacle Financial's markets throughout Tennessee, North Carolina, South Carolina, Georgia and Virginia, particularly in commercial and residential real estate markets; (ix) fluctuations or differences in interest rates on loans or deposits from those that Pinnacle Financial is modeling
or anticipating, including as a result of Pinnacle Bank's inability to better match deposit rates with the changes in the short-term rate environment, or that affect the yield curve; (x) the results of regulatory examinations; (xi) Pinnacle Financial's ability to identify potential candidates for, consummate, and achieve synergies from, potential future acquisitions; (xii) difficulties and delays in integrating acquired businesses or fully realizing costs savings and other benefits from acquisitions; (xiii) BHG's ability to profitably grow its business and successfully execute on its business plans; (xiv) risks of expansion into new geographic or product markets including the recent expansion into the Atlanta, Georgia metro market; (xv) any matter that would cause Pinnacle Financial to conclude that there was impairment of any asset, including goodwill or other intangible assets; (xvi) reduced ability to attract additional financial advisors (or failure of such advisors
to cause their clients to switch to Pinnacle Bank), to retain financial advisors (including as a result of the competitive environment for associates) or otherwise to attract customers from other financial institutions; (xvii) deterioration in the valuation of other real estate owned and increased expenses associated therewith; (xviii) inability to comply with regulatory capital requirements, including those resulting from changes to capital calculation methodologies, required capital maintenance levels or regulatory requests or directives, particularly if Pinnacle Bank's level of applicable commercial real estate loans were to exceed percentage levels of total capital in guidelines recommended by its regulators; (xix) approval of the declaration of any dividend by Pinnacle Financial's board of directors; (xx) the vulnerability of Pinnacle Bank's network and online banking portals, and the systems of parties with whom Pinnacle Bank contracts,
to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches; (xxi) the possibility of increased compliance and operational costs as a result of increased regulatory oversight (including by the Consumer Financial Protection Bureau), including oversight of companies in which Pinnacle Financial or Pinnacle Bank have significant investments, like BHG, and the development of additional banking products for Pinnacle Bank's corporate and consumer clients; (xxii) the risks associated with Pinnacle Financial and Pinnacle Bank being a minority investor in BHG, including the risk that the owners of a majority of the equity interests in BHG decide to sell the company if not prohibited from doing so by Pinnacle Financial or Pinnacle Bank; (xxiii) changes in state and federal legislation, regulations or policies
applicable to banks and other financial service providers, like BHG, including regulatory or legislative developments; (xxiv) the availability of and access to capital; (xxv) adverse results (including costs, fines, reputational harm, inability to obtain necessary approvals and/or other negative effects) from current or future litigation, regulatory examinations or other legal and/or regulatory actions, including as a result of Pinnacle Bank's participation in and execution of government programs related to the COVID-19 pandemic; and (xxvi) general competitive, economic, political and market conditions. Additional factors which could affect the forward looking statements can be found in Pinnacle Financial's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K filed with the SEC and available on the SEC's website
at http://www.sec.gov. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this report, which speak only as of the date hereof, whether as a result of new information, future events or otherwise.
Securities
held-to-maturity (fair value of $1.1 billion, net of allowance for credit losses of $188 at June 30, 2020 and fair value of $201.2 million at Dec. 31, 2019, respectively)
i1,048,035
i188,996
Consumer
loans held-for-sale
i69,443
i81,820
Commercial
loans held-for-sale
i16,201
i17,585
Loans
i22,520,300
i19,787,876
Less
allowance for credit losses
(i285,372)
(i94,777)
Loans,
net
i22,234,928
i19,693,099
Premises
and equipment, net
i281,739
i273,932
Equity
method investment
i302,879
i278,037
Accrued
interest receivable
i112,675
i84,462
Goodwill
i1,819,811
i1,819,811
Core
deposits and other intangible assets
i47,131
i51,130
Other
real estate owned
i22,080
i29,487
Other
assets
i1,383,451
i1,220,435
Total
assets
$
i33,342,112
$
i27,805,496
LIABILITIES
AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing
$
i6,892,864
$
i4,795,476
Interest-bearing
i4,815,012
i3,630,168
Savings
and money market accounts
i9,338,719
i7,813,939
Time
i4,475,234
i3,941,445
Total
deposits
i25,521,829
i20,181,028
Securities
sold under agreements to repurchase
i194,553
i126,354
Federal
Home Loan Bank advances
i1,787,551
i2,062,534
Subordinated
debt and other borrowings
i717,043
i749,080
Accrued
interest payable
i34,916
i42,183
Other
liabilities
i390,573
i288,569
Total
liabilities
i28,646,465
i23,449,748
Stockholders'
equity:
Preferred stock, no par value, 10.0 million shares authorized; 225,000 shares non-cumulative perpetual preferred stock, Series B, liquidation preference $225.0 million, issued and outstanding at June 30, 2020 and no shares issued and outstanding at Dec. 31, 2019, respectively.
i217,632
i—
Common
stock, par value $1.00; 180.0 million shares authorized; 75.8 million and 76.6 million shares issued and outstanding at June 30, 2020 and Dec. 31, 2019, respectively
i75,836
i76,564
Additional
paid-in capital
i3,019,286
i3,064,467
Retained
earnings
i1,218,367
i1,184,183
Accumulated
other comprehensive income, net of taxes
i164,526
i30,534
Total
stockholders' equity
i4,695,647
i4,355,748
Total
liabilities and stockholders' equity
$
i33,342,112
$
i27,805,496
See
accompanying notes to consolidated financial statements (unaudited).
PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
i
Note
1. Summary of Significant Accounting Policies
Nature of Business — Pinnacle Financial Partners, Inc. (Pinnacle Financial) is a financial holding company whose primary business is conducted by its wholly-owned subsidiary, Pinnacle Bank. Pinnacle Bank is a commercial bank headquartered in Nashville, Tennessee. Pinnacle Financial completed its acquisitions of CapitalMark Bank & Trust (CapitalMark), Magna Bank (Magna), Avenue Financial Holdings, Inc. (Avenue) and BNC Bancorp (BNC) on July 31, 2015, September 1, 2015, July 1, 2016 and June 16, 2017, respectively. Pinnacle Financial and Pinnacle Bank also collectively hold a i49%
interest in Bankers Healthcare Group, LLC (BHG), a company that primarily serves as a full-service commercial loan provider to healthcare and other professional practices. Pinnacle Bank provides a full range of banking services, including investment, mortgage, insurance, and comprehensive wealth management services, in its i12 primarily urban markets within Tennessee, the Carolinas, Virginia and beginning in December 2019, Georgia.
On July 2, 2019, Pinnacle
Bank acquired all of the outstanding stock of Advocate Capital, Inc. (Advocate Capital) for a cash price of $i59.0 million. Advocate Capital is a finance firm headquartered in Nashville, TN which supports the financial needs of legal firms through both case expense financing and working capital lines of credit. Pinnacle Financial accounted for the acquisition of Advocate Capital under the acquisition method in accordance with ASC Topic 805. Accordingly, the purchase price is allocated to the fair value of the assets acquired and liabilities acquired as of the date of acquisition. Determining
the fair value of assets and liabilities, particularly illiquid assets and liabilities, is a complicated process involving significant judgment regarding estimates and assumptions used to calculate estimated fair value. At the acquisition date, Advocate Capital's net assets were recorded at a fair value of approximately $i45.6 million, consisting mainly of loans receivable. Advocate Capital's $i134.3
million of indebtedness was also paid off in connection with consummation of the acquisition. The purchase price allocations for the acquisition of Advocate Capital were finalized during the second quarter of 2020.
i
Basis of Presentation — The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity
with U.S. generally accepted accounting principles (U.S. GAAP). All adjustments consisting of normally recurring accruals that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods covered by the report have been included. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes appearing in Pinnacle Financial's Annual Report on Form 10-K for the year ended December 31, 2019 (2019 10-K).
These consolidated financial statements include the accounts of Pinnacle Financial and its wholly-owned subsidiaries. Certain statutory trust affiliates of Pinnacle Financial, as noted in Note
11. Other Borrowings are included in these consolidated financial statements pursuant to the equity method of accounting. Significant intercompany transactions and accounts are eliminated in consolidation.
iUse of Estimates — The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for credit losses and determination of any impairment of goodwill or intangible assets. It is reasonably possible Pinnacle Financial's estimate of the allowance for credit losses and determination of impairment of goodwill or intangible assets could change as a result of the continued impact of the COVID-19 pandemic on the economy. The resulting change in these estimates could be material to Pinnacle Financial's consolidated financial statements. There have been no significant changes to Pinnacle Financial's significant accounting policies as disclosed in the 2019 10-K other than those that relate to the allowance for credit losses upon adoption of ASU 2016-13 as described later within Note 1.
Cash Flow Information — Supplemental cash flow information addressing certain cash and noncash transactions for the six months ended June 30, 2020 and 2019 was as follows (in thousands):
Loans charged-off to the allowance for credit losses
i20,695
i14,548
Loans
foreclosed upon and transferred to other real estate owned
i2,442
i11,760
Loans
foreclosed upon and transferred to other assets
i25
i93
Fixed
assets transferred to other real estate owned
i—
i5,126
Available-for-sale
securities transferred to held-to-maturity portfolio
i873,613
i—
Right-of-use
asset recognized during the period in exchange for lease obligations (1)
i2,928
i82,856
(1)Includes $i79.9 million recognized upon initial adoption of ASU 2016-02 on January 1, 2019.
/
i
Income
Per Common Share — Basic net income per common share (EPS) is computed by dividing net income by the weighted average common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock were exercised or converted. The difference between basic and diluted weighted average common shares outstanding is attributable to common stock options, restricted share awards, and restricted share unit awards. The dilutive effect of outstanding options, restricted share awards, and restricted share unit awards is reflected in diluted EPS by application of the treasury stock method.
i
The
following is a summary of the basic and diluted net income per common share calculations for the three and six months ended June 30, 2020 and 2019 (in thousands, except per share data):
Denominator
- Weighted average common shares outstanding
i75,211
i76,344
i75,507
i76,572
Basic
net income per common share
$
i0.83
$
i1.31
$
i1.20
$
i2.54
Diluted
net income per common share calculation:
Numerator – Net income
$
i62,444
$
i100,321
$
i90,800
$
i194,281
Denominator
- Weighted average common shares outstanding
i75,211
i76,344
i75,507
i76,572
Dilutive
shares contingently issuable
i112
i268
i139
i294
Weighted
average diluted common shares outstanding
i75,323
i76,612
i75,646
i76,866
Diluted
net income per common share
$
i0.83
$
i1.31
$
i1.20
$
i2.53
//
iAllowance
for Credit Losses - Loans - As described below under Recently Adopted Accounting Pronouncements, Pinnacle Financial adopted FASB ASC 326 effective January 1, 2020, which requires the estimation of an allowance for credit losses in accordance with the current expected credit loss (CECL) methodology. Pinnacle Financial's management assesses the adequacy of the allowance on a quarterly basis. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management's evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay a loan (including the timing of future payments), the estimated
value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. The level of the allowance for credit losses maintained by management is believed adequate to absorb all expected future losses inherent in the loan portfolio at the balance sheet date. The allowance is increased through provision for credit losses and decreased by charge-offs, net of recoveries of amounts previously charged-off.
The allowance for credit losses is measured on a collective basis for pools of loans with similar risk
characteristics. Pinnacle Financial has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses:
•Owner occupied commercial real estate mortgage loans - Owner occupied commercial real estate mortgage loans are secured by commercial office buildings, industrial buildings, warehouses or retail buildings where the owner of the building occupies the property. For such loans, repayment is largely dependent upon the operation of the borrower's business.
•Non-owner occupied commercial real estate loans - These loans represent investment real estate loans secured by office buildings, industrial buildings, warehouses, retail buildings, and multifamily residential housing. Repayment is primarily
dependent on lease income generated from the underlying collateral.
•Consumer real estate mortgage loans - Consumer real estate mortgage consists primarily of loans secured by 1-4 family residential properties, including home equity lines of credit. Repayment is primarily dependent on the personal cash flow of the borrower.
•Construction and land development loans - Construction and land development loans include loans where the repayment is dependent on the successful completion and eventual sale, refinance or operation of the related real estate project. Construction and land development loans include 1-4 family construction projects and commercial construction endeavors such as warehouses, apartments, office and retail space and land acquisition and development.
•Commercial
and industrial loans - Commercial and industrial loans include loans to business enterprises issued for commercial, industrial and/or other professional purposes. These loans are generally secured by equipment, inventory, and accounts receivable of the borrower and repayment is primarily dependent on business cash flows.
•Consumer and other loans - Consumer and other loans include all loans issued to individuals not included in the consumer real estate mortgage classification. Examples of consumer and other loans are automobile loans, consumer credit cards and loans to finance education, among others. Many consumer loans are unsecured. Repayment is primarily dependent on the personal cash flow of the borrower.
For commercial real estate, consumer real estate, construction
and land development, and commercial and industrial loans, Pinnacle Financial primarily utilizes a probability of default (PD) and loss given default (LGD) modeling approach. These models utilize historical correlations between default experience and certain macroeconomic factors as determined through a statistical regression analysis. All loan segments modeled using this approach consider changes in the national unemployment rate. In addition to the national unemployment rate, gross domestic product and the three month treasury rate are considered for owner occupied commercial real estate, the commercial real estate price index and the five year treasury rate are considered for construction loans, and the three month treasury rate is considered for commercial and industrial loans. Projections of these macroeconomic factors, obtained from an independent third party, are utilized to predict quarterly rates of default based on the statistical PD models. The predicted quarterly
default rates are then applied to the estimated future exposure at default (EAD), as determined based on contractual amortization terms and estimated prepayments. An estimated LGD, determined based on historical loss experience, is applied to the quarterly defaulted balances for each loan segment to estimate future losses of the loan's amortized cost.
Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each quarter by Pinnacle Financial and are dependent on the current economic environment among other factors. Upon implementation of CECL on January 1, 2020, a reasonable and supportable period of eighteen months was utilized
for all loan segments, followed by a twelve month straight line reversion to long term averages. At June 30, 2020, a reasonable and supportable period of twelve months was used for owner occupied commercial real estate, construction and land development and commercial and industrial, and a reasonable and supportable period of eighteen months was used for all other loan segments. The twelve month straight line reversion period was maintained for all loan segments at June 30, 2020.
For the consumer and other loan segment, a loss rate approach is utilized. For these loans, historical charge off rates are applied to projected future balances, as determined in the same manner as EAD for the statistically modeled loan segments. For credit cards, which have no amortization terms or contractual
maturities, future balances are estimated based on expected payment volume applied to the current balance.
The estimated loan losses for all loan segments are adjusted for changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative categories and the measurements used to quantify the risks within each of these categories are subjectively selected by management, but measured by objective measurements period over period. The data for each measurement may be obtained from internal or external sources. The current period measurements are evaluated and assigned a factor commensurate
with the current level of risk relative to past measurements over time. The resulting qualitative adjustments are applied to the relevant collectively evaluated loan portfolios. These adjustments are based upon quarterly trend assessments in portfolio concentrations, policy exceptions, associate retention, independent loan review results, collateral considerations, risk ratings, competition and peer group credit quality trends. The qualitative allowance allocation, as determined by the processes noted above, is increased or decreased for each loan segment based on the assessment of these various qualitative factors.
Loans that do not share similar risk characteristics with the collectively evaluated pools are evaluated on an individual basis and are excluded from the collectively evaluated pools. Individual evaluations are generally performed for loans greater than $1.0 million which
have experienced significant credit deterioration. Such loans are evaluated for credit losses based on either discounted cash flows or the fair value of collateral. When management determines that foreclosure is probable, expected credit losses are based on the fair value of the collateral, less selling costs. For loans for which foreclosure is not probable, but for which repayment is expected to be provided substantially through the operation or sale of the collateral, Pinnacle Financial has elected the practical expedient under ASC 326 to estimate expected credit losses based on the fair value of collateral, with selling costs considered in the event sale of the collateral is expected. Loans for which terms have been modified in a troubled debt restructuring (TDR) are evaluated using these same individual evaluation methods. In the event the discounted cash flow method is used for a TDR, the original interest rate is used to discount expected cash flows.
In
assessing the adequacy of the allowance for credit losses, Pinnacle Financial considers the results of Pinnacle Financial's ongoing independent loan review process. Pinnacle Financial undertakes this process both to ascertain those loans in the portfolio with elevated credit risk and to assist in its overall evaluation of the risk characteristics of the entire loan portfolio. Its loan review process includes the judgment of management, independent internal loan reviewers and reviews that may have been conducted by third-party reviewers including regulatory examiners. Pinnacle Financial incorporates relevant loan review results in the allowance.
In accordance with CECL, losses are estimated over the remaining contractual terms of loans, adjusted for prepayments. The contractual term excludes expected extensions, renewals and modifications unless management has a reasonable expectation
at the reporting date that a troubled debt restructuring will be executed or such renewals, extensions or modifications are included in the original loan agreement and are not unconditionally cancellable by Pinnacle Financial.
Credit losses are estimated on the amortized cost basis of loans, which includes the principal balance outstanding, purchase discounts and premiums, deferred loan fees and costs and accrued interest receivable. Accrued interest receivable is presented separately on the balance sheets and as allowed under ASU 2016-13 is excluded from the tabular loan disclosures in Note 4.
While policies and procedures used to estimate the allowance for credit losses, as well as the resultant provision for credit losses charged to income, are considered adequate by management and are reviewed periodically
by regulators, model validators and internal audit, they are necessarily approximate and imprecise. There are factors beyond Pinnacle Financial's control, such as changes in projected economic conditions, real estate markets or particular industry conditions which may materially impact asset quality and the adequacy of the allowance for credit losses and thus the resulting provision for credit losses.
Allowance for Credit Losses on Off Balance Sheet Credit Exposures - Pinnacle Financial estimates expected credit losses over the contractual term of obligations to extend credit, unless the obligation is unconditionally cancellable. The allowance for off balance sheet exposures is adjusted through other noninterest expense. The estimates are determined based on the likelihood of funding during the contractual term and an estimate of credit losses subsequent to funding.
Estimated credit losses on subsequently funded balances are based on the same assumptions as used to estimated credit losses on existing funded loans.
Allowance for Credit Losses - Securities Held-to-Maturity - Expected credit losses on debt securities classified as held-to-maturity are measured on a collective basis by major security type. The estimates of expected credit losses are based on historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The models rely on regression analyses to predict PD based on projected macroeconomic factors, including unemployment rates and GDP, among others. At June 30, 2020, Pinnacle Financial's held-to-maturity securities consisted entirely of municipal securities rated A or higher by the ratings agencies. A reasonable
and supportable period of 18 months and reversion period of 12 months is utilized to estimate credit losses on held-to-maturity municipal securities. The allowance is increased through provision for credit losses and decreased by charge-offs, net of recoveries of amounts previously charged-off.
Allowance for Credit Losses - Securities Available-for-Sale - For any securities classified as available-for-sale that are in an unrealized loss position at the balance sheet date, Pinnacle Financial assesses whether or not it intends to sell the security, or
more likely than not will be required to sell the security, before recovery of its amortized cost basis. If either criteria is met, the security's amortized cost basis is written down to fair value through net income. If neither criteria is met, Pinnacle Financial evaluates whether any portion of the decline in fair value is the result of credit deterioration. Such evaluations consider the extent to which the amortized cost of the security exceeds its fair value, changes in credit ratings and any other known adverse conditions related to the specific security. If the evaluation indicates that a credit loss exists, an allowance for credit losses is recorded through provisions for credit losses for the amount by which the amortized cost basis of the security exceeds the present value of cash flows expected to be collected, limited by the amount by which the amortized cost exceeds fair value. Any impairment not recognized in the allowance for credit losses is recognized
in other comprehensive income.
i
Recently Adopted Accounting Pronouncements— In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment to simplify how entities other than private companies, such as public business entities and not-for-profit entities, are required to test goodwill for impairment by
eliminating the comparison of the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. The amendments became effective for Pinnacle Financial on January 1, 2020 and did not have a material impact on Pinnacle Financial's consolidated financial statements.
In June 2016, the FASB issued Accounting Standards Update 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (Topic 326), and has issued subsequent amendments thereto, which introduces the current expected credit losses (CECL) methodology. Among other things, ASC 326 requires the measurement of all expected credit losses for financial assets, including loans and held-to-maturity debt securities, held at the reporting date based on historical experience, current
conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The new model requires institutions to calculate all probable and estimable losses that are expected to be incurred through the financial asset's contractual life through a provision for credit losses, including loans obtained as a result of any acquisition not deemed to be purchased credit deteriorated (PCD). ASC 326 also requires the allowance for credit losses for PCD loans to be determined in a manner similar to that of other financial assets measured at amortized cost; however, the initial allowance determined at acquisition is added to the purchase price rather than recorded as provision expense. In accordance with ASC 326, the disclosure of credit quality indicators related to the amortized cost of financing receivables is further disaggregated by year of origination (or vintage). Pinnacle Financial adopted ASU 2016-13 and all subsequent amendments thereto
effective January 1, 2020 using the modified retrospective method for all financial assets measured at amortized cost and off balance sheet credit exposures. Amounts for periods beginning on or after January 1, 2020 are presented under ASC 326 and all prior period information is presented in accordance with previously applicable GAAP. At January 1, 2020, Pinnacle Financial recognized a cumulative adjustment to retained earnings of $i31.8 million,
net of tax, attributable to an increase in the allowance for credit losses of $i34.3 million, an increase in the allowance for off balance sheet credit exposures of $i8.8 million,
and an increase in deferred tax assets of $i11.3 million. In addition, an allowance of $i3.8 million
was recognized on loans purchased with credit deterioration (PCD) previously classified as purchased credit impaired (PCI) with a corresponding adjustment to the gross carrying amount of the loans. Pinnacle Financial adopted ASC 326 using the prospective transition approach for PCD loans, which did not require re-evaluation of whether loans previously classified as PCI loans met the criteria of PCD assets at the date of adoption. The remaining noncredit discount will be accreted into interest income at the effective interest rate as of January 1, 2020.
/
i
Newly
Issued Not Yet Effective Accounting Standards — In March 2020, the FASB issued Accounting Standards Update 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020
through December 31, 2022. Pinnacle Financial is implementing a transition plan to identify and modify its loans and other financial instruments, including certain indebtedness, with attributes that are either directly or indirectly influenced by LIBOR. Pinnacle Financial is assessing ASU 2020-04 and its impact on the transition away from LIBOR for its loans and other financial instruments.
In January 2020, the FASB issued Accounting Standards Update 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. These amendments, among other things, clarify that a company should consider observable transactions that require a company
to either apply or discontinue the equity method of accounting under Topic 323,
Investments-Equity Method and Joint Ventures, for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that, when determining the accounting for certain forward contracts and purchased options a company should not consider, whether upon settlement or exercise, if the underlying securities would be accounted for under the equity method or fair value option. The guidance
is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is permitted, including early adoption in an interim period. An entity should apply ASU 2020-01 prospectively at the beginning of the interim period that includes the adoption date. Pinnacle Financial is assessing ASU 2020-01 and its impact on its accounting and disclosures.
In December 2019, the FASB issued Accounting Standards Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes to simplify various aspects of the current guidance to promote consistent application of the standard among reporting entities by moving certain exceptions to the general principles. The amendments are effective for fiscal
years beginning after December 15, 2020, with early adoption permitted. Pinnacle Financial does not plan to adopt this standard early. If this standard had been effective as of the date of the financial statements included in this report, there would have been no impact on Pinnacle Financial's consolidated financial statements.
Other than those pronouncements discussed above and those which have been recently adopted, we do not believe there were any other recently issued accounting pronouncements that are expected to materially impact Pinnacle Financial.
iReclassifications
— Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or stockholders' equity.
iSubsequent Events — ASC Topic 855, Subsequent Events, establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. Pinnacle Financial evaluated all events or transactions that occurred after June
30, 2020 through the date of the issued financial statements.
i
Note 2. Equity method investment
i
A
summary of BHG's financial position as of June 30, 2020 and December 31, 2019 and results of operations as of and for the three and six months ended June 30, 2020 and 2019, were as follows (in thousands):
At
June 30, 2020, technology, trade name and customer relationship intangibles, net of related amortization, totaled $i8.2 million compared to $i8.8
million as of December 31, 2019. Amortization expense of $i293,000 and $i587,000, respectively,
was included for the three and six months ended June 30, 2020 compared to $i475,000 and $i950,000,
respectively, for the same periods in the prior year. Accretion income of $i541,000 and $i1.1 million, respectively, was included in the three and six months ended June
30, 2020 compared to $i660,000 and $i1.3 million, respectively, for the same periods in the prior year.
During
the three months ended June 30, 2020, Pinnacle Financial and Pinnacle Bank received ino dividends from BHG. During the six months ended June 30, 2020, Pinnacle Financial and Pinnacle Bank received dividends from BHG of $i8.0
million in the aggregate. During the three and six months ended June 30, 2019, Pinnacle Financial and Pinnacle Bank received dividends of $i28.2 million and $i40.9
million, respectively, in the aggregate. Earnings from BHG are included in Pinnacle Financial's consolidated tax return. Profits from intercompany transactions are eliminated. iNo loans were purchased from BHG by Pinnacle Bank for the three and six month periods ended June 30, 2020 or 2019, respectively.
The
amortized cost and fair value of securities available-for-sale and held-to-maturity at June 30, 2020 and December 31, 2019 are summarized as follows (in thousands):
During
the first quarter of 2020, Pinnacle Financial transferred, at fair value, $873.6 million of municipal securities from the available-for-sale portfolio to the held-to-maturity portfolio. The related unrealized after tax gains of $i69.0 million remained in accumulated other comprehensive income (loss) and will be amortized over the remaining life of the securities, offsetting the related amortization of discount on the transferred securities. No gains or losses were
recognized at the time of transfer. At June 30, 2020, approximately $i1.3 billion of securities within Pinnacle Financial's investment portfolio were pledged to secure either public funds and other deposits or securities sold under agreements to repurchase. At June 30, 2020, repurchase agreements comprised of secured borrowings totaled $i194.6
million and were secured by $i194.6 million of pledged U.S. government agency securities, municipal securities, asset-backed securities, and corporate debentures. As the fair value of securities pledged to secure repurchase agreements may decline, Pinnacle Financial regularly evaluates its need to pledge additional securities to remain adequately secured.
iThe
amortized cost and fair value of debt securities as of June 30, 2020 by contractual maturity are shown below. Actual maturities may differ from contractual maturities of mortgage- and asset-backed securities since the mortgages and assets underlying the securities may be called or prepaid with or without penalty. Therefore, these securities are not included in the maturity categories in the following summary (in thousands):
At
June 30, 2020 and December 31, 2019, the following investments had unrealized losses. The table below classifies these investments according to the term of the unrealized losses of less than twelve months or twelve months or longer (in thousands):
Investments
with an Unrealized Loss of less than 12 months
Investments with an Unrealized Loss of 12 months or longer
The
applicable dates for determining when securities were in an unrealized loss position were June 30, 2020 and December 31, 2019. As such, it is possible that a security had a market value less than its amortized cost on other days during the past twelve-month periods ended June 30, 2020 and December 31, 2019, but is not in the "Investments with an Unrealized Loss of less than 12 months" category above.
As shown in the tables above, including both available-for-sale and held-to-maturity investment securities, at June 30, 2020, Pinnacle Financial
had approximately $i40.7 million in unrealized losses on $i965.1
million of securities. The unrealized losses associated with $873.6 million and $i179.8 million of municipal securities transferred from the available-for-sale portfolio to the held-to-maturity portfolio during the quarters ended March 31, 2020 and September 30, 2018, respectively, represent unrealized losses since the date of purchase, independent of the impact associated with changes in the cost basis upon transfer between
portfolios. As described in Note 1. Summary of Significant Accounting Policies, for any securities classified as available-for-sale that are in an unrealized loss position at the balance sheet date, Pinnacle Financial assesses whether or not it intends to sell the security, or more likely than not will be required to sell the security, before recovery of its amortized cost basis which would require a write-down to fair value through net income. Because Pinnacle Financial currently does not intend to sell those securities that have an unrealized loss at June 30, 2020, and it is not more-likely-than-not that Pinnacle Financial will be required to sell the securities before recovery of their amortized cost bases, which may be maturity, Pinnacle Financial has determined that no write-down is necessary. In addition, Pinnacle Financial evaluates whether any portion of the decline
in fair value is the result of credit deterioration, which would require the recognition of an allowance for credit losses. Such evaluations consider the extent to which the amortized cost of the security exceeds its fair value, changes in credit ratings and any other known adverse conditions related to the specific security. The unrealized losses associated with securities at June 30, 2020 are driven by changes in interest rates and are not due to the credit quality of the securities, and accordingly, no allowance for credit losses is considered necessary related to available-for-sale securities at June 30,
2020. These
securities will continue to be monitored as a part of Pinnacle Financial's ongoing evaluation of credit quality. Management evaluates the financial performance of the issuers on a quarterly basis to determine if it is probable that the issuers can make all contractual principal and interest payments.
The allowance for credit losses on held-to-maturity securities is measured on a collective basis by major security type as described in Note 1. Summary of Significant Accounting Policies. At June 30, 2020, Pinnacle Financial's held-to-maturity securities consist entirely of municipal securities. A reasonable and supportable period of 18 months and reversion period of 12 months was utilized to estimate credit losses on held-to-maturity municipal securities at June
30, 2020. With the implementation of CECL effective January 1, 2020, estimated credit losses on held-to-maturity municipal securities totaled approximately $i10,000. At June 30, 2020, the estimated allowance for credit losses on these securities increased to $i188,000,
with the increase driven largely by changes in macroeconomic projections.
Pinnacle Financial utilizes bond credit ratings assigned by third party ratings agencies to monitor the credit quality of debt securities held-to-maturity. At June 30, 2020, all debt securities classified as held-to-maturity were rated A or higher by the ratings agencies. Updated credit ratings are obtained as they become available from the ratings agencies.
Periodically, available-for-sale securities may be sold or the composition of the portfolio realigned to improve yields, quality or marketability, or to implement changes in investment or asset/liability strategy, including maintaining collateral requirements and raising funds for liquidity purposes or preparing for anticipated changes in
market interest rates. Additionally, if an available-for-sale security loses its investment grade or tax-exempt status, the underlying credit support is terminated or collection otherwise becomes uncertain based on factors known to management, Pinnacle Financial will consider selling the security, but will review each security on a case-by-case basis as these factors become known. Consistent with the investment policy, during the six months ended June 30, 2020, available-for-sale securities of approximately $i100.1
million were sold and net unrealized gains, net of tax, of $i247,000 were reclassified from accumulated other comprehensive income into net income.
The carrying values of Pinnacle Financial's investment securities could decline in the future if the financial condition of issuers deteriorates and management determines it is probable that
Pinnacle Financial will not recover the entire amortized cost bases of the securities. As a result, there is a risk that other-than-temporary impairment charges may occur in the future. Additionally, there is a risk that other-than-temporary impairment charges may occur in the future if management's intention to hold these securities to maturity and/or recovery changes. Pinnacle Financial has entered into various fair value hedging transactions to mitigate the impact of changing interest rates on the fair values of available for sale securities. See Note 8. Derivative Instruments for disclosure of the gains and losses recognized on derivative instruments and the cumulative fair value hedging adjustments to the carrying amount of the hedged securities.
i
Note
4. Loans and Allowance for Credit Losses
For financial reporting purposes, Pinnacle Financial classifies its loan portfolio based on the underlying collateral utilized to secure each loan. This classification is consistent with those utilized in the Quarterly Report of Condition and Income filed by Pinnacle Bank with the Federal Deposit Insurance Corporation (FDIC).
Pinnacle Financial uses the following loan categories for presentation of loan balances and the related allowance for credit losses on loans:
•Owner occupied commercial real estate mortgage loans - Owner occupied commercial real estate mortgage loans are secured by commercial office buildings, industrial buildings, warehouses or retail buildings where the owner of the building
occupies the property. For such loans, repayment is largely dependent upon the operation of the borrower's business.
•Non-owner occupied commercial real estate loans - These loans represent investment real estate loans secured by office buildings, industrial buildings, warehouses, retail buildings, and multifamily residential housing. Repayment is primarily dependent on lease income generated from the underlying collateral.
•Consumer real estate mortgage loans - Consumer real estate mortgage consists primarily of loans secured by 1-4 family residential properties, including home equity lines of credit. Repayment is primarily dependent on the personal cash flow of the borrower.
•Construction and land development loans -
Construction and land development loans include loans where the repayment is dependent on the successful completion and eventual sale, refinance or operation of the related real estate project. Construction and land development loans include 1-4 family construction projects and commercial construction endeavors such as warehouses, apartments, office and retail space and land acquisition and development.
•Commercial and industrial loans - Commercial and industrial loans include loans to business enterprises issued for commercial, industrial and/or other professional purposes. These loans are generally secured by equipment, inventory, and
accounts receivable of the borrower and repayment is primarily dependent on business cash flows. Loans amounting to $2.3 billion which were granted under the Paycheck Protection Program are included in this category.
•Consumer and other loans - Consumer and other loans include all loans issued to individuals not included in the consumer real estate mortgage classification. Examples of consumer and other loans are automobile loans, consumer credit cards and loans to finance education, among others. Many consumer loans are unsecured. Repayment is primarily dependent on the personal cash flow of the borrower.
Commercial
loans receive risk ratings assigned by a financial advisor subject to validation by Pinnacle Financial's independent loan review department. Risk ratings are categorized as pass, special mention, substandard, substandard-nonaccrual or doubtful-nonaccrual. Pass rated loans include six distinct ratings categories for loans that represent specific attributes. Pinnacle Financial believes that its categories follow those used by Pinnacle Bank's primary regulators. At June 30, 2020, approximately i82.5% of Pinnacle Financial's loan
portfolio was analyzed as a commercial loan type with a specifically assigned risk rating. Consumer loans and small business loans are generally not assigned an individual risk rating but are evaluated as either accrual or nonaccrual based on the performance of the individual loans. However, certain consumer real estate-mortgage loans and certain consumer and other loans receive a specific risk rating due to the loan proceeds being used for commercial purposes even though the collateral may be of a consumer loan nature. Consumer loans that have been placed on nonaccrual but have not otherwise been assigned a risk rating are believed by management to share risk characteristics with loans rated substandard-nonaccrual and have been presented as such in Pinnacle Financial's risk rating disclosures.
Risk ratings are subject to continual review by a financial advisor and a senior credit
officer. At least annually, Pinnacle Financial's credit procedures require every risk rated loan of $i1.0 million or more be subject to a formal credit risk review process. Each loan's risk rating is also subject to review by Pinnacle Financial's independent loan review department, which reviews a substantial portion of Pinnacle Financial's risk rated portfolio annually. Included in the coverage are independent loan reviews of loans in targeted higher-risk portfolio segments such as certain commercial and industrial loans, land loans and/or loan types in certain geographies. During the second quarter of 2020, Pinnacle Financial performed
an in-depth review of all risk-graded loans greater than $1.0 million for which we had granted the borrower the ability to defer the payment of principal and/or interest for a period of up to 90 days following the COVID-19 outbreak. Pinnacle Financial also performed an in-depth review of all of its hotel and retail commercial real estate loans greater than $1.0 million regardless of their receipt of deferral.
Following are the definitions of the risk rating categories used by Pinnacle Financial. Pass rated loans include all credits other than those included within these categories:
•Special mention loans have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset
or in Pinnacle Financial's credit position at some future date.
•Substandard loans are inadequately protected by the current net worth and financial capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize collection of the debt. Substandard loans are characterized by the distinct possibility that Pinnacle Financial could sustain some loss if the deficiencies are not corrected.
•Substandard-nonaccrual loans are substandard loans that have been placed on nonaccrual status.
•Doubtful-nonaccrual
loans have all the characteristics of substandard-nonaccrual loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
i
The table below presents loan balances classified within each risk rating category by primary loan type and based on year of origination as of June 30, 2020 (in thousands):
(1)
Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by Pinnacle Bank's primary regulators for loans classified as substandard, excluding troubled debt restructurings. Potential problem loans, which are not included in nonaccrual loans, amounted to approximately $i251.3 million at June
30, 2020, compared to $i276.0 million at December 31, 2019.
i
The table below presents the aging
of past due balances by loan segment at June 30, 2020 and December 31, 2019 (in thousands):
The following table details the changes in the allowance for credit losses for the three and six months ended June 30, 2020 and 2019, respectively, by loan classification (in thousands):
The
following table details the allowance for credit losses on loans and recorded investment in loans by loan classification and by impairment evaluation method as of December 31, 2019, as determined in accordance with ASC 310 prior to the adoption of ASU 2016-13 (in thousands):
Loans
acquired with deteriorated credit quality(1)
i—
i—
i—
i—
i—
i
i—
Total
allowance for loan losses
$
i33,369
$
i8,054
$
i12,662
$
i36,112
$
i3,595
$
i985
$
i94,777
Loans:
Collectively
evaluated for impairment
$
i7,681,608
$
i3,036,922
$
i2,426,901
$
i6,274,280
$
i289,106
$
i19,708,817
Individually
evaluated for impairment
i18,122
i25,018
i561
i14,295
i148
i58,144
Loans
acquired with deteriorated credit quality
i9,488
i6,685
i3,021
i1,721
i—
i20,915
Total
loans
$
i7,709,218
$
i3,068,625
$
i2,430,483
$
i6,290,296
$
i289,254
$
i19,787,876
(1)
Prior to the adoption of ASC 326 on January 1, 2020, an allowance for loan losses was recorded on loans acquired with deteriorated credit quality only in the event of additional credit deterioration subsequent to acquisition.
The adequacy of the allowance for credit losses is reviewed by Pinnacle Financial's management on a quarterly basis.
This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management's evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay the loan (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. The level of the allowance for credit losses maintained by management is believed adequate to absorb all expected future losses inherent in the loan portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.
As described in Note 1. Summary of Significant Accounting Policies, Pinnacle Financial adopted ASU 2016-13 on January 1, 2020, which introduced the CECL methodology for estimating all expected losses over the life of a financial asset. Under the CECL methodology the allowance for credit losses is measured on a collective basis for pools of loans with similar risk characteristics, and for loans that do not share similar risk characteristics with the collectively evaluated pools, evaluations are performed on an individual basis. For all loan segments collectively evaluated, losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. Upon implementation of
ASU 2016-13 on January 1, 2020, Pinnacle Financial utilized a reasonable and supportable period of eighteen months for all loan segments, followed by a twelve month straight line reversion to long term averages. At June 30, 2020, a reasonable and supportable period of twelve months was utilized for owner occupied commercial real estate, construction and land development, and commercial and industrial in response to the relatively high level of economic uncertainly related to the ongoing COVID-19 pandemic. For all other loan segments, the reasonable and supportable period of eighteen months was maintained as longer variable lag structures are used within their statistical models, which inherently mitigates the uncertainty in the economic projections by placing less reliance on sudden changes in the projections. The twelve month straight line reversion period was maintained
for all loan segments at June 30, 2020. Upon adoption of ASU 2016-13, the opening balance of the allowance for credit losses was increased by $38.1 million through retained earnings. The additional increase during the three months ended June 30, 2020 is primarily attributable to the change in projected economic conditions resulting from the COVID-19 pandemic, with the projected increase in the unemployment rate being the most significant driver.
i
The
following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine
The table below presents the amortized cost basis of loans on nonaccrual status and loans past due 90 or more days and still accruing interest at June 30, 2020 and December 31, 2019. Also presented is the balance of loans on nonaccrual status at June 30, 2020 for which there was no related allowance for credit losses recorded (in thousands):
Nonaccrual loans with no allowance for credit losses
Loans past due 90 or more days and still accruing
Total nonaccrual loans
Loans past due 90 or more days and still accruing
Commercial
real estate:
Owner-occupied
$
i11,806
$
i4,325
$
i—
$
i11,654
$
i—
Non-owner
occupied
i10,454
i7,540
i—
i7,173
i—
Consumer
real estate – mortgage
i23,237
i—
i18
i24,667
i168
Construction
and land development
i3,230
i1,222
i—
i2,278
i—
Commercial
and industrial
i13,780
i6,753
i1,459
i15,685
i946
Consumer
and other
i55
i—
i505
i148
i501
Total
$
i62,562
$
i19,840
$
i1,982
$
i61,605
$
i1,615
/
Pinnacle
Financial's policy is the accrual of interest income will be discontinued when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is more than 90 days past due, unless the loan is both well secured and in the process of collection. As such, at the date loans are placed on nonaccrual status, Pinnacle Financial reverses all previously accrued interest income against current year earnings. Pinnacle Financial's policy is once a loan is placed on nonaccrual status each subsequent payment is reviewed on a case-by-case basis to determine if the payment should be applied to interest or principal pursuant to regulatory guidelines. Pinnacle Financial recognized ino
interest income from cash payments received on nonaccrual loans during the three and six months ended June 30, 2020, compared to $i89,000 and $i176,000
during the three and six months ended June 30, 2019, respectively. Had these nonaccruing loans been on accruing status, interest income would have been higher by $i854,000 and $i1.6
million for the three and six months ended June 30, 2020, respectively, compared to $i1.4 million and $i2.6
million higher for the three and six months ended June 30, 2019, respectively. Approximately $i32.1 million and $i35.8
million of nonaccrual loans as of June 30, 2020 and December 31, 2019, respectively, were performing pursuant to their contractual terms at those dates.
i
The following table presents impaired loans at December 31, 2019 as determined under ASC 310 prior to the adoption of ASU 2016-13. Impaired loans generally include nonaccrual
loans, troubled debt restructurings, and other loans deemed to be impaired but that continue to accrue interest. Presented are the recorded investment, unpaid principal balance and related allowance of impaired loans at December 31, 2019 by loan classification (in thousands):
The following table details the average recorded investment and the amount of interest income recognized on a cash basis for the three and six months ended June 30, 2019, respectively, of impaired loans by loan classification as determined under ASC 310 prior to the adoption of ASU 2016-13 (in thousands):
Three months ended
Six
months ended
Average recorded investment
Interest income recognized
Average recorded investment
Interest income recognized
Impaired loans with an allowance:
Commercial
real estate – mortgage
$
i15,589
$
i—
$
i15,097
$
i—
Consumer
real estate – mortgage
i22,219
i—
i21,434
i—
Construction
and land development
i747
i—
i692
i—
Commercial
and industrial
i9,718
i—
i9,563
i—
Consumer
and other
i221
i—
i475
i—
Total
$
i48,494
$
i—
$
i47,261
$
i—
Impaired
loans without an allowance:
Commercial real estate – mortgage
$
i13,503
$
i89
$
i13,910
$
i176
Consumer
real estate – mortgage
i10,658
i—
i9,521
i—
Construction
and land development
i—
i—
i595
i—
Commercial
and industrial
i13,505
i—
i13,868
i—
Consumer
and other
i—
i—
i—
i—
Total
$
i37,666
$
i89
$
i37,894
$
i176
Total
impaired loans
$
i86,160
$
i89
$
i85,155
$
i176
i
Prior
to the adoption of ASU 2016-13, loans acquired with deteriorated credit quality, referred to under ASC 310-30 as purchased credit impaired loans and under ASU 2016-13 as purchased credit deteriorated loans, were assigned a credit related purchase discount and non-credit related purchase discount at acquisition. Upon adoption of ASU 2016-13 on January 1, 2020, the remaining credit related discount was re-classified to a component of the allowance for credit losses. The remaining non-credit discount will continue to be accreted into income over the remaining lives of the related loans. The following table provides a rollforward of purchased credit deteriorated loans from December 31, 2019 through June 30, 2020 (in thousands):
The
carrying value is adjusted for additional draws, pursuant to contractual arrangements, offset by loan paydowns. Year-to-date settlements include both loans that were charged-off as well as loans that were paid off, typically as a result of refinancings at other institutions.
At June 30, 2020 and December 31, 2019, there were $i3.3 million
and $i4.9 million, respectively, of troubled debt restructurings that were performing as of their restructure date and which were accruing interest. Troubled commercial loans are restructured by specialists within Pinnacle Bank's Special Assets Group, and all restructurings are approved by committees and/or credit officers separate and apart from the normal loan approval process. These specialists are charged with reducing Pinnacle Financial's overall risk and exposure to loss in the event of a restructuring
by obtaining some or all of the following: improved documentation, additional guaranties, increase in curtailments, reduction in collateral release terms, additional collateral or other similar strategies.
The
following table outlines the amount of each loan category where troubled debt restructurings were made during the three and six months ended June 30, 2020 and 2019 (dollars in thousands):
Post Modification Outstanding Recorded Investment, net of related allowance
2020
Commercial real estate:
Owner-occupied
i—
$
i—
$
i—
i—
$
i—
$
i—
Non-owner
occupied
i—
i—
i—
i—
i—
i—
Consumer
real estate – mortgage
i—
i—
i—
i1
i807
i807
Construction
and land development
i—
i—
i—
i—
i—
i—
Commercial
and industrial
i—
i—
i—
i—
i—
i—
Consumer
and other
i—
i—
i—
i—
i—
i—
i—
$
i—
$
i—
i1
$
i807
$
i807
2019
Commercial
real estate:
i—
$
i—
$
i—
i—
$
i—
$
i—
Consumer
real estate – mortgage
i1
i712
i626
i1
i712
i626
Construction
and land development
i1
i21
i19
i1
i21
i19
Commercial
and industrial
i1
i1,397
i796
i1
i1,397
i796
Consumer
and other
i—
i—
i—
i—
i—
i—
i3
$
i2,130
$
i1,441
i3
$
i2,130
$
i1,441
/
There
were no troubled debt restructurings made during the three months ended June 30, 2020. During the six months ended June 30, 2020 and 2019, there were ino troubled debt restructurings that subsequently defaulted within twelve months of the restructuring.
In
response to the COVID-19 pandemic and its economic impact to its customers, Pinnacle Bank implemented a short-term modification program in accordance with interagency regulatory guidance to provide temporary payment relief to those borrowers directly impacted by COVID-19 who were not more than 30 days past due at the time of the modification. This program allows for a deferral of payments for 90 days, which Pinnacle Bank may extend for an additional 90 days, for a maximum of 180 days on a cumulative and successive basis. Pursuant to the interagency regulatory guidance, Pinnacle Financial may elect to not classify loans for which these deferrals are granted as troubled debt restructurings.
i
Pinnacle
Financial analyzes its commercial loan portfolio to determine if a concentration of credit risk exists to any industries. Pinnacle Financial utilizes broadly accepted industry classification systems in order to classify borrowers into various industry classifications. Pinnacle Financial has a credit exposure (loans outstanding plus unfunded lines of credit) exceeding i25% of Pinnacle Bank's total risk-based capital to borrowers in the following industries at June 30, 2020 with the comparative exposures for December
31, 2019 (in thousands):
Pinnacle Financial monitors two ratios regarding construction and commercial real estate lending as part of its concentration management processes. Both ratios are calculated by dividing certain types of loan balances for each of the two categories by Pinnacle Bank’s total risk-based capital. At both June 30, 2020 and December 31, 2019, Pinnacle Bank’s construction and land development loans as a percentage of total risk-based capital were i83.6%. Non-owner
occupied commercial real estate and multifamily loans (including construction and land development loans) as a percentage of total risk-based capital were i275.0% and i268.3%
as of June 30, 2020 and December 31, 2019, respectively. Banking regulations have established guidelines for the construction ratio of less than 100% of total risk-based capital and for the non-owner occupied ratio of less than 300% of total risk-based capital. When a bank’s ratios are in excess of one or both of these guidelines, banking regulations generally require an increased level of monitoring in these lending areas by bank management. At June 30, 2020, Pinnacle Bank was within the 100% and 300% guidelines and has established what it believes to be appropriate controls to monitor its lending in these areas as it aims to keep the level of these loans below the 100% and 300% thresholds.
At June 30,
2020, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $i11.1 million to current directors, executive officers, and their related entities, of which $i7.1
million had been drawn upon. At December 31, 2019, Pinnacle Bank had granted loans and other extensions of credit amounting to approximately $i10.6 million to directors, executive officers, and their related entities, of which approximately $i6.8
million had been drawn upon. All loans to directors, executive officers, and their related entities were performing in accordance with contractual terms at June 30, 2020 and December 31, 2019.
At June 30, 2020, Pinnacle Financial had approximately $i16.2 million in commercial loans held for sale compared to $i17.6 million
at December 31, 2019, which primarily included commercial real estate and apartment loans originated for sale to a third-party as part of a multi-family loan program. Such loans are closed under a pass-through commitment structure wherein Pinnacle Bank's loan commitment to the borrower is the same as the third party's take-out commitment to Pinnacle Bank and the third party purchase typically occurs within thirty days of Pinnacle Bank closing with the borrowers.
Residential Lending
At June 30, 2020, Pinnacle Financial had approximately $i53.7
million of mortgage loans held-for-sale compared to approximately $i61.6 million at December 31, 2019. Total loan volumes sold during the six months ended June 30, 2020 were approximately $i837.4
million compared to approximately $i485.6 million for the six months ended June 30, 2019. During the three and six months ended June 30, 2020, Pinnacle Financial recognized $i19.6
million and $i28.2 million, respectively, in gains on the sale of these loans, net of commissions paid, compared to $i6.0 million and $i10.9
million, respectively, net of commissions paid, during the three and six months ended June 30, 2019.
These mortgage loans held-for-sale are originated internally and are primarily to borrowers in Pinnacle Bank's geographic markets. These sales are typically on a mandatory basis to investors that follow conventional government sponsored entities (GSE) and the Department of Housing and Urban Development/U.S. Department of Veterans Affairs (HUD/VA) guidelines.
Each purchaser of a mortgage loan held-for-sale has specific guidelines and criteria for sellers of loans and the risk of credit loss with regard to the principal amount of the loans sold is generally transferred to the purchasers upon sale. While the loans are sold without recourse, the purchase agreements require
Pinnacle Bank to make certain representations and warranties regarding the existence and sufficiency of file documentation and the absence of fraud by borrowers or other third parties such as appraisers in connection with obtaining the loan. If it is determined that the loans sold were in breach of these representations or warranties, Pinnacle Bank has obligations to either repurchase the loan for the unpaid principal balance and related investor fees or make the purchaser whole for the economic benefits of the loan. To date, Pinnacle Bank's liability pursuant to the terms of these representations and warranties has been insignificant to Pinnacle Bank.
ASC 740, Income Taxes, defines the threshold for recognizing the benefits of tax return positions in the financial statements as "more-likely-than-not" to be sustained by the taxing authority. This section also provides guidance on the derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties, and includes guidance concerning accounting for income tax uncertainties
in interim periods.
The unrecognized tax benefit related to uncertain tax positions related to state income tax filings was $i6.9 million at June 30, 2020 and December 31, 2019, respectively. No change was recorded to the unrecognized tax benefit related to uncertain tax positions in each of the three and six month periods ended June 30, 2020
and 2019.
Pinnacle Financial's policy is to recognize interest and/or penalties related to income tax matters in income tax expense. For both the three and six months ended June 30, 2020 and 2019, respectively, there were ino interest and penalties recorded in the income statement.
Pinnacle
Financial's effective tax rate for the three and six months ended June 30, 2020 was expense of i15.2% and i9.5%,
respectively, compared to expense of i19.6% for the three and six months ended June 30, 2019. The difference between the effective tax rate and the federal and state income tax statutory rate of i26.14%
at June 30, 2020 and 2019 is primarily due to investments in bank qualified municipal securities, tax benefits of Pinnacle Bank's real estate investment trust subsidiary, participation in the Tennessee Community Investment Tax Credit (CITC) program, and tax benefits associated with share-based compensation, bank-owned life insurance and our captive insurance subsidiary, offset in part by the limitation on deductibility of meals and entertainment expense, non-deductible executive compensation and non-deductible FDIC premiums.
Income tax expense is also impacted by the vesting of equity-based awards and the exercise of employee stock options, which expense or benefit is recorded as a discrete item as a component of total income tax, the amount of which is dependent upon the change in the
grant date fair value and the vest date fair value of the underlying award. Accordingly, for the three and six months ended June 30, 2020 we recognized excess tax expense of $i272,000 and benefits of $i590,000,
respectively, compared to excess tax expense of $i68,000 and benefits of $i701,000,
respectively, for the three and six months ended June 30, 2019. For the six months ended June 30, 2020, income tax expense was also impacted by provision for credit losses, including provision for credit losses resulting from the COVID-19 pandemic, which was recorded as a discrete item as a component of total income tax. Accordingly, we recognized a tax benefit of $i22.4 million for the six months ended June 30, 2020.
/
i
Note
6. Commitments and Contingent Liabilities
In the normal course of business, Pinnacle Bank has entered into off-balance sheet financial instruments which include commitments to extend credit (i.e., including unfunded lines of credit) and standby letters of credit. Commitments to extend credit are usually the result of lines of credit granted to existing borrowers under agreements that the total outstanding indebtedness will not exceed a specific amount during the term of the indebtedness. Typical borrowers are commercial concerns that use lines of credit to supplement their treasury management functions, and thus their total outstanding indebtedness may fluctuate during any time period based on the seasonality of their business and the resultant timing of their cash flows. Other typical lines of credit are related to home equity loans granted to consumers. Commitments to extend credit generally have
fixed expiration dates or other termination clauses and may require payment of a fee. At June 30, 2020, these commitments amounted to $i8.7 billion, of which approximately $i1.1
billion related to home equity lines of credit.
Standby letters of credit are generally issued on behalf of an applicant (Pinnacle Bank's customer) to a specifically named beneficiary and are the result of a particular business arrangement that exists between the applicant and the beneficiary. Standby letters of credit have fixed expiration dates and are usually for terms of itwo years or less unless terminated beforehand due to criteria specified in the standby letter of credit. A typical arrangement involves the applicant routinely being
indebted to the beneficiary for such items as inventory purchases, insurance, utilities, lease guarantees or other third party commercial transactions. The standby letter of credit would permit the beneficiary to obtain payment from Pinnacle Bank under certain prescribed circumstances. Subsequently, Pinnacle Bank would then seek reimbursement from the applicant pursuant to the terms of the standby letter of credit. At June 30, 2020, these commitments amounted to $i213.3 million.
Pinnacle
Bank typically follows the same credit policies and underwriting practices when making these commitments as it does for on-balance sheet instruments. Each customer's creditworthiness is typically evaluated on a case-by-case basis, and the amount of collateral obtained, if any, is based on management's credit evaluation of the customer. Collateral held varies but may include cash, real estate and improvements, marketable securities, accounts receivable, inventory, equipment and personal property.
The
contractual amounts of these commitments are not reflected in the consolidated financial statements and only amounts drawn upon would be reflected in the future. Since many of the commitments are expected to expire without being drawn upon, the contractual amounts do not necessarily represent future cash requirements. However, should the commitments be drawn upon and should Pinnacle Bank's customers default on their resulting obligation to Pinnacle Bank, the maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those commitments. At June 30, 2020 and December 31, 2019, Pinnacle Financial had accrued $i20.8
million and $i2.4 million, respectively, for the inherent risks associated with these off-balance sheet commitments. The adoption of ASU 2016-13 effective January 1, 2020, which introduced the CECL methodology for measuring credit losses, as discussed more fully in Note. 1 Summary of Significant Accounting Policies, increased the opening balance of our accrual for off-balance sheet commitments at adoption by $i8.8 million.
The remainder of the increase is largely attributable to the anticipated economic impact of the COVID-19 pandemic and its effect on Pinnacle Financial's CECL credit loss modeling for the three and six months ended June 30, 2020.
In June 2020, a purported class action lawsuit was filed against Pinnacle Bank alleging, among other claims, that Pinnacle Bank failed to pay fees to purported agents of PPP borrowers that the plaintiff alleges were owed under the PPP in violation of SBA regulations. Pinnacle Bank disputes the plaintiff’s claims and intends to vigorously defend itself in connection with this proceeding.
Various legal claims also arise from time to time in the normal course of business. In the opinion of management, the resolutions of these claims outstanding
at June 30, 2020 are not expected to have a material adverse impact on Pinnacle Financial's consolidated financial condition, operating results or cash flows.
i
Note 7. Stock Options and Restricted Shares
The
2018 Omnibus Equity Incentive Plan (the "2018 Plan") permits Pinnacle Financial to reissue outstanding awards that are subsequently forfeited, settled in cash, withheld by Pinnacle Financial to cover withholding taxes or expire unexercised and returned to the 2018 Plan. At June 30, 2020, there were approximately i838,996 shares available for issuance under the 2018 Plan.
The BNC Bancorp 2013 Amended and Restated Omnibus Stock Incentive Plan (the "BNC Plan") was assumed by Pinnacle Financial in connection with its merger with BNC. As of June 30, 2020, there were ino shares remaining available for issuance from the BNC Plan. iNo
new awards may be granted under equity incentive plans of Pinnacle Financial other than the 2018 Plan.
Upon the acquisition of CapitalMark, Pinnacle Financial assumed approximately i858,000 stock options under the CapitalMark Option Plan. iNo
further awards remain available for issuance under the CapitalMark Option Plan. At June 30, 2020, all of the remaining options outstanding were granted under the CapitalMark Option Plan.
Common Stock Options
i
A summary of the stock option activity within the equity incentive plans during the six
months ended June 30, 2020 and information regarding expected vesting, contractual terms remaining, intrinsic values and other matters is as follows:
Number
Weighted-Average Exercise Price
Weighted-Average Contractual Remaining Term (in years)
(1)The
aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted closing price of Pinnacle Financial common stock of $i64.00 per common share at December 31, 2019 for the i119,274
options that were in-the-money at December 31, 2019.
(2)The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted closing price of Pinnacle Financial common stock of $i41.99 per common share at June 30, 2020 for the i109,487
options that were in-the-money at June 30, 2020.
/
Compensation costs related to stock options granted under Pinnacle Financial's equity incentive plans have been fully recognized and all outstanding option awards are fully vested.
(1)Represents
shares forfeited due to employee termination and/or retirement. iNo shares were forfeited due to failure to meet performance targets.
Pinnacle Financial has granted restricted share awards to associates and outside directors
with a time-based vesting criteria. Compensation expense associated with time-based vesting restricted share awards is recognized over the time period that the restrictions associated with the awards lapse on a straight-line basis based on the total cost of the award. The following table outlines restricted stock grants that were made, grouped by similar vesting criteria, during the six months ended June 30, 2020. The table reflects the life-to-date activity for these awards:
Grant Year
Group
(1)
Vesting
Period in years
Shares awarded
Restrictions Lapsed and shares released to participants
Shares Forfeited by participants (4)
Shares Unvested
Time Based Awards
2020
Associates
(2)
i3
-
i5
i231,020
i97
i2,973
i227,950
Outside
Director Awards (3)
2020
Outside directors
i1
i18,525
i—
i—
i18,525
(1)Groups
include employees (referred to as associates above) and outside directors. When the restricted shares are awarded, a participant receives voting rights and forfeitable dividend rights with respect to the shares, but is not able to transfer the shares until the restrictions have lapsed. Once the restrictions lapse, the participant is taxed on the value of the award and may elect to sell some shares (or have Pinnacle Financial withhold some shares) to pay the applicable income taxes associated with the award. Alternatively, the recipient can pay the withholding taxes in cash. For time-based vesting restricted share awards, dividends paid on shares for which the forfeiture restrictions do not lapse will be recouped by Pinnacle Financial at the time of termination. For performance-based vesting awards to Pinnacle Financial's directors, dividends are placed into escrow until the forfeiture restrictions on such shares lapse.
(2)The
forfeiture restrictions on these restricted share awards lapse in equal annual installments on the anniversary date of the grant.
(3)Restricted share awards are issued to the outside members of the board of directors in accordance with their board compensation plan. Restrictions lapse on February 28, 2021 based on each individual board member meeting their attendance goals for the various board and board committee meetings to which each member was scheduled to attend.
(4)These shares represent forfeitures resulting from recipients whose employment or board membership was terminated during the year-to-date period ended June 30, 2020. Any dividends paid on shares for which the forfeiture restrictions do not lapse will be recouped by Pinnacle
Financial at the time of termination or will not be distributed from escrow, as applicable.
The
following table details the performance-based vesting restricted stock unit awards outstanding at June 30, 2020:
Units Awarded
Grant
year
Named Executive Officers
(NEOs) (1)
Leadership Team other than NEOs
Applicable Performance Periods associated with each tranche (fiscal year)
Service period per tranche (in years)
Subsequent holding period per tranche (in years)
Period in which units to be settled into shares of common stock(2)
2020
i136,137
—
i204,220
i59,648
2020
i2
i3
2025
2021
i2
i2
2025
2022
i2
i1
2025
2019
i166,211
-
i249,343
i52,244
2019
i2
i3
2024
2020
i2
i2
2024
2021
i2
i1
2024
2018
i96,878
-
i145,339
i25,990
2018
i2
i3
2023
2019
i2
i2
2023
2020
i2
i1
2023
2017
i72,537
-
i109,339
i24,916
2017
i2
i3
2022
2018
i2
i2
2022
2019
i2
i1
2022
2016
i73,474
-
i110,223
i26,683
2016
i2
i3
2021
2017
i2
i2
2021
2018
i2
i1
2021
(1)The
named executive officers are awarded a range of awards that may be earned based on attainment of goals between a target level of performance and a maximum level of performance.
(2)Restricted share unit awards, if earned, will be settled in shares of Pinnacle Financial Common Stock in the periods noted in the table, if Pinnacle Bank's ratio of non-performing assets to its loans plus ORE is less than amounts established in the applicable award agreement.
/
During the six months ended June 30, 2020, the restrictions associated with i129,723
performance-based vesting restricted stock unit awards granted in prior years and lapsed, based on the terms of the agreement and approval by Pinnacle Financial's Human Resources and Compensation Committee, and were settled into shares of Pinnacle Financial common stock with i43,996 shares being withheld to pay the taxes associated with the settlement of those shares.
Stock compensation expense related to both restricted share awards
and restricted share units for the three and six months ended June 30, 2020 was $i4.1 million and $i9.6 million, respectively, compared to $i5.2
million and $i10.1 million, respectively, for the three and six months ended June 30, 2019. As of the June 30, 2020, the total compensation cost related to unvested restricted share awards and performance-based vesting restricted stock units not yet recognized was $i45.1
million. This expense, if the underlying units are earned, is expected to be recognized over a weighted-average period of i2.06 years.
i
Note
8. Derivative Instruments
Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship.
Non-hedge derivatives
For derivatives not designated as hedges, the gain or loss is recognized in current period earnings. Pinnacle Financial enters into interest rate swaps (swaps) to facilitate customer transactions and meet their financing needs. Upon entering into these instruments to meet customer needs, Pinnacle Financial enters into offsetting positions in order to minimize the risk to Pinnacle Financial. These swaps qualify as derivatives, but are not designated as hedging instruments. The income
statement impact of the offsetting positions is limited to changes in the reserve for counterparty credit risk. iA summary of Pinnacle Financial's interest rate swaps to facilitate customers' transactions as of June 30, 2020 and December 31, 2019 is included in the following table (in thousands):
The
effects of Pinnacle Financial's interest rate swaps to facilitate customers' transactions on the income statement during the three and six months ended June 30, 2020 and 2019 were as follows (in thousands):
For derivative instruments that are designated and qualify as a cash flow hedge, the aggregate fair value of the derivative instrument is recorded in other assets or other liabilities with any gain or loss related to changes in fair value recorded in accumulated other comprehensive income, net of tax. The gain or loss is reclassified into earnings in the same period during which the hedged asset or liability affects earnings and is presented in the same income statement line item as the earnings effect of the hedged asset or liability. Pinnacle Financial uses interest rate floors in an effort to mitigate the impact of declining interest rates on LIBOR-based variable rate loans. Pinnacle Financial uses forward cash flow hedges in an effort to manage future interest rate exposure on borrowings. The hedging strategy converts the LIBOR-based variable interest rate on forecasted
borrowings to a fixed interest rate and is used in an effort to protect Pinnacle Financial from floating interest rate variability. A summary of Pinnacle Financial's cash flow hedge relationships as of June 30, 2020 and December 31, 2019 is as follows (in thousands):
The
effects of Pinnacle Financial's cash flow hedge relationships on the statement of comprehensive income (loss) during the three and six months ended June 30, 2020 and 2019 were as follows, net of tax (in thousands):
Amount of Gain (Loss) Recognized
in Other Comprehensive Income (Loss)
Three Months Ended June 30,
Six Months Ended June 30,
Asset derivatives
2020
2019
2020
2019
Interest
rate floor - loans
$
i6,318
$
i7,924
$
i71,667
$
i7,924
Liability
derivatives
Interest rate swaps - borrowings
$
i141
$
(i980)
$
(i1,439)
$
(i1,503)
$
i6,459
$
i6,944
$
i70,228
$
i6,421
The
cash flow hedges were determined to be highly effective during the periods presented and as a result qualify for hedge accounting treatment. The hedge would no longer be considered effective if a portion of the hedge becomes ineffective, the item hedged is no longer in existence or Pinnacle Financial discontinues hedge accounting. Pinnacle Financial expects the hedges at June 30, 2020 to continue to be highly effective and qualify for hedge accounting during the remaining terms of the original hedging transactions. Gains totaling $i123,000
net of tax and losses totaling $i1.7 million net of tax were reclassified from accumulated other
comprehensive income (loss) into net income during the three and six months ended June 30, 2020, respectively, compared to losses totaling $i73,000 net of tax and gains totaling $i183,000
net of tax during the three and six months ended June 30, 2019, respectively. During the first quarter of 2020, loan interest rate floors entered into in the second quarter of 2019 with a notional amount totaling $i1.3 billion and unrealized gains totaling $i16.5
million were terminated. These unrealized gains are being amortized into income on a straight line basis through October 2021. Approximately $i8.1 million in unrealized gains, net of tax, are expected to be reclassified from accumulated other comprehensive income (loss) into net income over the next twelve months related to terminated cash flow hedges.
Derivatives designated as fair value hedges
For
derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. The gain or loss on the derivative instrument is presented on the same income statement line item as the earnings effect of the hedged item. Pinnacle Financial utilizes interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate callable available-for-sale securities. The hedging strategy converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities.
A summary of Pinnacle Financial's
fair value hedge relationships as of June 30, 2020 and December 31, 2019 is as follows (in thousands):
The
effects of Pinnacle Financial's fair value hedge relationships on the income statement during the three and six months ended June 30, 2020 and 2019 were as follows (in thousands):
Location
of Loss on Derivative
Amount of Loss Recognized in Income
Three Months Ended June 30,
Six Months Ended June 30,
Liability derivatives
2020
2019
2020
2019
Interest
rate swaps - securities
Interest income on securities
$
(i2,559)
$
(i15,963)
$
(i41,432)
$
(i26,243)
Interest
rate swaps - loans
Interest income on loans
$
i—
$
(i2,061)
$
i—
$
(i6,915)
Location
of Gain on Hedged Item
Amount of Gain Recognized in Income
Three Months Ended June 30,
Six Months Ended June 30,
Liability derivatives - hedged items
2020
2019
2020
2019
Interest
rate swaps - securities
Interest income on securities
$
i2,559
$
i15,963
$
i41,432
$
i26,243
Interest
rate swaps - loans
Interest income on loans
$
i—
$
i2,061
$
i—
$
i6,915
The following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges at June 30, 2020 and December 31, 2019 (in thousands):
Carrying Amount of the Hedged Assets
Cumulative
Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets
During
the three and six months ended June 30, 2020, amortization expense totaling $i1.0 million and $i2.1 million, respectively, related to previously terminated fair value hedges was recognized
as a reduction to interest income on loans.
FASB
ASC 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value in U.S. GAAP and expands disclosures about fair value measurements. The definition of fair value focuses on the exit price, i.e., the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not the entry price, i.e., the price that would be paid to acquire the asset or received to assume the liability at the measurement date. The statement emphasizes that fair value is a market-based measurement; not an entity-specific measurement. Therefore, the fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.
Valuation Hierarchy
FASB
ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
•Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
•Level 3 – inputs to the valuation methodology are unobservable and
significant to the fair value measurement.
A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy.
Assets
Securities available-for-sale – Where quoted prices are available for identical securities in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government securities and certain other financial products. If quoted market prices are not
available, then fair values are estimated by using pricing models that use observable inputs or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation and more complex pricing models or discounted cash flows are used, securities are classified within Level 3 of the valuation hierarchy.
Other investments – Included in other investments are investments recorded at fair value primarily in certain nonpublic investments and funds. The valuation of these nonpublic investments requires management judgment due to the absence of observable quoted market prices, inherent lack of liquidity and the long-term nature of such assets. These investments are valued initially based upon transaction price. The carrying
values of other investments are adjusted either upwards or downwards from the transaction price to reflect expected exit values as evidenced by financing and sale transactions with third parties, or when determination of a valuation adjustment is confirmed through ongoing reviews by senior investment managers. A variety of factors are reviewed and monitored to assess positive and negative changes in valuation including, but not limited to, current operating performance and future expectations of the particular investment, industry valuations of comparable public companies and changes in market outlook and the third-party financing environment over time. In determining valuation adjustments resulting from the investment review process, emphasis is placed on current company performance and market conditions. These investments are included in Level 3 of the valuation hierarchy if the entities and funds are not widely traded and the underlying investments are in privately-held
and/or start-up companies for which market values are not readily available. Certain investments in funds for which the underlying assets of the fund represent publicly traded investments are included in Level 2 of the valuation hierarchy.
Other assets – Included in other assets are certain assets carried at fair value, including interest rate swap agreements to facilitate customer transactions, interest rate floors designated as cash flow hedges, and interest rate locks associated with the mortgage loan pipeline. The carrying amount of interest rate swap agreements is based on Pinnacle Financial's pricing models that utilize observable market inputs. The fair value of the cash flow hedge agreements is determined by calculating the difference between the discounted fixed rate cash flows and the discounted variable rate cash flows. The fair value of the mortgage loan pipeline
is based upon the projected sales price of the underlying loans, taking into account market interest rates and other market factors at the measurement date, net of the projected fallout rate. Pinnacle Financial reflects these assets within Level 2 of the valuation hierarchy as these assets are valued using similar transactions that occur in the market.
Collateral dependent loans – Collateral dependent loans are measured at the fair value of the collateral securing the loan less estimated selling costs. The fair value of real estate collateral is determined based on real estate appraisals which are
generally based on recent sales of comparable properties which are then adjusted for property specific factors. Non real estate collateral is valued based on various sources, including third party asset valuations and internally determined values based on cost adjusted for depreciation and other judgmentally determined discount factors. Collateral dependent loans are classified within Level 3 of the hierarchy due to the unobservable inputs used in determining their fair value such as collateral values and the borrower's underlying financial condition.
Other real estate owned – Other real estate owned (OREO) represents real estate foreclosed upon by Pinnacle Bank through loan defaults by customers or acquired by deed in lieu of foreclosure. A significant portion of these amounts relate to lots, homes and development projects that are either completed or are in various stages
of construction for which Pinnacle Financial believes it has adequate collateral. Upon foreclosure, the property is recorded at the lower of cost or fair value, based on appraised value, less selling costs estimated as of the date acquired with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation downward adjustments are determined on a specific property basis and are included as a component of noninterest expense along with holding costs. Any gains or losses realized at the time of disposal are also reflected in noninterest expense, as applicable. OREO is included in Level 3 of the valuation hierarchy due to the lack of observable market inputs into the determination of fair value as appraisal values are property-specific and sensitive to the changes in the overall economic environment.
Liabilities
Other
liabilities – Pinnacle Financial has certain liabilities carried at fair value including certain interest rate swap agreements to facilitate customer transactions, interest rate swaps designated as fair value and cash flow hedges, and interest rate locks associated with the funding for its mortgage loan originations. The fair value of these liabilities is based on Pinnacle Financial's pricing models that utilize observable market inputs and is reflected within Level 2 of the valuation hierarchy.
The
following tables present financial instruments measured at fair value on a recurring basis as of June 30, 2020 and December 31, 2019, by caption on the consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above) (in thousands):
Total carrying value in the
consolidated balance sheet
Quoted market prices in an active market (Level 1)
Models with significant observable market parameters (Level 2)
Models with significant unobservable market parameters (Level 3)
(1)
Amount is net of valuation allowance of $i3.3 million at December 31, 2019 as required by ASC 310-10, "Receivables."
/
In the case of the investment securities portfolio, Pinnacle Financial monitors the portfolio to ascertain when transfers between levels have been affected.
The nature of the remaining assets and liabilities is such that transfers in and out of any level are expected to be rare. For the six months ended June 30, 2020, there were ino transfers between Levels 1, 2 or 3.
The table below includes a rollforward of the balance sheet amounts for the three and six months ended June 30, 2020 and June 30, 2019 (including the change in fair value) for financial instruments classified by Pinnacle Financial within Level 3 of the valuation hierarchy measured at fair value on a recurring basis including changes
in fair value due in part to observable factors that are part of the valuation methodology (in thousands):
Changes
in unrealized gains/losses included in other comprehensive income for assets and liabilities still held at period-end
i501
i—
i1,504
i—
i480
i—
i1,008
i—
Purchases
i—
i1,366
i—
i3,518
i—
i3,727
i—
i5,188
Issuances
i—
i—
i—
i—
i—
i—
i—
i—
Settlements
i—
(i232)
i—
(i584)
(i1,143)
(i819)
(i399)
(i1,017)
Transfers
out of Level 3
i—
i—
i—
i—
i—
i—
i—
i—
Fair
value, end of period
$
i15,295
$
i40,612
$
i15,263
$
i31,522
$
i15,295
$
i40,612
$
i15,263
$
i31,522
Total
realized gains (losses) included in income related to financial assets and liabilities still on the consolidated balance sheet at period-end
$
i27
$
(i278)
$
i29
$
i481
$
i55
$
(i452)
$
i59
$
i929
/
i
The
following tables present the carrying amounts, estimated fair value and placement in the fair value hierarchy of Pinnacle Financial's financial instruments at June 30, 2020 and December 31, 2019. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash, cash equivalents, and restricted cash, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as non-interest bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity (in thousands):
(1)Estimated
fair values are consistent with an exit-price concept. The assumptions used to estimate the fair values are intended to approximate those that a market-participant would realize in a hypothetical orderly transaction.
(2)At the end of each quarter, Pinnacle Financial evaluates the inherent risks of the outstanding off-balance sheet commitments, including both commitments for unfunded loans and standby letters of credit. In making this evaluation, Pinnacle Financial utilizes credit loss expectations on funded loans from our allowance for credit losses methodology and evaluates the probability that the outstanding commitment will eventually become a funded loan. As a result, at June 30, 2020 and December 31, 2019, Pinnacle Financial included in other liabilities $i20.8
million and $i2.4 million, respectively, representing expected credit losses on off-balance sheet commitments, which are reflected in the estimated fair values of the related commitments. Also included in the fair values at June 30, 2020 and December 31, 2019 are unamortized fees related to these commitments of $i1.4
million at both dates.
i
Note 10. Regulatory Matters
Pursuant to Tennessee banking law, Pinnacle Bank may not, without the prior consent of the Commissioner of the Tennessee Department of Financial Institutions (TDFI), pay any dividends
to Pinnacle Financial in a calendar year in excess of the total of Pinnacle Bank's retained net income for that year plus the retained net income for the preceding itwo years. Under Tennessee corporate law, Pinnacle Financial is not permitted to pay dividends if, after giving effect to such payment, it would not be able to pay its debts as they become due in the usual course of business or its total assets would be less than the sum of its total liabilities plus any amounts needed to satisfy any preferential rights if it were dissolving. In addition, in deciding whether or not to declare a dividend of any particular size, Pinnacle Financial's
board of directors must consider its and Pinnacle Bank's current and prospective capital, liquidity, and other needs. In addition to state law limitations on Pinnacle Financial's ability to pay dividends, the Federal Reserve imposes limitations on Pinnacle Financial's ability to pay dividends. Federal Reserve regulations limit dividends, stock repurchases and discretionary bonuses to executive officers if Pinnacle Financial's regulatory capital is below the level of regulatory minimums plus the applicable capital conservation buffer.
In addition, the Federal Reserve has issued supervisory guidance advising bank holding companies to eliminate, defer or reduce dividends paid on common stock and other forms of Tier 1 capital where the company’s net income available to shareholders for the past four quarters,
net of dividends previously paid during that period, is not sufficient to fully fund the dividends, the company’s prospective rate of earnings retention is not consistent with the company’s capital needs and overall current and prospective financial condition or the company will not meet, or is in danger of not meeting, minimum regulatory capital adequacy ratios. Recent supplements to this guidance reiterate the need for bank holding companies to inform their applicable reserve bank sufficiently in advance of the proposed payment of a dividend in certain circumstances.
During the six months ended June
30, 2020, Pinnacle Bank paid $i94.1 million in dividends to Pinnacle Financial. As of June 30, 2020, Pinnacle Bank could pay approximately $i619.2
million of additional dividends to Pinnacle Financial without prior approval of the Commissioner of the TDFI. Since the fourth quarter of 2018, Pinnacle Financial has paid a quarterly common stock dividend of $i0.16 per share. The amount and timing of all future dividend payments by Pinnacle Financial, if any, is subject to discretion of Pinnacle Financial's board of directors and will depend on Pinnacle Financial's receipt of dividends, including dividends on Pinnacle Financial's 6.75% fixed rate non-cumulative perpetual preferred stock, Series B (the Series B Preferred Stock) from Pinnacle
Bank, earnings, capital position, financial condition and other factors, including regulatory capital requirements, as they become known to Pinnacle Financial and receipt of any regulatory approvals that may become required as a result of each of Pinnacle Financial's or Pinnacle Bank's financial results.
Pinnacle Financial and Pinnacle Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Pinnacle Financial and Pinnacle Bank must meet specific capital guidelines
that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Pinnacle Financial's and Pinnacle Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Pinnacle Financial and its banking subsidiary to maintain minimum amounts and ratios of common equity Tier 1 capital to risk-weighted assets, Tier 1 capital to risk-weighted assets, total risk-based capital to risk-weighted assets and Tier 1 capital to average assets.
As permitted by the interim final rule issued on March
27, 2020 by the federal banking regulatory agencies, each of Pinnacle Bank and Pinnacle Financial has elected the option to delay the estimated impact on regulatory capital of Pinnacle Financial's and Pinnacle Bank's adoption of ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, which was effective January 1, 2020. The initial impact of adoption of ASU 2016-13, as well as 25% of the quarterly increases in the allowance for credit losses subsequent to adoption of ASU 2016-13 (collectively the “transition adjustments”), will be delayed for two years. After two years, the cumulative amount of the transition adjustments will become fixed and will be phased out of the regulatory capital calculations evenly over a three year period, with 75% recognized in year three, 50% recognized in year four, and 25% recognized in year five. After five
years, the temporary regulatory capital benefits will be fully reversed.
i
Management believes, as of June 30, 2020, that Pinnacle Financial and Pinnacle Bank met all capital adequacy requirements to which they are subject. To be categorized as well-capitalized under applicable banking regulations, Pinnacle Bank must maintain certain total risk-based, Tier 1 risk-based, common equity Tier
1 and Tier 1 leverage ratios as set forth in the following table and not be subject to a written agreement, order or directive to maintain a higher capital level. The capital conservation buffer is not included in the required ratios of the table presented below. Pinnacle Financial's and Pinnacle Bank's actual capital amounts and resulting ratios, not including the capital conservation buffer, are presented in the following table (in thousands):
Actual
Minimum
Capital Requirement
Minimum To Be Well-Capitalized Under Prompt Corrective Action Regulations
During the second quarter of 2020, Pinnacle Financial issued i9.0
million depositary shares, each representing a 1/40th interest in a share of Series B preferred stock in a registered public offering to both retail and institutional investors. Net proceeds from the transaction were approximately $i217.6 million after deducting the underwriting discounts and offering expenses payable by Pinnacle Financial. The net proceeds were retained by Pinnacle Financial and are available to support the capital needs of Pinnacle Financial and Pinnacle Bank, to support Pinnacle Financial's obligations,
including interest payments on its outstanding indebtedness, and for other general corporate purposes.
i
Note 11. Other Borrowings
i
Pinnacle
Financial has itwelve wholly-owned subsidiaries that are statutory business trusts created for the exclusive purpose of issuing i30-year capital
trust preferred securities, and Pinnacle Financial and Pinnacle Bank have entered into certain other subordinated debt agreements. On April 22, 2020, Pinnacle Financial established a credit facility with the Federal Reserve Bank in conjunction with the SBA Paycheck Protection Program, with available borrowing capacity equal to the outstanding balance of Paycheck Protection Program loans, which totaled approximately $i2.2 billion at June 30, 2020. Pinnacle Financial also
had a $i75.0 million revolving credit facility with no outstanding borrowings as of June 30, 2020 that matured on July 24, 2020 and was not renewed. These instruments are outlined below as of June 30, 2020 (in thousands):
(1)
Migrates to ithree month LIBOR + 3.128% beginning July 30, 2020 through the end of the term.
(2) Migrates to ithree month LIBOR + 3.884% beginning November
16, 2021 through the end of the term.
(3) Migrates to ithree month LIBOR + 2.775% beginning September 15, 2024 through the end of the term.
(4) Borrowing capacity on the revolving credit facility is $i75.0
million. At June 30, 2020, there were ino amounts outstanding under this facility. An unused fee of i0.30%
is assessed on the average daily unused amount of the line. This credit facility matured on July 24, 2020 and was not renewed.
/
On September 11, 2019, Pinnacle Financial issued $300.0 aggregate principal amount of 4.125% Fixed-to-Floating Rate Subordinated Notes due 2029 (the 2029 Notes) in a public offering. The offering and sale of the 2029 Notes yielded net proceeds of approximately $i296.5 million
after deducting the underwriting discount and offering expenses payable by Pinnacle Financial. Pinnacle Financial used approximately $i8.8 million of such proceeds to redeem the previously outstanding Subordinated Note due October 15, 2023, which Pinnacle Financial assumed in the BNC merger and which carried an interest rate of 7.23% at the time of such redemption, which occurred on September 30, 2019. Pinnacle Financial also used a portion of the net proceeds
of this offering to
redeem, effective January 1, 2020, the outstanding balance and accrued interest of the $i20.0 million
aggregate principal amount of Avenue subordinated notes and $i60.0 million aggregate principal amount of BNC subordinated notes. Pinnacle Financial intends to use the remainder of the net proceeds from the offering of the 2029 Notes for general corporate purposes, including providing capital to support the growth of Pinnacle Bank's business.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of our financial condition at June 30, 2020 and December 31, 2019 and our results of operations for the three and six months ended June 30, 2020 and 2019. The purpose of this discussion is to focus on information about our financial condition and results of operations which is not otherwise apparent from our consolidated financial statements. The following discussion and analysis should be read along with our consolidated financial statements and the related notes included elsewhere herein and the risk factors
discussed in Part II, Item 1A - Risk Factors, herein as well as our Annual Report on Form 10-K for the year ended December 31, 2019 (Form 10-K) and the other reports we have filed with the Securities and Exchange Commission since we filed that Form 10-K.
Impact of COVID-19 Pandemic
On January 30, 2020, the World Health Organization declared a global health emergency related to a novel strain of the coronavirus, COVID-19. With that declaration, we activated our pandemic response team and began work to prepare both our associates and clients for the impact of COVID-19. The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption
in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve. These actions included the decision by the Federal Reserve Open Markets Committee to lower the target for the federal funds rate to a range of between zero to 0.25% on March 15, 2020. This action followed a prior reduction of the targeted federal funds rate to a range of 1.0% to 1.25% on March 3, 2020.
We have been intentional in our response to the COVID-19 pandemic to ensure strength in our balance sheet, including increases in liquidity and reserves. As a part of this intentional response, during the second quarter of 2020, we performed an in-depth review of all risk-graded loans greater than $1.0 million for which we had granted the borrower the ability to defer
the payment of principal and/or interest for a period of up to 90 days following the COVID-19 outbreak. We also performed an in-depth review of all of our hotel and retail commercial real estate loans greater than $1.0 million regardless of their receipt of deferral. Additionally, we have continued to adjust our business practices, including restricting employee travel, encouraging employees to work from home, where possible, converting to drive-thru only service with specific needs facilitated by appointment, implementing social distancing guidelines within our offices and by the launch of our pandemic response team, which continues to meet on a regular basis.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of
the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program ("PPP"), a program designed to aid small- and medium-sized businesses, sole proprietors and other self-employed persons through federally guaranteed loans distributed through banks. These loans are intended to guarantee eight to 24 weeks of payroll and other costs to provide support to participating businesses and increase the ability of these businesses to retain workers. As of June 30, 2020, we had obtained approvals for approximately 14,000 clients totaling approximately $2.3 billion in approved loans. These loans are fully guaranteed by the SBA, carry a term of two or five years, dependent on the date originated, and a 1.0% annualized rate. Inclusive of fees from the SBA, our yield on PPP loans in the second quarter was 2.89%. The reduction in approved dollars from the amounts we previously disclosed as of April
30, 2020 is the result of PPP loans that borrowers chose to return to the SBA prior to June 30, 2020.
We have also implemented a short-term loan modification program to provide temporary payment relief to certain of our borrowers. This program allows for a deferral of principal and/or interest payments for 90 days, which we may extend for an additional 90 days, for a maximum of 180 days on a cumulative and successive basis. As of June 30, 2020, we had granted deferrals on approximately $4.2 billion in aggregate principal amount of loans. As of July 17, 2020, loans with aggregate principal balances of approximately $2.7 billion remained on deferral.
We believe our response has allowed and continues
to allow us to appropriately support our associates, clients and their communities. The COVID-19 pandemic along with the implementation of CECL have contributed to an increased provision for credit losses for the first half of 2020 and an extended duration of economic disruption resulting from the virus could lead to increased net charge-offs and continued elevated levels of provisioning expense. We continue to monitor both the impact of COVID-19 and the effects of the CARES Act closely; however, the extent to which each will impact our operations and financial results during the remainder of 2020 remains uncertain.
Overview
Our diluted net income per common share for the three and six months ended June 30, 2020 was $0.83 and $1.20, respectively, compared to $1.31 and $2.53, respectively, for the
same periods in 2019. At June 30, 2020, reflecting the significant number of loans
we had originated under the PPP, loans had increased to $22.5 billion, as compared to $19.8 billion at December 31, 2019, and total deposits increased to $25.5 billion at June 30, 2020 from $20.2 billion at December 31, 2019.
Results of Operations. Our net interest income increased to $200.7 million and
$394.2 million, respectively, for the three and six months ended June 30, 2020 compared to $188.9 million and $376.2 million, respectively, for the same periods in the prior year, representing increases of $11.7 million and $18.0 million, respectively. For the three and six months ended June 30, 2020 when compared to the comparable periods in 2019, this increase was largely the result of lower cost of funds, the impact of both interest and fees related to the PPP and our acquisition of additional liquidity in response to the economic uncertainty resulting from the COVID-19 pandemic as well as organic loan growth during the comparable periods. The net interest margin (the ratio of net interest income to average earning assets) for the three and six months ended June 30, 2020 was 2.87% and 3.06%, respectively, compared to
3.48% and 3.55%, respectively, for the same periods in 2019 and reflects the impact of loans made pursuant to the PPP and our acquisition of additional on-balance sheet liquidity as noted above, the decline in short-term interest rates, declining levels of positive impact from purchase accounting and the competitive rate environments for loans and deposits in our markets.
Our provision for credit losses was $68.3 million and $168.2 million, respectively, for the three and six months ended June 30, 2020 compared to $7.2 million and $14.4 million, respectively, for the same periods in 2019. The primary drivers of the increase in provision were the anticipated economic impact of the COVID-19 pandemic and our adoption of FASB ASU 2016-13 on January 1, 2020. ASU 2016-13, which introduces the current expected
credit losses (CECL) methodology, requires us to estimate all expected credit losses over the remaining life of our loan portfolio. Also contributing to the increase in provision was an increase in net charge-offs, which totaled $5.4 million and $15.5 million, respectively, for the three and six months ended June 30, 2020 compared to $4.1 million and $7.7 million, respectively, for the same periods in 2019. The increase in net charge-offs in the first six months of 2020 was in large part the result of an approximately $5.0 million charge-off related to a single credit in the commercial and industrial loan category during the first quarter of 2020. This credit was criticized going into the COVID-19 pandemic and as a result of the pandemic suffered further deterioration resulting in its partial charge-off during the first quarter of 2020. During the second quarter of 2020, we had a partial recovery of approximately $1.7
million on this credit.
At June 30, 2020, our allowance for credit losses as a percentage of total loans, inclusive of PPP loans, was 1.27% compared to 0.48% at December 31, 2019. The increase in the allowance for credit losses is largely the result of the implementation of CECL on January 1, 2020, which resulted in an adjustment to the opening balance of the allowance for credit losses of $38.1 million, and increased provisioning during the first half of 2020 due to the anticipated economic impact of the COVID-19 pandemic. The increase in the opening balance upon the implementation of CECL is partially attributable to a change in the treatment of acquired loans. Prior to the adoption of CECL, acquired loans required an allowance only if estimated credit losses exceeded the remaining purchase
accounting fair value discounts. Under CECL, an allowance for credit losses is recognized for all loans without regard to fair value discounts. Also contributing to the increase in the opening balance upon adoption was an overall increase in reserve rates under CECL due to the estimation of all expected credit losses over the remaining contractual life of the portfolio rather than only probable incurred losses as was required under the prior accounting standard.
Noninterest income increased by $2.3 million, or 3.2%, and $21.6 million, or 17.7%, respectively, during the three and six months ended June 30, 2020 compared to the same periods in 2019. The growth in noninterest income was in large part attributable to gains on mortgage loans sold, net, which increased by $13.6 million and $17.3 million, respectively, for the three and six months ended
June 30, 2020 as compared to the same periods in the prior year, largely due to the favorable interest rate environment as well are our increased number of mortgage originators in the respective periods. These gains on mortgage loans sold, net, were offset in part by a decrease in income from our equity method investment in BHG of $15.1 million, or 46.7%, and $12.8 million, or 28.0%, respectively, during the three and six months ended June 30, 2020 compared to the same periods in the prior year. Additionally impacting noninterest income were wealth management revenues of $12.2 million and $28.8 million, respectively, for the three and six months ended June 30, 2020 compared to $11.5 million and $23.2 million, respectively, in the same periods in the prior year as well as $128,000 in net losses and $335,000 in net gains
on sales of securities, respectively, during the three and six months ended June 30, 2020 compared to $4.5 million and $6.4 million, respectively, in net losses on sales of securities during the same periods in the prior year. Other noninterest income, which is the result of fee revenue lines of business other than those noted above, increased during the three and six months ended June 30, 2020 by $725,000 and $6.2 million, respectively, when compared to the same periods in the prior year.
Noninterest expense increased by $3.9 million, or 3.1%, and $27.2 million, or 11.3%, during the three and six months ended June 30, 2020 compared to the three and six months ended June 30, 2019. Impacting noninterest expense for the three and
six months ended June 30, 2020 as compared to the same prior year periods was the $1.7 million decrease and $8.4 million increase, respectively, in salaries and employee benefits. The change in salaries and employee benefits was the result of an increase in our associate base in the first six months of 2020 versus the first six months of 2019 offset in part, or in the case of the three months ended June 30, 2020, in whole, by the reduction of our cash incentive plan accrual as well as the reduction in stock-based compensation expense due to our performance through the first half of 2020 compared to the earnings per share performance metric targets established pursuant to our
annual cash incentive plan and the return on average tangible assets performance metric targets applicable pursuant to certain performance-based equity awards we have previously awarded, each due to the effects of COVID-19 on our anticipated earnings and performance for the year ended December 31, 2020. Also impacting noninterest expense in the first half of 2020 was $9.7 million in lending related costs related to an increase in our off balance sheet reserves. The increase in the expense related to off balance sheet reserves during the six months ended June 30, 2020 was largely due to the impact of the COVID-19 pandemic on expected credit losses under CECL.
Our efficiency ratio (the ratio of noninterest expense to the sum of net interest income and noninterest
income) was 48.1% and 50.0%, respectively, for the three and six months ended June 30, 2020 compared to 49.2% and 48.6%, respectively, for the same periods in 2019. The efficiency ratio measures the amount of expense that is incurred to generate a dollar of revenue.
During the three and six months ended June 30, 2020, we recorded income tax expense of $11.2 million and $9.6 million, respectively, compared to income tax expense of $24.4 million and $47.5 million, respectively, for the three and six months ended June 30, 2019. Our effective tax rate for the three and six months ended June 30, 2020 was 15.2% and 9.5%, respectively, compared to 19.6% for both the three and six months ended June
30, 2019. Our tax expense in the first half of 2020 was impacted by the provision for credit losses recorded in response to the COVID-19 pandemic, a portion of which was recorded as a discrete item of total income tax in the first quarter of 2020 and contributed a tax benefit of $22.4 million. Our tax rate in each period was also impacted by the vesting and exercise of equity-based awards previously granted under our equity-based compensation program, resulting in the recognition of tax expense of $272,000 and a tax benefit of $590,000, respectively, for the three and six months ended June 30, 2020 compared to tax expense of $68,000 and a tax benefit of $701,000, respectively, for the three and six months ended June 30, 2019.
Financial Condition. Net loans increased $2.7 billion, or 13.8%, during
the six months ended June 30, 2020, when compared to December 31, 2019. Contributing to increased loan volumes during the six months ended June 30, 2020, were $2.2 billion of loans, as of June 30, 2020, issued through the Small Business Administration's (SBA's) Paycheck Protection Program (PPP). The remainder of the increase is primarily the result of loans made to borrowers that principally operate or are located in our core markets that were made prior to the COVID-19 pandemic, increases in the number of relationship advisors we employ and continued focus on attracting new customers to our company. Total deposits were $25.5 billion at June
30, 2020, compared to $20.2 billion at December 31, 2019, an increase of $5.3 billion, or 26.5%. Deposit growth during the period was likely aided by our clients' need to build liquidity going into the COVID-19 pandemic and current stock market conditions, but was also due in part to our intentional emphasis on gathering low cost core deposits during 2020. Although it is difficult to measure precisely the level of increased deposits that came to us from the PPP, we estimate that our PPP borrowers increased their deposit balances with us by approximately $1.7 billion between March 31, 2020 and June 30, 2020.
Capital and Liquidity. At June 30, 2020 and December
31, 2019, our capital ratios, including our bank's capital ratios, exceeded regulatory minimum capital requirements and those necessary to be considered well-capitalized under applicable federal regulations. See Note 10. Regulatory Matters in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q. From time to time we may be required to support the capital needs of our bank (Pinnacle Bank). At June 30, 2020, we had approximately $318.8 million of cash at the parent company to be used to support our bank.
During the second quarter of 2020, we issued 9.0 million depositary shares, each representing a 1/40th interest in a share of our 6.75% fixed rate non-cumulative, perpetual preferred stock, Series B (Series B Preferred Stock) in a registered public offering to both retail and institutional investors.
Net proceeds from the transaction after underwriting discounts and offering expenses payable by us were approximately $217.6 million. The net proceeds were retained at Pinnacle Financial and are available to support our capital needs and other obligations, including payments related to our outstanding indebtedness, to support the capital needs and other obligations of our bank and for other general corporate purposes. Additionally, we believe we have various capital raising techniques available to us to provide for the capital needs of our company and bank, such as the $300 million subordinated debt offering issued during the third quarter of 2019 or entering into a new revolving credit facility with another financial institution. We also periodically evaluate capital markets conditions to identify opportunities to access those markets if necessary or prudent to support our capital
levels.
On November 13, 2018, Pinnacle Financial announced that its board of directors authorized a share repurchase program for up to $100.0 million of Pinnacle Financial’s outstanding common stock and on October 15, 2019, the board approved an additional $100.0 million of repurchase authorization. The initial repurchase program expired on March 31, 2020, with the additional $100.0 million authorization expiring on December 31, 2020. Prior to January 1, 2020, we repurchased approximately 1.5 million shares of our common stock at an aggregate cost of $82.1 million. During the quarter ended March 31, 2020, we repurchased approximately
1.0 million shares of our common stock at an aggregate cost of $50.8 million. Our last purchase of shares of our common stock occurred on March 19, 2020. We suspended our repurchase program at the end of the first quarter of 2020 and it remains suspended until we gain more clarity on the length and depth of the COVID-19 pandemic.
The accounting principles we follow and our methods of applying these principles conform with U.S. GAAP and with general practices within the banking industry. On January 1,
2020, we adopted FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326) which significantly changes our methodology for determining our allowance for credit losses, and ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment which simplifies our process for performing goodwill impairment testing.See Note 1. Summary of Significant Accounting Policies in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q for further information related to these changes. There have been no other significant changes to our Critical Accounting Estimates as described in our Form 10-K.
Selected
Financial Information
The following is a summary of certain financial information as of or for the three and six month periods ended June 30, 2020 and as of December 31, 2019 and for the three and six months ended June 30, 2019 (dollars in thousands, except per share data):
Net
interest income after provision for credit losses
132,325
181,723
(27.2)
%
225,988
361,785
(37.5)
%
Noninterest income
72,954
70,682
3.2
%
143,331
121,745
17.7
%
Noninterest
expense
131,605
127,686
3.1
%
268,954
241,737
11.3
%
Net income before income taxes
73,674
124,719
(40.9)
%
100,365
241,793
(58.5)
%
Income
tax expense
11,230
24,398
(54.0)
%
9,565
47,512
(79.9)
%
Net income
$
62,444
$
100,321
(37.8)
%
$
90,800
$
194,281
(53.3)
%
Per
Share Data:
Basic net income per common share
$
0.83
$
1.31
(36.6)
%
$
1.20
$
2.54
(52.8)
%
Diluted
net income per common share
$
0.83
$
1.31
(36.6)
%
$
1.20
$
2.53
(52.6)
%
Balance
Sheet:
Loans, net of allowance for credit losses
$
22,234,928
$
19,693,099
12.9
%
$
22,234,928
$
19,693,099
12.9
%
Deposits
$
25,521,829
$
20,181,028
26.5
%
$
25,521,829
$
20,181,028
26.5
%
Performance
Ratios:
Return on average assets (1)
0.77
%
1.55
%
(50.3)
%
0.60
%
1.54
%
(61.0)
%
Return
on average stockholders' equity (2)
5.58
%
9.77
%
(42.9)
%
4.10
%
9.63
%
(57.4)
%
Return on average common stockholders' equity (3)
5.66
%
9.77
%
(42.1)
%
4.12
%
9.63
%
(57.2)
%
(1)
Return on average assets is the result of net income for the reported period on an annualized basis, divided by average assets for the period.
(2) Return on average stockholders' equity is the result of net income for the reported period on an annualized basis, divided by average stockholders' equity for the period.
(3) Return on average common stockholders' equity is the result of net income for the reported period on an annualized basis, divided by average common stockholders' equity for the period.
Results of Operations
Net Interest Income. Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other
interest-bearing liabilities and is the most significant component of our revenues.
Net interest income totaled $200.7 million and $394.2 million, respectively, for the three and six months ended June 30, 2020 compared to $188.9 million and $376.2 million, respectively, for the same periods in the prior year, representing increases of $11.7 million and $18.0 million, respectively. For the three and six months ended June 30, 2020 when compared to the comparable periods in 2019, this increase was largely the result of lower funding costs, the impact of the PPP and our acquisition of additional on-balance
sheet liquidity in response to the economic uncertainty resulting from the COVID-19 pandemic as well as organic loan growth during the comparable periods.
The following tables set forth the amount of our average balances, interest income or interest expense for each category of interest-earning assets and interest-bearing liabilities and the average interest rate for interest-earning assets and interest-bearing liabilities, net interest spread and net interest margin for the three and six months ended June 30, 2020 and 2019 (dollars in thousands):
(1) Average balances of nonaccrual loans are included in the above amounts.
(2) Yields computed on tax-exempt instruments on a tax equivalent basis and include $6.9 million of taxable equivalent income for each of the three months ended June
30, 2020 and the three months ended June 30, 2019. The tax-exempt benefit has been reduced by the projected impact of tax-exempt income that will be disallowed pursuant to IRS Regulations as of and for the period presented.
(3) Yields realized on interest-bearing assets less the rates paid on interest-bearing liabilities. The net interest spread calculation excludes the impact of demand deposits. Had the impact of demand deposits been included, the net interest spread for the three months ended June 30, 2020 would have been 2.84% compared to a net interest spread of 3.42% for the three months ended June 30, 2019.
(4) Net interest margin is the result of annualized net interest income calculated on a tax-equivalent basis divided by average interest-earning
assets for the period.
(1) Average balances of nonaccrual loans are included in the above amounts.
(2) Yields computed on tax-exempt instruments on a tax equivalent basis and include $14.0 million of taxable equivalent income for the six months ended June 30, 2020 compared to $13.4 million for the six months ended June 30, 2019. The tax-exempt benefit
has been reduced by the projected impact of tax-exempt income that will be disallowed pursuant to IRS Regulations as of and for the period presented.
(3) Yields realized on interest-bearing assets less the rates paid on interest-bearing liabilities. The net interest spread calculation excludes the impact of demand deposits. Had the impact of demand deposits been included, the net interest spread for the six months ended June 30, 2020 would have been 3.02% compared to a net interest spread of 3.49% for the six months ended June 30, 2019.
(4) Net interest margin is the result of annualized net interest income calculated on a tax-equivalent basis divided by average interest-earning assets for the period.
For the three and six months ended June 30, 2020, our net interest margin was 2.87% and 3.06%, respectively, compared to 3.48% and 3.55%, respectively, for the same periods in 2019. Our net interest margin for the three and six months ended June 30, 2020 reflects the impact of PPP and the firm's acquisition of additional on-balance sheet liquidity as noted above, the decline in short-term interest rates, declining levels of positive impact from purchase accounting and the competitive rate environments for loans and deposits in our markets. More specifically, our net interest margin was negatively impacted by yield compression in our earning asset portfolio due to a declining macroeconomic interest rate environment, which included a 150 basis points reduction in the federal funds rate in
March 2020. This decrease was offset somewhat by a decrease in funding costs. During the three and six months ended June 30, 2020, our earning asset yield decreased by 127 basis points and 93 basis points, respectively, from the same periods in the prior year. Our total funding rates decreased by 69 basis points and 46 basis points, respectively, compared to the same periods in the prior year.
We continue to deploy various asset liability management strategies to manage our risk to interest rate fluctuations. Pricing for creditworthy borrowers and meaningful depositors is very competitive in our markets and this competition has adversely impacted, and may continue to adversely impact, our margins. This challenging competitive environment may continue during 2020 even during a time of economic uncertainty due to COVID-19. We also expect the positive impact
of purchase accounting on our net interest income will lessen in future periods, which will negatively affect our net interest margin in 2020. We have sought to mitigate much of the negative impact that reductions in short-term interest rates would have on our net interest margin through restructuring a portion of our investment securities portfolio, purchasing loan interest rate floors, and unwinding fixed-to-floating loan interest rate swaps. Those tactics have benefited us during this recent period of falling short-term interest rates. However, our net interest margin could be additionally impacted if we are not able to continue to lower deposit rates at a pace necessary to offset declines in our earning asset yields. We determined that holding elevated levels of on-balance sheet liquidity is a prudent response to the COVID-19 pandemic. This strategy will negatively impact the net interest margin until on-balance sheet liquidity returns to more normalized levels.
We seek to fund increased loan volumes by growing our core deposits, but will utilize non-core funding to fund shortfalls, if any. To the extent that our dependence on non-core funding sources increases during 2020, our net interest margin would likely be negatively impacted as we may not be able to reduce the rates we pay on these deposits as quickly as we can on core deposits.
Provision for Credit Losses. On January 1, 2020, we adopted FASB ASU 2016-13, which introduces the current expected credit losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our loan and held-to-maturity securities portfolios. Accordingly, the provision for credit losses represents a charge to earnings necessary to establish an allowance for credit losses that, in management's evaluation, is adequate to
provide coverage for all expected credit losses. The provision for credit losses amounted to $68.3 million and $168.2 million, respectively, for the three and six months ended June 30, 2020 compared to $7.2 million and $14.4 million, respectively, for the three and six months ended June 30, 2019. Provision expense is impacted by organic loan growth in our loan portfolio, our internal assessment of the credit quality of the loan portfolio, our expectations about future economic conditions and net charge-offs. The primary driver of the increase in provision for credit losses for the three and six months ended June 30, 2020 was the estimated economic impact of the COVID-19 pandemic. Our CECL model relies on projected macroeconomic conditions, including unemployment and GDP, as key inputs to estimate future credit losses. As
a result, the anticipated deterioration in economic conditions resulting from COVID-19 has resulted in a significant increase in expected credit losses. Also contributing to the increase in provision was an increase in net charge-offs, which totaled $5.4 million and $15.5 million, respectively, for the three and six months ended June 30, 2020 compared to $4.1 million and $7.7 million, respectively, for the same periods in 2019. The increase in net charge-offs in the first six months of 2020 was in large part the result of an approximately $5.0 million charge-off related to a single credit in the commercial and industrial loan category during the first quarter of 2020. This credit was criticized going into the COVID-19 pandemic and as a result of the pandemic suffered further deterioration resulting in its partial charge-off during the first quarter of 2020. During the second quarter of 2020, we had a partial recovery
of approximately $1.7 million on this credit.
Our allowance for credit losses reflects an amount deemed appropriate to adequately cover all expected future losses as of the date the allowance is determined based on our allowance for credit losses assessment methodology. At June 30, 2020, our allowance for credit losses as a percentage of total loans, inclusive of PPP loans, was 1.27%, up from 0.48% at December 31, 2019. The increase in the allowance for credit losses is largely the result of the implementation of CECL on January 1, 2020, which resulted in an adjustment to the opening balance of the allowance for credit losses of $38.1 million, and increased provisioning during the three and six months ended June 30,
2020 due to the estimated economic impact of the COVID-19 pandemic.
Noninterest Income.Our noninterest income is composed of several components, some of which vary significantly between quarterly and annual periods. Service charges on deposit accounts and other noninterest income generally reflect customer growth trends, while fees from our wealth management departments, gains on mortgage loans sold, gains and losses on the sale of securities and gains or losses related to our efforts to mitigate risks associated with interest rate volatility will often reflect financial market conditions and fluctuate from period to period.
Investment
(gains) losses on sales of securities, net
(128)
(4,466)
97.1%
335
(6,426)
105.2%
Trust fees
3,958
3,461
14.4%
8,128
6,756
20.3%
Income
from equity method investment
17,208
32,261
(46.7)%
32,800
45,551
(28.0)%
Other noninterest income:
Interchange and
other consumer fees
8,323
9,088
(8.4)%
18,292
16,595
10.2%
Bank-owned life insurance
4,726
4,201
12.5%
9,378
8,296
13.0%
Loan
swap fees
614
799
(23.2)%
2,801
1,560
79.6%
SBA loan sales
941
1,171
(19.6)%
2,282
1,743
30.9%
Gain
(loss) on other equity investments
(278)
832
(133.4)%
(452)
1,614
(128.0)%
Other noninterest income
2,859
369
674.8%
4,942
1,274
287.9%
Total
other noninterest income
17,185
16,460
4.4%
37,243
31,082
19.8%
Total noninterest income
$
72,954
$
70,682
3.2%
$
143,331
$
121,745
17.7%
The
decrease in service charges on deposit accounts in the three and six months ended June 30, 2020 compared to the three and six months ended June 30, 2019 is primarily related to analysis fees due to a decrease in the transaction volume of commercial checking accounts which we believe is the result of the COVID-19 pandemic.
Income from our wealth management groups (investments, insurance and trust) is also included in noninterest income. For the three and six months ended June 30, 2020, commissions and fees from investment services at our financial advisory unit, Pinnacle Asset Management, a division of Pinnacle Bank, increased by $103,000 and $3.9 million when compared to the three and six months ended June 30,
2019. At June 30, 2020 and 2019, Pinnacle Asset Management was receiving commissions and fees in connection with approximately $4.5 billion and $4.3 billion, respectively, in brokerage assets. Revenues from the sale of insurance products by our insurance subsidiaries for the three and six months ended June 30, 2020 increased by $84,000 and $396,000, respectively, compared to the same periods in the prior year. Included in insurance revenues for the six months ended June 30, 2020 was $1.1 million of contingent income received in the first quarter of 2020 that was based on 2019 sales production and claims experience compared to $873,000 recorded in the same period in the prior year.
Additionally, at June 30, 2020, our trust department was receiving fees on approximately $2.9 billion of managed assets compared to $2.4 billion at June 30, 2019, reflecting organic growth and increased market valuations. The growth in our wealth management businesses is attributable to the addition of associates in these areas, market volatility and the attractive markets in which we operate.
Gains on mortgage loans sold, net, consists of fees from the origination and sale of mortgage loans. These mortgage fees are for loans primarily originated in our current markets that are subsequently sold to third-party investors. Substantially all of these loan sales transfer servicing rights to the buyer. Generally, mortgage origination fees increase in lower interest rate environments and more robust housing markets
and decrease in rising interest rate environments and more challenging housing markets. Mortgage origination fees will fluctuate from quarter to quarter as the rate environment changes. Gains on mortgage loans sold, net, were $19.6 million and $28.2 million, respectively, for the three and six months ended June 30, 2020 compared to $6.0 million and $10.9 million, respectively, for the same periods in the prior year. This sizeable increase is the direct result of the current interest rate environment and the strong markets in which we operate. We hedge a portion of our mortgage pipeline as part of a mandatory delivery program. The hedge is not designated as a hedge for GAAP purposes and, as such, changes in its fair value are recorded directly through the income statement. There is a positive correlation between the dollar amount of the mortgage pipeline and the value of this hedge. Therefore, the change in the outstanding
mortgage pipeline at the end of any reporting period will directly impact the amount of gain recorded for mortgage loans held for sale during that reporting period. At June 30, 2020, the mortgage pipeline included $340.7 million in loans expected to close in 2020 compared to $134.6 million in loans at June 30, 2019 expected to close in 2019.
Investment gains and losses on sales, net represent the net gains and losses on sales of investment securities in our available-for-sale securities portfolio during the periods noted. During the six months ended June
30, 2020, we sold approximately $100.1 million of securities for a net gain of $335,000 compared to the six months ended June 30, 2019, when we sold approximately $476.7 million of securities for a net loss of $6.4 million.
Income from equity-method investment. Income from equity-method investment is comprised solely of income from our 49% equity-method investment in BHG. BHG is engaged in the origination of commercial and consumer loans primarily to healthcare providers and other professionals throughout the United States. The loans originated by BHG are either financed by secured borrowings or sold without recourse to independent financial institutions and investors. BHG has expanded its operations to include commercial lending to other professional service firms such as attorneys, accountants and others.
Income
from this equity-method investment was $17.2 million and $32.8 million, respectively, for the three and six months ended June 30, 2020 compared to $32.3 million and $45.6 million, respectively, for the same periods last year. Historically, BHG has sold the majority of the loans its originates to a network of bank purchasers through a combination of online auctions, direct sales and its direct purchase option. In the second half of 2019, BHG began retaining more loans on its balance sheet than historically had been the case in recent years. As a result of the economic disruption resulting from the COVID-19 pandemic, BHG, in the first six months of 2020, sold more loans through its auction platform than we had anticipated would be the case earlier in the year and will likely slow its transition to holding more loans on its balance sheet as the effects of COVID-19 are monitored. As is the case for our business, the impact
of the COVID-19 pandemic on BHG's business is not fully known at this point though we believe its business, including demand for its loans and losses it may incur as a result of borrowers experiencing financial difficulty, will be negatively impacted.
Income from equity-method investment is recorded net of amortization expense associated with customer lists and other intangible assets of $293,000 and $587,000, respectively, for the three and six months ended June 30, 2020 compared to $475,000 and $950,000, respectively, for the three and six months ended June 30, 2019. At June 30, 2020, there were $8.2 million of these intangible assets that are expected to be amortized in lesser amounts over the next 15 years. Also
included in income from equity-method investment, is accretion income associated with the fair valuation of certain of BHG's liabilities of $541,000 and $1.1 million, respectively, for the three and six months ended June 30, 2020, compared to $660,000 and $1.3 million, respectively, for the three and six months ended June 30, 2019. At June 30, 2020, there were $3.7 million of these liabilities that are expected to accrete into income in lesser amounts over the next six years.
During the three months ended June 30, 2020, Pinnacle Financial and Pinnacle Bank received no dividends from BHG. During the six months ended June 30, 2020, Pinnacle Financial and Pinnacle
Bank received $8.0 million in dividends from BHG in the aggregate. During the three and six months ended June 30, 2019, Pinnacle Financial and Pinnacle Bank received dividends of $28.2 million and $40.9 million, respectively, in the aggregate. Dividends from BHG during such periods reduced the carrying amount of our investment in BHG, while earnings from BHG during such periods increased the carrying amount of our investment in BHG. Profits from intercompany transactions are eliminated. Our proportionate share of earnings from BHG is included in our consolidated tax return. No loans were purchased from BHG by Pinnacle Bank for the three and six month periods ended June 30, 2020 or 2019, respectively. Earnings from BHG are likely to fluctuate from period-to-period.
As our ownership interest in BHG is 49% and
our representatives do not occupy a majority of the seats on BHG's board of managers, we do not consolidate BHG's results of operations or financial position into our financial statements but record the net result of BHG's activities at our percentage ownership in income from equity method investment in noninterest income. For the three and six months ended June 30, 2020, BHG reported $92.8 million and $190.7 million, respectively, in revenues, net of substitution losses of $28.1 million and $44.4 million, respectively, compared to revenues of $108.0 million and $170.8 million, respectively, for the three and six months ended June 30, 2019, net of substitution losses of $12.7 million and $25.1 million, respectively.
Approximately $67.3 million and $136.9 million, respectively, of BHG's revenues for the three
and six months ended June 30, 2020 related to gains on the sale of commercial loans BHG had previously issued primarily to doctor, dentist and other medical practices compared to $90.5 million and $139.2 million, respectively, for the three and six months ended June 30, 2019. BHG refers to this activity as its core product. BHG typically funds these loans from cash reserves on its balance sheet. Subsequent to origination, these core product loans have typically been sold by BHG with no recourse to a network of community banks and other financial institutions at a premium to the par value of the loan. The purchaser may access a BHG cash reserve account of up to 3% of the loan balance to support loan payments. BHG retains no servicing or other responsibilities related to the core product loan once sold. As a result, this gain on sale premium represents BHG's compensation
for absorbing the costs to originate the loan as well as marketing expenses associated with maintaining its business model.
At June 30, 2020 and 2019, there were $3.2 billion and $2.2 billion, respectively, in core product loans previously sold by BHG that were being actively serviced by BHG's network of bank purchasers. BHG, at its sole option, may also provide purchasers of these core product loans the ability to substitute the acquired loan with another more recently-issued BHG loan
should the previously-acquired loan become at least 90-days past due as to its monthly payments. This substitution is subject to the purchaser having adhered to the standards of its purchase agreement with BHG. Additionally, all substitutions are subject to the approval by BHG's board of managers. As a result, the reacquired loans are deemed purchased credit impaired and recorded on BHG's balance sheet at the net present value of the loan's anticipated cash flows. BHG will then initiate collection efforts and attempt to restore the reacquired loan to performing status. As a result, BHG maintained a liability as of June 30, 2020 and 2019 of $229.3 million and $100.3 million, respectively, that represents an estimate of the future inherent losses for the outstanding core portfolio that may be subject to future substitution. This liability represents 7.2% and 4.6%, respectively,
of core product loans previously sold by BHG that remain outstanding as of June 30, 2020 and 2019, respectively. The increase in this liability in the six months ended June 30, 2020 was principally the result of the economic disruption associated with the COVID-19 pandemic which has adversely impacted physician and dental practices in a material manner.
BHG will maintain loans on its balance sheet for a period of time prior to sale or transfer to a purchaser. Alternatively, BHG may elect to keep certain loans on its balance sheet through maturity. From time to time, BHG may hold a higher volume of these loans depending upon the timing of loan originations, its loan pipeline and market demand as well as the deployment of its business strategy. As previously discussed,
BHG realigned its business model to retain more of its originated loans on the balance sheet beginning in the second half of 2019. At June 30, 2020, BHG reported loans totaling $839.3 million compared to $467.2 million as of June 30, 2019. A portion of these loans do not qualify for sale accounting and accordingly an offsetting secured borrowing liability has been recorded. At June 30, 2020 and 2019, BHG had $310.4 million and $217.6 million, respectively, of secured borrowings associated with loans held for investment which did not qualify for sale accounting. At June 30, 2020 and 2019, BHG reported allowance for loan losses totaling $9.5 million and $2.3 million, respectively.
Interest income and fees amounted to $22.0 million and $46.1 million, respectively, for the three and six months ended June 30, 2020 compared to $13.5 million and $24.2 million, respectively, for the three and six months ended June 30, 2019.
BHG also sometimes refers loans to other financial institutions and, based on an agreement with the institution, earns a fee for doing so. Typically, these are loans that BHG believes would either be classified as consumer-type loans rather than commercial loans, fail to meet the credit underwriting standards of BHG but another institution will accept the loans or are loans issued to borrowers in certain geographic locations where BHG has elected not to do business. For the three and six months ended June 30, 2020, BHG recognized
fee income of $195,000 and $753,000, respectively, compared to $495,000 and $1.1 million, respectively, for the same periods in the prior year related to these activities.
Included in other noninterest income are interchange and other consumer fees, gains from bank-owned life insurance, swap fees earned for the facilitation of derivative transactions for our clients, SBA loan sales, gains or losses on other equity investments and other noninterest income items. Interchange revenues decreased in the three months ended June 30, 2020 as a result of decreased debit and credit card transactions as compared to the comparable period in 2019, which we believe is the result of the COVID-19 pandemic. Interchange revenues increased during the six months ended June 30, 2020 as compared to the same period in 2019 due to
increased loan fees primarily as a result of loan prepayments during the second quarter of 2020. Other noninterest income included changes in the cash surrender value of bank-owned life insurance which was $4.7 million and $9.4 million, respectively, for the three and six months ended June 30, 2020 compared to $4.2 million and $8.3 million, respectively, for the three and six months ended June 30, 2019. During the six months ended June 30, 2019, we purchased $110.0 million of new bank-owned life insurance policies. The assets that support these policies are administered by the life insurance carriers and the income we recognize (i.e., increases or decreases in the cash surrender value of the policies) on these policies is dependent upon the crediting rates applied by the insurance carriers, which are subject to change at
the discretion of the carriers, subject to any applicable floors. Earnings on these policies generally are not taxable. Loan swap fees increased by $1.2 million during the six months ended June 30, 2020 as compared to the same period in 2019 due primarily to reduced third party fees and an increase in the volume of activity resulting from the current interest rate environment. SBA loan sales are also included in other noninterest income and fluctuate based on the current market environment. Additionally, the carrying values of other equity investments are adjusted either upwards or downwards from the transaction price to reflect expected exit values as evidenced by financing and sale transactions with third parties, or when determination of a valuation adjustment is confirmed through ongoing reviews by senior investment managers. Other other noninterest income fluctuated during the three and six months ended June
30, 2020 as compared to the same periods in 2019 due to the $1.5 million loss on the sale of the high-yield automobile portfolio in the second quarter of 2019.
Noninterest Expense.Noninterest expense consists of salaries and employee benefits, equipment and occupancy expenses, other real estate expenses, and other operating expenses. The following is a summary of our noninterest expense for the three and six months ended June 30, 2020 and 2019
(in thousands):
Total salaries and employee benefits expenses decreased approximately $1.7 million and increased approximately
$8.4 million, respectively, for the three and six months ended June 30, 2020 compared to the same periods in 2019. The change in salaries and employee benefits was the result of an increase in our associate base in 2020 versus 2019 offset in part, or in the case of the three months ended June 30, 2020, in whole, by the reduction of our cash incentive plan accrual as well as the reduction in stock-based compensation expense due to our performance through the first half of 2020 compared to the earnings per diluted share performance metric targets established pursuant to our annual cash incentive plan and the return on average tangible assets performance metric targets applicable pursuant to certain performance-based equity awards we have previously granted, each due to the effects of COVID-19 on our anticipated earnings and performance for the year ended December
31, 2020. At June 30, 2020, our associate base was 2,577.5 full-time equivalent associates as compared to 2,361.0 at June 30, 2019. We expect salary and benefit expenses will continue to rise though at a lesser percentage rate on a linked-quarter basis as we slow our hiring efforts and focus primarily on expanding our associate base in the Atlanta market and those hires critical to our business across the rest of our franchise.
We believe that cash and equity incentives are a valuable tool in motivating an associate base that is focused on providing our clients effective financial advice and increasing shareholder value. As a result, and unlike many other financial institutions, all of our bank's non-commissioned associates participate in our annual cash incentive plan with a minimum targeted bonus equal
to 10% of each associate's annual salary, and all of our bank's associates participate in our equity compensation plans. Under the annual cash incentive plan, the targeted level of incentive payments requires achievement of a certain soundness threshold and a targeted level of, and average rate paid on, core deposits and earnings (subject to certain adjustments). To the extent that the soundness threshold is met and core deposit volumes and rates and earnings are above or below the targeted amount, the aggregate incentive payments are increased or decreased. Historically, we have paid between 0% and 125% of our targeted incentives. Through the second quarter of 2020, we have accrued incentive costs for the cash incentive plan in 2020 at approximately 25% of our targeted awards in light of our expectations that our 2020 results will not meet the minimum level of earnings per diluted share required under the plan. The rate at which we are accruing for payouts under the
plan is largely the result of the current and expected future impact of the COVID-19 pandemic on our results of operations and deposit volumes and costs. The current rate of 25% is solely the result of our newly implemented deposit component for which our associates are outperforming with respect to both deposit and volume goals.
Also included in employee benefits and other expense for the three and six months ended June 30, 2020 were approximately $4.1 million and $9.6 million, respectively, of compensation expenses related to equity-based
awards for restricted shares or restricted share units, including those with performance-based vesting criteria, compared to $5.2 million and $10.1 million, respectively, for the three and six months ended June 30, 2019. Under our equity incentive plans, we provide a broad-based equity incentive program for all of our bank's associates. We believe that equity incentives provide a vehicle for all associates to become meaningful shareholders of Pinnacle Financial over an extended period of time and create a shareholder-centric culture throughout our organization. Our compensation expense associated with equity awards for the three and six months ended June 30, 2020 decreased when compared to the three and six months ended June 30, 2019 primarily as a result of the fact that our performance through the first half of 2020 made
it unlikely that these awards would be earned as a result of the pandemic. Our compensation expense associated with equity awards with time-based vesting criteria is likely to continue to increase during the remainder of 2020 when compared to 2019 as a result of the increased number of associates and our intention to hire additional experienced financial advisors, though for the remainder of 2020 we will focus primarily on expanding our associate base in the Atlanta market and those hires critical to our business across the rest of our franchise. Compensation expense associated with our performance-based vesting awards will be impacted by our performance in 2020 and will likely continue to be less than prior year comparable periods.
Employee benefits and other expenses were $10.8 million and $24.8 million, respectively, for the three and six months ended June 30,
2020 compared to $11.6 million and $22.6 million, respectively, for the three and six months ended June 30, 2019 and include costs associated with our 401k plan, health insurance and payroll taxes.
Equipment and occupancy expenses for the three and six months ended June 30, 2020 were $22.0 million and $43.0 million, respectively, compared to $23.8 million and $43.2 million, respectively, for the three and six months ended June 30, 2019. These costs were generally consistent between periods though we expect to incur additional costs in future periods as we continue to enhance our technology infrastructure.
Other real estate income and expenses for the three and six months ended June
30, 2020 were $2.9 million and $5.3 million, respectively, as compared to $2.5 million and $2.8 million, respectively, for the same periods in the prior year. Included in the six months ended June 30, 2020 were writedowns in the first quarter of 2020 of previously foreclosed upon properties to market value based on updated appraisals received.
Marketing and business development expense for the three and six months ended June 30, 2020 was $2.1 million and $5.4 million, respectively, compared to $3.3 million and $6.2 million, respectively, for the three and six months ended June 30, 2019. The primary source of the decrease for the three and six months ended June 30, 2020 as compared to the same periods 2019
is the result of limited in-person client meetings and business development expenses as a result of the restrictions resulting from the COVID-19 pandemic.
Intangible amortization expense was $2.5 million and $5.0 million, respectively, for the three and six months ended June 30, 2020 compared to $2.3 million and $4.6 million, respectively, for the same periods in 2019. The following table outlines our amortizing intangible assets, their initial valuation and amortizable lives at June 30, 2020:
Year acquired
Initial Valuation
(in millions)
Amortizable Life (in years)
Remaining Value (in millions)
Core Deposit Intangible:
CapitalMark
2015
$
6.2
7
$
0.6
Magna
Bank
2015
3.2
6
0.1
Avenue
2016
8.8
9
2.7
BNC
2017
48.1
10
27.9
Book
of Business Intangible:
Miller Loughry Beach Insurance
2008
$
1.3
20
$
0.2
CapitalMark
2015
0.3
16
0.1
BNC Insurance
2017
0.4
20
0.3
BNC
Trust
2017
1.9
10
1.3
Advocate Capital
2019
13.6
13
11.5
These
assets are being amortized on an accelerated basis which reflects the anticipated life of the underlying assets. Amortization expense of these intangibles is estimated to decrease from $9.1 million to $5.1 million per year over the next five years with lesser amounts for the remaining amortization period.
Other noninterest expenses, which consists primarily of deposit, lending, wealth management and administrative expenses increased by $8.0 million and $16.8 million, respectively, for the three and six months ended June 30, 2020 when compared to the three and six months ended June
30, 2019. Deposit related expense increased by $804,000 and $1.5 million, respectively, during the three and six months ended June 30, 2020 when compared to the same periods in 2019. Lending related expenses increased $5.1 million and $11.8 million, respectively, during the three and six months ended June 30, 2020 when compared to the same periods in 2019. This increase is primarily the result of building our off-balance sheet reserves following the implementation of CECL effective January 1, 2020 and the effect that macroeconomic factors impacted by the COVID-19 pandemic had on our CECL models. Wealth management related expenses decreased during the three and six months ended June 30, 2020 when compared to the same periods in 2019. Total other noninterest expenses increased
by $2.3 million and $3.6 million, respectively, during the three and six months ended June 30, 2020 when compared to the same periods in 2019. This increase is primarily the result of $2.9 million in FHLB prepayment penalties as a result of our prepayment of $392.5 million in FHLB borrowings during the second quarter of 2020.
Our efficiency ratio (the ratio of noninterest expense to the sum of net interest income and noninterest income) was 48.1% and 50.0%, respectively, for the three and six months ended June 30, 2020 compared to 49.2% and 48.6%, respectively, for the same periods in 2019. The efficiency ratio measures the amount of expense that is incurred to generate a dollar of revenue. The efficiency ratio for the three and six months ended June 30, 2020
compared to the same periods in 2019 was impacted in part by increased noninterest expense during the period as a result of our building of off-balance sheet reserves upon the adoption of CECL during the quarter as well as net gains and losses on sales of securities, gains on mortgage loans sold and income from our equity method investment in BHG in both periods.
Income Taxes. During the three and six months ended June 30, 2020, we recorded income tax expense of $11.2 million and $9.6 million, respectively, compared to income tax expense of $24.4 million and $47.5 million, respectively, for the three and six months ended June 30, 2019. Our effective tax rate for the three and six months ended June 30, 2020 was 15.2% and 9.5%, respectively,
compared to 19.6% for both the three and six months ended June 30, 2019. Our effective tax rate differs from the combined federal and state income tax statutory rate in effect of 26.14% primarily due to our investments in bank-qualified municipal securities, tax benefits from our real estate investment trust subsidiary, participation in Tennessee's Community Investment Tax Credit (CITC) program, tax benefits associated with share-based compensation, bank-owned life insurance and our captive insurance subsidiary, offset in part by the limitation on deductibility of meals and entertainment expense, non-deductible FDIC insurance premiums and non-deductible executive compensation. Our tax expense in the six months ended June 30, 2020 was impacted by the provision expense recorded in response to the COVID-19 pandemic, which was recorded in the first quarter of 2020 as a discrete
item of total income tax and contributed a tax benefit of $22.4 million. Our tax rate in each period was also impacted by the vesting and exercise of equity-based awards previously granted under our equity-based compensation program, resulting in the recognition of tax expense of $272,000 and a tax benefit of $590,000, respectively, for the three and six months ended June 30, 2020 compared to tax expense of $68,000 and a tax benefit of $701,000, respectively, for the three and six months ended June 30, 2019.
Loans. The composition of loans at June 30, 2020 and at December 31, 2019 and the percentage (%) of each classification to total loans are summarized as follows (in thousands):
At June 30, 2020, our loan portfolio composition had changed modestly from the composition at December 31, 2019 principally as a result of the PPP loans, though commercial real estate and commercial and industrial lending generally continue to make up the largest segments of our portfolio. At June 30, 2020, approximately 33.5% of the outstanding principal balance of our commercial real estate loans was secured by owner-occupied commercial real estate properties, compared to 34.6% at December 31, 2019. Owner-occupied commercial real estate is similar in many ways to our commercial and industrial lending in that these loans are generally made to businesses on the basis of the cash flows of
the business rather than on the valuation of the real estate. Additionally, the construction and land development loan segment continues to be a meaningful portion of our portfolio and reflects the development and growth of the local economies in which we operate and is diversified between commercial, residential and land.
Banking regulations have established guidelines for the construction ratio of less than 100% of total risk-based capital and for the non-owner occupied ratio of less than 300% of total risk-based capital. Should a bank’s ratios be in excess of these guidelines, banking regulations generally require an increased level of monitoring in these lending areas by bank management. Both ratios are calculated by dividing certain types of loan balances for each of the two categories by Pinnacle Bank’s total risk-based capital. At both June 30, 2020
and December 31, 2019, Pinnacle Bank’s construction and land development loans as a percentage of total risk-based capital were 83.6%. Construction and land development, non-owner occupied commercial real estate and multifamily loans as a percentage of total risk-based capital were 275.0% and 268.3% as of June 30, 2020 and December 31, 2019, respectively. At June 30, 2020, Pinnacle Bank was within the 100% and 300% guidelines and has established what it believes to be appropriate controls to monitor its lending in these areas as it aims to keep the level of these loans to below the 100% and 300% thresholds.
The following table classifies our fixed and variable rate loans at June
30, 2020 according to contractual maturities of (1) one year or less, (2) after one year through five years, and (3) after five years. The table also classifies our variable rate loans pursuant to the contractual repricing dates of the underlying loans (in thousands):
The
above information does not consider the impact of scheduled principal payments.
Loans in Past Due Status. The following table is a summary of our loans that were past due at least 30 days but less than 89 days and 90 days or more past due as of June 30, 2020 and December 31, 2019 (in thousands):
Loans past due 30 to 89 days as a percentage of total loans
0.10
%
0.21
%
Loans
past due 90 days or more as a percentage of total loans
0.13
%
0.11
%
Total loans in past due status as a percentage of total loans
0.23
%
0.32
%
Potential Problem Loans. Potential problem loans, which are not included in nonperforming assets, amounted to approximately $251.3 million, or 1.1% of total loans at June 30,
2020, compared to $276.0 million, or 1.4% of total loans at December 31, 2019. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by Pinnacle Bank's primary regulators, for loans classified as substandard, excluding the impact of substandard nonaccrual loans and substandard troubled debt restructurings. Troubled debt restructurings are not included in potential problem loans. Approximately $5.4 million of potential problem loans were past due at least 30 days but less than 90 days as of June 30, 2020.
Nonperforming Assets
and Troubled Debt Restructurings. At June 30, 2020, we had $84.7 million in nonperforming assets compared to $91.1 million at December 31, 2019. Included in nonperforming assets were $62.6 million in nonaccrual loans and $22.1 million in OREO and other nonperforming assets at June 30, 2020 and $61.6 million in nonaccrual loans and $29.5 million in OREO and other nonperforming assets at December 31, 2019. At June 30, 2020 and December 31, 2019, there were $3.3 million and $4.9 million, respectively, of troubled debt restructurings, all of which were accruing as of the restructured date and remain on accrual status. In response to the COVID-19 pandemic
and its economic impact to its customers, Pinnacle Bank implemented a short-term modification program in accordance with interagency regulatory guidance to provide temporary payment relief to those borrowers directly impacted by COVID-19 who were not more than 30 days past due as of December 31, 2019. This program allows for a deferral of payments of principal and/or interest for 90 days, which Pinnacle Bank may extend for an additional 90 days, for a maximum of 180 days on a cumulative and successive basis. Pursuant to the interagency regulatory guidance, Pinnacle Financial may elect to not classify loans for which these deferrals are granted as troubled debt restructurings. As of June 30, 2020, we had granted deferrals on approximately $4.2 billion in aggregate principal amount of loans. As of July 17, 2020, approximately
$2.7 billion in aggregate principal loan balances remained on deferral.
Allowance for Credit Losses on Loans (allowance). On January 1, 2020, we adopted FASB ASU 2016-13, which introduces the current expected credit losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our loan portfolio. Accordingly, beginning in 2020, the allowance for credit losses represents an amount that, in management's evaluation, is adequate to provide coverage for all expected future credit losses on outstanding loans. As of June 30, 2020 and December 31, 2019, our allowance for credit losses was approximately $285.4 million and $94.8 million, respectively, which our management believes to be adequate at each
of the respective dates. Our allowance for credit losses as a percentage of total loans, inclusive of PPP loans, was 1.27% at June 30, 2020, up from 0.48% at December 31, 2019.
The increase in the allowance for credit losses is largely the result of the implementation of ASU 2016-13 on January 1, 2020, which resulted in an adjustment to the opening balance of the allowance for credit losses of $38.1 million, and increased provisioning during
the six months ended
June 30, 2020 due primarily to the estimated economic impact of the COVID-19 pandemic. Our CECL models rely largely on projections of macroeconomic conditions to estimate future credit losses. Macroeconomic factors used in the model include the national unemployment rate, gross domestic product, the commercial real estate price index and certain US Treasury interest rates. Projections of these macroeconomic factors, obtained from an independent third party, are utilized to predict quarterly rates of default. Projected macroeconomic factors have experienced significant deterioration during the six months ended June 30, 2020, which has resulted in the significant increase in our allowance for credit losses during the same period.
Under the CECL methodology the allowance for credit losses is measured on a collective
basis for pools of loans with similar risk characteristics, and for loans that do not share similar risk characteristics with the collectively evaluated pools, evaluations are performed on an individual basis. Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. At June 30, 2020, reasonable and supportable periods ranging from 12 to 18 months were utilized followed by a 12 month straight line reversion period to long term averages.
The overall balance of our allowance at December 31, 2019 was impacted by fair value accounting on our acquired loan portfolios, for which an allowance for credit losses was only necessary if it exceeded the remaining fair value discount.
Subsequent to the adoption of ASU 2016-13 on January 1, 2020, an allowance for credit losses is recognized for all acquired loans, regardless of the amount of remaining fair value discounts. In addition, the remaining nonaccretable discount at December 31, 2019 was reclassified into the allowance for credit losses upon adoption of ASU 2016-13 on January 1, 2020. At June 30, 2020, the remaining fair value discount for all acquired portfolios was $38.0 million, all of which is expected to be accreted into income over the remaining contractual lives of the related loans.
For the six months ended June 30, 2020, the net fair value discount changed as follows
(in thousands):
The following table sets forth, based on management's estimate, the allocation of the allowance for credit losses to categories of loans as well as the unallocated portion as of June 30, 2020 and December 31, 2019 and the percentage of loans in each category to total loans (in thousands):
The
following is a summary of changes in the allowance for credit losses on loans for the six months ended June 30, 2020 and for the year ended December 31, 2019 and the ratio of the allowance for credit losses on loans to total loans as of the end of each period (in thousands):
Ratio of allowance for credit losses on loans to total loans outstanding at end of period
1.27
%
0.48
%
Ratio
of net charge-offs to average total loans outstanding for the period (1)
0.15
%
0.08
%
(1) Net charge-offs for the year-to-date period ended June 30, 2020 have been annualized.
Pinnacle Financial's management assesses the adequacy of the allowance on a quarterly basis. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management's evaluation of historical default and loss experience, current and projected
economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay the loan (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off. For further discussion regarding our allowance for credit losses, refer to Critical Accounting Estimates in Part I Item 2 - Critical Accounting Estimates herein. We expect that the economic disruption caused by the COVID-19 pandemic will cause our net charge-offs to increase in 2020 when compared to comparable periods in 2019.
Based upon our evaluation of the loan portfolio, we believe the allowance for credit losses to be adequate to absorb our estimate of expected future credit losses on loans outstanding at June 30, 2020. While our policies and procedures used to estimate the allowance for credit losses as well as the resultant provision for credit losses charged to operations are considered adequate by management, they are necessarily approximate and imprecise. There are factors beyond our control, such as conditions in the local and national economy, local real estate market or a particular industry or borrower which may negatively impact, materially, our asset quality and the adequacy of our allowance for credit losses and, thus, the resulting provision for credit losses. In particular, the length and severity of the economic disruption of the COVID-19
pandemic is difficult to predict and each may be worse than we have estimated, which could cause our provision for credit losses to be negatively impacted for the duration of the pandemic and its aftermath. We believe borrowers that operate in the restaurant, entertainment, hospitality, medical, dental, retail and construction sectors, including owners of commercial real estate properties and hotels, continue to be the most likely to be negatively impacted by the economic disruptions related to the COVID-19 pandemic, though other businesses and nonprofit and religious organizations have been, and are likely to continue to be, negatively impacted as well. If the strict social distancing practices or safer-at-home directives that were initially implemented in response to the spread of COVID-19 were to return, these impacts could be more severe than currently anticipated.
Investments.Our investment portfolio, consisting primarily of Federal agency bonds, mortgage-backed securities, and state and municipal securities amounted to $4.4 billion and $3.7 billion at June 30, 2020 and December 31, 2019, respectively. Our investment portfolio serves many purposes including serving as a stable source of income, as collateral for public funds deposits and as a potential liquidity source. A summary of our investment portfolio at June 30, 2020 and December 31, 2019 follows:
(*) The metric is presented net of fair value hedges
tied to certain investment portfolio holdings. The effective duration of the investment portfolio without the fair value hedges as of June 30, 2020 and December 31, 2019 was 5.45% and 5.89%, respectively.
Restricted Cash. Our restricted cash balances totaled approximately $254.6 million at June 30, 2020, compared to $137.0 million at December 31, 2019. This restricted cash is maintained at other financial institutions as collateral primarily for our derivative portfolio. The increase in restricted cash is attributable primarily to an increase in collateral requirements on certain derivative instruments for which the fair value has declined. See Note 8. Derivative
Instruments in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q.
Deposits and Other Borrowings. We had approximately $25.5 billion of deposits at June 30, 2020 compared to $20.2 billion at December 31, 2019. Our deposits consist of noninterest and interest-bearing demand accounts, savings accounts, money market accounts and time deposits. Additionally, we routinely enter into agreements with certain customers to sell certain securities under agreements to repurchase the security the following day. These agreements (which are typically associated with comprehensive treasury management programs for our clients and provide them with short-term returns for their excess funds) amounted to $194.6 million at June
30, 2020 and $126.4 million at December 31, 2019. Additionally, at June 30, 2020 and December 31, 2019, Pinnacle Bank had borrowed $1.8 billion and $2.1 billion, respectively, in advances from the Federal Home Loan Bank of Cincinnati (FHLB). During the three and six months ended June 30, 2020, $392.5 million in FHLB advances were restructured and prepayment penalties of $2.9 million were recognized in expense for the three months ended June 30, 2020. At June 30, 2020, Pinnacle Bank had approximately $2.4 billion in additional availability with the FHLB; however, incremental borrowings are subject to applicable collateral requirements and are made in a formal request by
Pinnacle Bank and the subsequent approval by the FHLB. Our efforts to increase our on-balance sheet liquidity in the second half of the first quarter resulted in increased borrowings from the FHLB Cincinnati.
Generally, we have classified our funding base as either core funding or noncore funding as shown in the table below. The following table represents the balances of our deposits and other funding and the percentage of each type to the total at June 30, 2020 and December 31, 2019:
(1)The
reciprocating categories consists of deposits we receive from a bank network (the Promontory network) in connection with deposits of our customers in excess of our FDIC coverage limit that we place with the Promontory network.
As noted in the table above, our core funding as a percentage of total funding decreased from 76.2% at December 31, 2019 to 75.8% at June 30, 2020, primarily as a result of the significant increase in deposits estimated to have been funded by PPP loans, offset in part by our intentional increase in wholesale funding to build on-balance sheet liquidity as we prepared for the initial impact of the COVID-19 pandemic. Competition for core deposits in our markets remains very competitive and we anticipate that our percentage of non-core funding is likely to increase as PPP loan funds are utilized.
When wholesale funding is necessary to complement the company's core deposit base, management determines which source is best suited to address both liquidity risk management and interest rate risk management objectives. Our Asset Liability Management Policy imposes limitations on overall wholesale funding reliance and on brokered deposit exposure specifically. Both our overall reliance on wholesale funding and exposure to brokered deposits and brokered time deposits were within those policy limitations as of June 30, 2020.
Our funding policies impose limits on the amount of non-core funding we can utilize based on the non-core funding dependency ratio which is calculated pursuant to regulatory
guidelines. Periodically, we may exceed our policy limitations, at which time management will develop plans to bring our funding sources back into compliance with our core funding ratios. At June 30, 2020 and December 31, 2019, we were in compliance with our core funding policies. Though growing our core deposit base is a key strategic objective of our firm and we experienced meaningful growth in core deposits in the first half of 2020, we may increase our non-core funding amounts from current levels if we need to do so to fund growth or increase levels of on-balance sheet liquidity, but we do not currently anticipate that such increases will exceed the limits we have established in our internal policies for total levels of non-core funding.
The amount of time deposits as of June 30, 2020 amounted to $4.5 billion. The following table shows our time deposits in denominations of $100,000 and less and in denominations greater than $100,000 by category based on time remaining until maturity and the weighted average rate for each category as of June 30, 2020 (in thousands):
Balances
Weighted Avg.
Rate
Denominations less than $100,000
Three months or less
$
492,482
1.68
%
Over three but less than six months
429,745
1.90
%
Over six
but less than twelve months
841,281
1.36
%
Over twelve months
726,287
1.06
%
$
2,489,795
1.43
%
Denominations
$100,000 and greater
Three months or less
$
644,536
1.86
%
Over three but less than six months
433,041
1.70
%
Over six but less than twelve months
576,978
1.63
%
Over
twelve months
330,884
1.85
%
$
1,985,439
1.76
%
Totals
$
4,475,234
1.57
%
Subordinated
debt and other borrowings. We have established, or through acquisition acquired, twelve statutory business trusts which were established to issue 30-year trust preferred securities and certain other subordinated debt agreements. These securities qualify as Tier 2 capital subject to annual phase outs beginning five years from maturity. On April 22, 2020, we established a credit facility with the Federal Reserve Bank in conjunction with the PPP, with available borrowing capacity equal to the outstanding balance of PPP loans, which totaled approximately $2.2 billion at June 30, 2020. We also had a $75.0 million revolving credit facility with no outstanding borrowings as of June 30, 2020 that matured on July 24, 2020 and was not renewed. These instruments
are outlined below (in thousands):
(1) Migrates to three month LIBOR + 3.128% beginning July 30, 2020 through the end of the term.
(2) Migrates to three month LIBOR + 3.884% beginning November 16, 2021 through the end of the term.
(3) Migrates to three month LIBOR + 2.775% beginning September 15, 2024 through the end of the term.
(4) Borrowing capacity on the revolving credit facility is $75.0 million. At June 30, 2020, there were no amounts outstanding under this facility. An unused fee of 0.30%
is assessed on the average daily unused amount of the line. This credit facility matured on July 24, 2020 and was not renewed.
Effective January 1, 2020, we used $80.0 million of the net proceeds from our 2019 subordinated debt offering to redeem certain other of our subordinated notes, including the $20.0 million aggregate principal amount of Avenue subordinated notes and $60.0 million aggregate principal amount of BNC subordinated notes. We had previously anticipated using $130 million of the net proceeds from our 2019 subordinated debt offering to redeem two tranches of subordinated notes issued by Pinnacle Bank with a maturity date of July 30, 2025 but have decided to not redeem those notes at this time in light of the uncertainty resulting from the
ongoing COVID-19 pandemic. Pursuant to regulatory guidelines, once the maturity date on these subordinated notes is within five years, a portion of the notes will no longer be eligible to be included in regulatory capital, with an additional portion being excluded each year over the five year period approaching maturity.
Capital Resources. At June 30, 2020, our shareholders' equity amounted to $4.7 billion compared to $4.4 billion at December 31, 2019. During the second quarter of 2020, we issued 9.0 million depositary shares, each representing a 1/40th interest in a share of Series B Preferred Stock with a liquidation preference of $1,000 per share of Series B Preferred Stock in a registered public offering to both retail and institutional investors. Net proceeds from the transaction
after underwriting discounts and offering costs were approximately $217.6 million. The net proceeds were retained by Pinnacle Financial and are available to support our obligations including payments related to our outstanding indebtedness, to support the capital needs of our company and our bank, and for other general corporate purposes. Additionally, shareholders' equity during the six months ended June 30, 2020 was impacted by increases in our net income and other comprehensive income offset in part by $50.8 million related to shares repurchased pursuant to the share repurchase programs authorized by our board of directors in November 2018 and October 2019 and dividends of $24.8 million paid on shares of our common stock. We currently have approximately $67.2 million remaining of our authorized repurchase program which is set to
expire December 31, 2020. In March 2020, we suspended our share repurchase program in light of uncertainty regarding the length and severity of the COVID-19 pandemic. Our share repurchase program remains suspended as of the date of this filing. For additional information regarding our capital and shareholders’ equity, see Note 10. Regulatory Matters in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q.
Dividends. Pursuant to Tennessee banking law, our bank may not, without the prior consent of the TDFI, pay any dividends to us in a calendar year in excess of the total of our bank's retained net profits for that year plus the retained net profits for the preceding two years, which was $619.2 million at June 30, 2020. During
the six months ended June 30, 2020, our bank paid dividends of $94.1 million to us which is within the limits allowed by the TDFI.
During the three and six months ended June 30, 2020, we paid $12.4 million and $24.8 million, respectively, in dividends to our common shareholders. On July 21, 2020, our board of directors declared a $0.16 per share quarterly cash dividend to common shareholders which should approximate $12.4 million in aggregate dividend payments that are expected to be paid on Aug. 28, 2020 to common shareholders of record as of the close of business on Aug. 7, 2020. Additionally, on that same day, our board of directors approved a quarterly dividend
of approximately $3.8 million, or $16.88 per share (or $0.422 per depositary share), on the Series B Preferred Stock payable on Sept. 1, 2020 to shareholders of record at the close of business on Aug. 17, 2020. The amount and timing of all future dividend payments, if any, is subject to board discretion and will depend on our earnings, capital position, financial condition and other factors, including, if necessary, our receipt of dividends from Pinnacle Bank, regulatory capital requirements, as they become known to us and receipt of any regulatory approvals that may become required as a result of our and our bank subsidiary's financial results.
Market and Liquidity Risk Management
Our
objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. Our Asset Liability Management Committee (ALCO) is charged with the responsibility of monitoring these policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.
Interest Rate Sensitivity. In the normal course of business, we are exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates the interest rate risk so that we can meet customer demands for various types of loans and deposits. ALCO determines the most appropriate amounts of on-balance sheet and off-balance sheet items. Measurements which we use to help us manage
interest rate sensitivity include an earnings simulation model and an economic value of equity (EVE) model.
Our interest rate sensitivity modeling incorporates a number of assumptions for both earnings simulation and EVE, including loan and deposit re-pricing characteristics, the rate of loan prepayments, etc. ALCO periodically reviews these assumptions for accuracy based
on historical data and future expectations. Our ALCO policy requires that the base scenario assumes rates remain flat and is the scenario to which all others are compared in order to measure the change in net interest income and EVE. Policy
limits are applied to the results of certain modeling scenarios. While the primary policy scenarios focus is on a twelve month time frame for the earnings simulations model, longer time horizons are also modeled. All policy scenarios assume a static volume forecast where the balance sheet is held constant, although other scenarios are modeled.
During the first half of 2020, several unique events occurred that are noteworthy when comparing the results of both the earnings simulation and the economic value of equity modeling results as of June 30, 2020 to the modeling results at December 31, 2019:
•In response to the COVID-19 pandemic, the Federal Reserve reduced the target federal funds rate by 150 basis points.
•We built over $2.5 billion in additional on-balance-sheet liquidity.
•We unwound a $1.3 billion in-the-money interest rate floor.
Earnings simulation model. We believe interest rate risk is best measured by our earnings simulation modeling. Earning assets, interest-bearing liabilities and off-balance sheet financial instruments are combined with forecasts of interest rates for the next 12 months and are combined with other factors in order to produce various earnings simulations over that same 12-month period. To limit interest rate risk, we have policy guidelines for our earnings at risk which seek to limit the variance of net interest income in both gradual and instantaneous changes to interest rates. For instantaneous upward and downward changes
in rates from management's flat interest rate forecast over the next twelve months, assuming a static balance sheet, the following estimated changes are calculated:
Estimated % Change in Net Interest Income Over 12 Months
*: Negative interest rates are not contemplated in these scenarios. The Treasury curve and all short-term rate indices, such as Fed Funds, LIBOR, etc., are assumed to be zero bound.
While an instantaneous and severe shift in interest rates was used in this analysis to provide an estimate of exposure under these scenarios, we believe that a gradual shift in interest rates would have a more modest impact. Further, the earnings simulation model does not take into account factors such as future balance
sheet growth, changes in product mix, changes in yield curve relationships, hedging activities we might take and changing product spreads that could mitigate any potential adverse impact of changes in interest rates.
The behavior of our deposit portfolio in the baseline forecast and in alternate interest rate scenarios set out in the table above is a key assumption in our projected estimates of net interest income. The projected impact on net interest income in the table above assumes no change in deposit portfolio size or mix from the baseline forecast in alternative rate environments. In higher rate scenarios, any customer activity resulting in the replacement of low-cost or noninterest-bearing deposits with higher-yielding deposits or market-based funding would reduce the assumed benefit of those deposits. The projected impact on net interest income in the table above also assumes a "through-the-cycle"
non-maturity deposit beta which may not be an accurate predictor of actual deposit rate changes realized in scenarios of smaller and/or non-parallel interest rate movements.
At June 30, 2020, our earnings simulation model indicated we were in compliance with our policies for interest rate scenarios for which we model as required by our board approved Asset Liability Policy.
Economic value of equity model. While earnings simulation modeling attempts to determine the impact of a changing rate environment to our net interest income, our EVE model measures estimated changes to the economic values of our assets, liabilities and off-balance sheet items as a result of interest rate changes. Economic values are determined by discounting expected cash flows from assets, liabilities
and off-balance sheet items, which establishes a base case EVE. We then shock rates as prescribed by our Asset Liability Policy and measure the sensitivity in EVE values for each of those shocked rate scenarios versus the base case. The Asset Liability Policy sets limits for those sensitivities. At June 30, 2020, our EVE modeling calculated the following estimated changes in EVE due to instantaneous upward and downward changes in rates:
*: Negative interest rates are not contemplated in these scenarios. The Treasury curve and all short-term rate indices, such as Fed Funds, LIBOR, etc., are assumed
to be zero bound.
While an instantaneous and severe shift in interest rates was used in this analysis to provide an estimate of exposure under these scenarios, we believe that a gradual shift in interest rates would have a more modest impact. Since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon (i.e., the current year). Further, EVE does not take into account factors such as future balance sheet growth, changes in product mix, changes in yield curve relationships, hedging activities we might take and changing product spreads that could mitigate the adverse impact of changes in interest rates.
At June 30, 2020, our EVE
model indicated we were in compliance with our policies for all interest rate scenarios for which we model as required by our board approved Asset Liability Policy.
Most likely earnings simulation models. We also analyze a most-likely earnings simulation scenario that projects the expected change in rates based on a forward yield curve adopted by management using expected balance sheet volumes forecasted by management. Separate growth assumptions are developed for loans, investments, deposits, etc. Other interest rate scenarios analyzed by management may include delayed rate shocks, yield curve steepening or flattening, or other variations in rate movements to further analyze or stress our balance sheet under various interest rate scenarios. Each scenario is evaluated by management. These processes assist management to better anticipate our financial results and, as a result, management
may determine the need to invest in other operating strategies and tactics which might enhance results or better position the firm's balance sheet to reduce interest rate risk going forward.
Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates,
while interest rates on other types may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as interest rate caps and floors) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies.
Management's model governance, model implementation and model validation processes and controls
are subject to review in our regulatory examinations to ensure they are in compliance with the most recent regulatory guidelines and industry and regulatory practices. Management utilizes a respected, sophisticated third party asset liability modeling software to help ensure implementation of management's assumptions into the model are processed as intended in a robust manner. That said, there are numerous assumptions regarding financial instrument behavior that are integrated into the model. The assumptions are formulated by combining observations gleaned from our historical studies of financial instruments and our best estimations of how, if at all, these instruments may behave in the future given changes in economic conditions, technology, etc. These assumptions may prove to be inaccurate. Additionally, given the large number of assumptions built into firms' asset liability modeling software, it is difficult, at best, to compare our results to other firms.
ALCO
may determine that Pinnacle Financial should over time become more or less asset or liability sensitive depending on the underlying balance sheet circumstances and our conclusions as to anticipated interest rate fluctuations in future periods. At present, ALCO has determined that its "most likely" rate scenario considers no change in short-term interest rates throughout the remainder of 2020. Our "most likely" rate forecast is based primarily on information we acquire from a service which includes a consensus forecast of numerous interest rate benchmarks. We may implement additional actions designed to achieve our desired sensitivity position which could change from time to time.
We have in the past used, and may in the future continue to use, derivative financial instruments as one tool to manage our interest rate sensitivity, including in our mortgage lending program, while continuing to meet
the credit and deposit needs of our customers. For further details on the derivatives we currently use, see Note 8. Derivative Instruments in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q.
We may also enter into interest rate swaps to facilitate customer transactions and meet their financing needs. These swaps qualify as derivatives, even though they are not designated as hedging instruments.
Liquidity Risk Management. The purpose of liquidity risk management is to ensure
that there are sufficient cash flows to satisfy loan demand, deposit withdrawals, and our other needs. Traditional sources of liquidity for a bank include asset maturities and growth in core deposits. A bank may achieve its desired liquidity objectives from the management of its assets and liabilities and by internally generated funding through its operations. Funds invested in marketable instruments that can be readily sold and the continuous maturing of other earning assets are sources of liquidity from an asset perspective. The liability base provides sources of liquidity through attraction of increased deposits and borrowing funds from various other institutions.
To assist in determining the adequacy of our liquidity, we perform a variety of liquidity stress tests including idiosyncratic, systemic and combined scenarios for both moderate and severe events. Liquidity is defined as the ability to convert
assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining our ability to meet the daily cash flow requirements of our customers, both depositors and borrowers. We seek to maintain a sufficiently liquid asset balance to ensure our ability to meet our obligations. The amount of the appropriate minimum liquid asset balance is determined through severe liquidity stress testing as measured by our liquidity coverage ratio calculation. At June 30, 2020, we were in compliance with our internal policies related to liquidity coverage ratio.
Changes in interest rates also affect our liquidity position. We currently price deposits in response to market rates. If deposits are not priced in response to market rates, a loss of deposits, particularly noncore deposit, could
occur which would negatively affect our liquidity position.
Scheduled loan payments are a relatively stable source of funds, but loan payoffs and deposit flows fluctuate significantly, being influenced by interest rates, general economic conditions and competition. Additionally, debt security investments are subject to prepayment and call provisions that could accelerate their payoff prior to stated maturity. We attempt to price our deposit products to meet our asset/liability objectives consistent with local market conditions. Our ALCO is responsible for monitoring our ongoing liquidity needs. Our regulators also monitor our liquidity and capital resources on a periodic basis.
In addition, our bank is a member of the FHLB Cincinnati. As a result, our bank receives advances from the FHLB Cincinnati, pursuant to the terms of various borrowing agreements,
which support our funding needs. Under the borrowing agreements with the FHLB Cincinnati, our bank has pledged certain qualifying residential mortgage loans and, pursuant to a blanket lien, all qualifying commercial mortgage loans as collateral. As such, Pinnacle Bank may use the FHLB Cincinnati as a source of liquidity depending on its ALCO strategies. Additionally, we may pledge additional qualifying assets, reduce the amount of pledged assets or experience changes in the value of pledged assets with the FHLB Cincinnati to increase or decrease our borrowing capacity with the FHLB Cincinnati. At June 30, 2020, we estimate we had $2.4 billion in additional borrowing capacity with the FHLB Cincinnati. However, incremental borrowings are made via a formal request by Pinnacle Bank and the subsequent approval by the FHLB Cincinnati. During the three and six months ended June 30,
2020, $392.5 million in FHLB advances were restructured and prepayment penalties of $2.9 million were recognized in expense for the three months ended June 30, 2020. At June 30, 2020, our bank had received advances from the FHLB Cincinnati totaling $1.8 billion. At June 30, 2020, the scheduled maturities of Pinnacle Bank's FHLB Cincinnati advances and interest rates are as follows (in thousands):
Scheduled Maturities
Amount
Interest
Rates (1)
2020
$
125,000
0.62%
2021
575,000
0.89%
2022
—
—%
2023
—
—%
2024
200,000
2.09%
Thereafter
891,266
1.95%
Total
$
1,791,266
Weighted
average interest rate
1.53%
(1)Some FHLB Cincinnati advances include variable interest rates and could increase in the future. The table reflects rates in effect as of June 30, 2020.
Pinnacle Bank also has accommodations with upstream correspondent banks available for unsecured short-term advances which aggregate $195 million. These accommodations have various covenants related to their term and availability, and in most cases must be repaid within a month of borrowing. We had no outstanding borrowings at June 30, 2020 under these agreements. Our bank also had approximately $3.4 billion
in available Federal Reserve discount window lines of credit at June 30, 2020.
At June 30, 2020, excluding reciprocating time and money market deposits issued through the Promontory Network, we had $3.3 billion of brokered deposits. Historically, we have issued brokered certificates of deposit through several different brokerage houses based on competitive bid. During the first half of 2020, and in response to the uncertainty resulting from the COVID-19 pandemic, we intentionally increased our levels of on-balance sheet liquidity. During the first quarter of 2020, this increase was funded by a
combination of increased core deposits, increased borrowings from the FHLB Cincinnati and increases in brokered time deposits. Core deposit growth during the second quarter of 2020 increased such that we were able to prepay certain wholesale maturities while maintaining an elevated level of on-balance sheet liquidity.
Banking regulators have defined additional liquidity guidelines, through the issuance of the Basel III Liquidity Coverage Ratio (LCR) and the Modified LCR. These regulatory guidelines became effective January 2015 with phase in over subsequent years and require these large institutions to follow prescriptive guidance in determining an absolute level of a high quality liquid asset (HQLA) buffer that must be maintained on their balance sheets in order to withstand a potential liquidity crisis event. Although Pinnacle Financial follows the
principles outlined in the Interagency Policy Statement on Liquidity Risk Management, issued March 2010, to determine its HQLA buffer, Pinnacle Financial is not currently subject to these regulations. However, these formulas could eventually be imposed on smaller banks, such as Pinnacle Bank, and require an increase in the absolute level of liquidity on our balance sheet, which could result in lower net interest margins for us in future periods.
At June 30, 2020, we had no individually significant commitments for capital expenditures. But, we believe the number of our locations, including non-branch locations, will increase over an extended period of time across our footprint and that certain of our locations will be in need of required renovations. In future periods, these expansions and renovation projects may lead to additional equipment and occupancy expenses
as well as related increases in salaries and benefits expense. Additionally, we expect we will continue to incur costs associated with technology improvements to enhance the infrastructure of our firm.
Off-Balance Sheet Arrangements. At June 30, 2020, we had outstanding standby letters of credit of $213.3 million and unfunded loan commitments outstanding of $8.7 billion. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, Pinnacle Bank has the ability to liquidate Federal funds sold or, on a short-term basis, to borrow and purchase Federal funds from other financial institutions.
Impact
of Inflation
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with U.S. GAAP and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation.
Recently Adopted Accounting Pronouncements
See "Part I - Item 1. Consolidated Financial Statements - Note.
1 Summary of Significant Accounting Policies" of this Report for further information.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item 3 is included on pages 43 through 67 of Part I - Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations."
ITEM
4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Pinnacle Financial maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"), that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to Pinnacle Financial's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Pinnacle Financial carried out an evaluation, under the supervision and with
the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that Pinnacle Financial's disclosure controls and procedures were effective as of the end of the period covered by this report in ensuring that the information required to be disclosed by Pinnacle Financial in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to Pinnacle Financial's management (including the Principal Executive Officer and Principal Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
Changes
in Internal Controls
No change in our internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f) or 15d-(f)) occurred during fiscal quarter ended June 30, 2020 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Various legal proceedings to which Pinnacle Financial or a subsidiary of Pinnacle Financial is a party arise from time to time in the normal course of business. There are no material pending legal proceedings to which Pinnacle Financial or a subsidiary of Pinnacle Financial is a party or of which any of their property is the subject.
Investing in Pinnacle Financial
involves various risks which are particular to our company, our industry and our market area. We believe all significant risks to investors in Pinnacle Financial have been outlined in Part II, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019. However, other risks may prove to be important in the future, and new risks may emerge at any time. We cannot predict with certainty all potential developments which could materially affect our financial performance or condition. There has been no material change to our risk factors as previously disclosed in the above described Annual Report on Form 10-K except as set forth below:
The COVID-19 pandemic is adversely affecting our business and the businesses of a significant percentage of our
customers as well as certain of our third-party vendors and service providers, and the adverse impacts on our business, financial position, capital, liquidity, results of operations and prospects could be significant.
The spread of COVID-19 has created a global public health crisis that has resulted in uncertainty, volatility and deterioration in financial markets and in governmental, commercial and consumer activity including in the United States, where we conduct substantially all of our activity.
To combat the spread of COVID-19, federal, state and local governments have taken a variety of actions that have materially and adversely affected the businesses and lives of our customers. These actions have included orders closing non-essential businesses and restricting movement of individuals through the issuance of safer-at-home orders and other
guidance encouraging individuals to observe strict social distancing measures. At times, the actions being taken by governmental authorities are not always coordinated or consistent across states or even within states and the impact of those actions across our markets may be uneven. These actions, together with the independent actions of individuals and businesses aimed at slowing the spread of the virus, have resulted in extensive economic disruption and rapid declines in consumer and commercial activity. Many businesses are experiencing significant declines in revenue and there has been a rapid rise in unemployment rates throughout our markets with corresponding negative effects on consumer spending and behavior. Global supply chains have also been negatively impacted as have equity and debt markets. Whether the efforts to stop the spread of COVID-19 will be successful is unknown at this time as in recent weeks the number of cases, hospitalizations and death in some
of our markets has trended upward following efforts to re-open the economies in our markets, and continued spread of the disease or continuation of higher levels of cases, hospitalizations and death over the remainder of 2020 or into 2021 will further negatively impact the businesses and lives of our customers and our results of operations.
In March 2020, the Federal Open Market Committee reduced the target Federal funds rate by 150 basis points and for a portion of March 2020 the 10-year treasury bond rate fell to below 1.00% for the first time in history. These actions, and other actions being taken by governmental and regulatory agencies affecting monetary policy in response to the unprecedented challenges resulting from the spread of COVID-19, have negatively impacted our net interest margin and our results and are likely to continue to negatively impact our net interest margin and our results throughout
the remainder of 2020 and possibly into 2021. The fair values of certain of our investments are also likely to decline as a result of COVID-19.
As a result of COVID-19, many of our borrowers, particularly those that operate in the restaurant, entertainment, hospitality, medical, dental, retail and construction sectors, but also other businesses as well, including owners of commercial real estate properties and hotels, are experiencing varying degrees of financial distress, which is expected to continue, and may likely increase, over the coming months. As a result, these borrowers will likely have difficulty paying, on a timely basis, interest and principal payments on their loans and the value of collateral securing these obligations is likely to be adversely impacted as well. Though we have offered these borrowers, and others, the ability to defer interest and/or principal payments for 90 days which we
may extend for an additional 90 days, that deferral period may not be sufficient to allow the impacts of COVID-19 to have sufficiently subsided, and these borrowers may still be experiencing distress at the expiration of those deferral periods. As a result, these borrowers may have difficulty satisfying their obligations to us. Disruptions to our customers’ businesses, together with volatility in the stock market, could also result in declines to our wealth management revenues.
The economic pressures and uncertainties arising from the COVID-19 pandemic may result in specific changes in consumer and business spending and borrowing and saving habits, affecting the demand for loans and other products and services we offer. Consumers affected by COVID-19 may continue to demonstrate changed behavior even after the crisis is over. For example, consumers may decrease discretionary spending on a permanent or long-term
basis, certain industries may take longer to recover (particularly those that rely on travel or large gatherings) as consumers may be hesitant to return to full social interaction, We lend to customers operating in such industries including restaurants, hotels/lodging, entertainment, retail and commercial real estate, among others, that have been significantly impacted by COVID-19 and we are continuing to monitor these customers closely. The potential changes in behaviors driven by COVID-19 also present heightened liquidity risks, for example, arising from increased
demand for our products and services (such as elevated levels of draws on credit facilities) or decreased
demand for our products and services (such as idiosyncratic, or broad-based, market or other developments that lead to deposit outflows).
Like our borrowers, BHG’s borrowers have been similarly affected by COVID-19. Many of BHG’s borrowers are medical or dental practices that have been particularly impacted by safer-at-home orders that have effectively caused those practices’ revenues to decline materially as a result of elective procedures being prohibited, cancelled or delayed or individuals’ decisions to postpone non-emergency procedures, even as restrictions on elective procedures are relaxed. For those loans that BHG has sold through its auction platform, BHG may at its sole discretion, in response to a request from a purchaser of a loan, agree to substitute a performing loan for one that has become past due. If requests for substitutions increase, and BHG opts to provide the substitution. BHG’s credit
losses may likewise increase and its results of operations would be adversely impacted.
COVID-19’s economic disruption has also impacted many states and municipalities. As a result, many states and municipalities are facing a strain on resources and a reduction in tax collections and some of these have sought assistance from the Federal government to cover the cost of resource depletion and tax shortfalls. The ability of states and municipalities to fund shortfalls could have an adverse effect on their ability to sustain debt maintenance obligations which would negatively impact the value of our municipal bond portfolio.
Banks and bank holding companies have been particularly impacted by the COVID-19 pandemic as a result of disruption and volatility in the global capital markets. This disruption has impacted our cost of capital and may adversely
affect our ability to access the capital markets if we need or desire to do so and, although the ultimate impact cannot be reliably estimated at this time in light of the uncertainties and ongoing developments noted herein, such impacts could be material. Furthermore, bank regulatory agencies have been (and are expected to continue to be) very proactive in responding to both market and supervisory concerns arising from the COVID-19 pandemic as well as the potential impact on customers, especially borrowers. As shown during and following the financial crisis, periods of economic and financial disruption and stress have, in the past, resulted in increased scrutiny of banking organizations. We are closely monitoring the potential for new laws and regulations impacting lending and funding practices as well as capital and liquidity standards. Such changes could require us to maintain significantly more capital, with common equity as a more predominant component, or manage
the composition of our assets and liabilities to comply with formulaic liquidity requirements. Furthermore, provisions of the CARES Act allow, but do not require, the FDIC to guarantee deposit obligations of banks in non-interest-bearing transaction accounts through December 31, 2020. Participation in any such guarantee program may result in fees and other assessments as the FDIC determines and may include special assessments. Other provisions of the CARES Act as well as actions taken by bank regulators, such as potential relief for working with borrowers who are distressed as a result of the effects of COVID-19, could similarly impact aggregate deposit insurance expense.
As we sought to protect the health and safety of our employees and customers during the first and second quarter of 2020, we took numerous actions to modify our business operations, including
restricting employee travel, directing a significant percentage of our employees that were able to do so to work from home, closing the lobbies of many of our branches, and in some cases the branch itself, and implementing our business continuity plans and protocols. We may take further actions in the future either of our own volition or as a result of government orders or directives. Though we believe we have been able to adequately service our clients under these restrictions, we cannot provide any assurances that our ability to do so wouldn’t be negatively impacted if additional restrictions are necessary or imposed on us in the future, including if key employees of ours or a significant number of our associates become ill as a result of contracting the virus. Given our preference for hiring experienced lenders the average age of an associate of ours may be higher than many of our peers and those of our associates who are of an age that puts them in a higher risk
category may be more susceptible to contracting the virus. We rely on the services of various key vendors and business partners to service our clients and if those companies’ businesses or workforces are impacted in ways similar to those that may impact our business, our ability to service our customers could be impacted.
The economic uncertainty caused by COVID-19’s spread and the efforts of government and non-governmental authorities and the behavior of individuals seeking to slow its spread, have caused our provision expense for credit losses to increase materially in the
first half of 2020 and may contribute to further elevated levels of provision expense through the duration of the pandemic and any recovery period following its end. Increased provision levels would negatively impact our capital levels which may impact our ability to pay dividends or cause us to need to
access the capital markets to support our capital needs. We have also taken efforts to increase our on-balance sheet liquidity and those efforts have caused, and may continue to cause, our net interest margin to be adversely impacted.
COVID-19 has not yet been contained, and given the ongoing and fluid nature of the country’s response to the pandemic, it is difficult for us to accurately estimate the length and severity of the economic disruption being caused by COVID-19. As a result, the extent to which our results of operations, provision expense, capital levels, liquidity ratios and published credit ratings will be impacted is difficult to predict.
Our participation in the PPP may expose us to financial liability, credit losses, compliance costs or reputational damage.
Under the CARES Act, Congress created the PPP and authorized the Treasury to implement rules regarding the program. Banks, like us, and non-bank lenders, including BHG, facilitated funding under the program on behalf of the SBA for borrowers that were eligible participants. Since the roll out of the PPP, Treasury has issued rules and other interpretive guidance seeking to address uncertainty surrounding the program and its eligibility and other criteria. This constantly changing guidance caused challenges for us and other lenders under the program, like BHG, in finalizing and submitting applications. We are beginning to receive requests from our customers for forgiveness of their obligations under their PPP loans and again guidance
is lacking from the Treasury and SBA on how to process these requests. As a result, we, and other lenders under the PPP, may face criticism from customers or others that are seeking forgiveness. This criticism could cause reputational damage to us and there is a possibility that customers or others may threaten and pursue legal action against banks and other lenders like us and BHG under the program. Moreover, as a result of updated guidance regarding the PPP and its eligibility standards, some borrowers that received loans through our processing efforts, have repaid their loans in full and others may choose to do the same. If that happens, we may not receive the fees that we were entitled to as a result of originating these loans.
Among other regulatory requirements, PPP loans are subject to forbearance of loan payments for a six-month period to the extent that loans are not eligible for forgiveness.
If PPP borrowers fail to qualify for loan forgiveness, including by failing to use the funds appropriately in order to qualify for forgiveness under the program, we and BHG have a greater risk of holding these loans at unfavorable interest rates. In addition, because of the short time period between the passing of the CARES Act and the implementation of the PPP, there is ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes us and BHG to risks relating to noncompliance with the PPP. There is risk that the SBA or another governmental entity could conclude there is a deficiency in the manner in which we or BHG originated, funded, or serviced PPP loans, which may or may not be related to the ambiguity in the CARES Act or the rules and guidance promulgated by the SBA and the Treasury regarding the operation of the PPP. In the event of such deficiency, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty,
or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from us or BHG.
Since the commencement of the PPP, several banks have been subject to litigation regarding the process and procedures that such banks followed in accepting and processing applications for the PPP. We and BHG may be exposed to the risk of similar litigation, from both customers and non-customers that contacted us or BHG regarding obtaining PPP loans with respect to the processes and procedures we or BHG used in processing applications for the PPP. Legal proceedings related to our or BHG’s participation in the PPP, like the purported class action lawsuit filed against our bank subsidiary in June 2020 that alleges, among other claims, that our bank subsidiary failed to pay fees to purported agents of PPP borrowers that the plaintiff alleges were owed under the PPP in violation of SBA regulations,
if not resolved in a manner that is favorable to us, or BHG, may result in significant financial liability to us or BHG, or adversely affect our, or BHG’s results of operations, financial condition or reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs, or reputational damage caused by PPP-related litigation could have a material adverse impact on our or BHG's reputation, business, financial condition, and results of operations.
In addition, we may be subject to regulatory scrutiny regarding our processing of PPP applications or our origination or servicing of PPP loans. While the SBA has said that in many instances, banks may rely on the certifications of borrowers regarding their eligibility for PPP loans, we do have several obligations under the PPP, and if the SBA found that we did not meet those obligations, the remedies the SBA may seek
against us are unknown but may include not guarantying the PPP loans resulting in credit exposure to borrowers who may be unable to repay their loans. The PPP may also attract significant interest from federal and state enforcement authorities, oversight agencies, regulators, and Congressional committees. State Attorneys General and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations entitling us to rely on borrower certifications, and take more aggressive action against us for alleged violations of the provisions governing our participation in the PPP.
Additional issuances of preferred stock or securities convertible into preferred stock may further dilute existing holders of the depositary shares.
We may determine that it is advisable, or we may
encounter circumstances where we determine it is necessary, to issue additional shares of preferred stock, securities convertible into, exchangeable for, or that represent an interest in preferred stock, or preferred stock-equivalent securities to fund strategic initiatives or other business needs or to build additional capital. Our board of directors is authorized to cause us to issue one or more classes or series of preferred stock from time to time without any action on the part of our shareholders, including issuing additional shares of our 6.75% fixed rate non-cumulative perpetual preferred stock, Series B (Series B preferred stock) or additional depositary shares. Our board of directors also has the power, without shareholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights, and preferences over the Series B preferred stock with respect to dividends or upon our dissolution,
liquidation or winding-up and other terms.
Although the affirmative vote or consent of the holders of at least two-thirds of all outstanding shares of the Series B preferred stock, voting together as a single class with any parity stock having similar voting rights, is required to authorize or issue any shares of capital stock senior in rights and preferences to the Series B preferred stock, if we issue preferred stock or depositary shares in the future with voting rights that dilute the voting power of the Series B preferred stock or depositary shares, the rights of holders of the depositary shares or the market price of the
depositary shares could be adversely affected. The market price of the depositary shares could decline as a result of these other offerings, as well as other sales of a large block of depositary shares, Series B preferred stock, or similar securities in the market thereafter, or the perception that such sales could occur. Holders of the Series B preferred stock are not entitled to preemptive rights or other protections against dilution.
Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of the depositary shares bear the risk of our future offerings reducing the market price of the depositary shares and diluting their holdings in the depositary shares.
Our
ability to declare and pay dividends is limited.
While our board of directors has approved the payment of a quarterly cash dividend on our common stock since the fourth quarter of 2013 and approved the payment of the initial quarterly dividend on the Series B Preferred Stock (and underlying depositary shares), there can be no assurance of whether or when we may pay dividends on our capital stock in the future. Future dividends, if any, will be declared and paid at the discretion of our board of directors and will depend on a number of factors, including our and Pinnacle Bank’s capital levels. Moreover, our ability to pay dividends on our common stock is limited by the terms of our Series B preferred stock which provides that if we have not paid dividends on the Series B preferred stock for the most recently completed dividend period, then no dividend or distribution shall be declared, paid, or
set aside for payment on shares of our common stock.
Our principal source of funds used to pay cash dividends on our common stock will be cash we may hold from time to time as well as dividends that we receive from Pinnacle Bank. Although Pinnacle Bank’s asset quality, earnings performance, liquidity and capital requirements will be taken into account before we declare or pay any future dividends on our common stock, our board of directors will also consider our liquidity and capital requirements and our board of directors could determine to declare and pay dividends without relying on dividend payments from Pinnacle Bank.
Federal and state banking laws and regulations and state corporate laws restrict the amount of dividends we may declare and pay and that Pinnacle Bank may declare and pay to us. For example, Federal Reserve
regulations implementing the capital rules required under Basel III do not permit dividends unless capital levels exceed certain higher levels applying capital conservation buffers. In addition, the Federal Reserve has issued supervisory guidance advising bank holding companies to eliminate, defer or reduce dividends paid on common stock and other forms of Tier 1 capital, like the Series B preferred stock, where the company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends, the company’s prospective rate of earnings retention is not consistent with the company’s capital needs and overall current and
prospective financial condition or the company will not meet, or is in danger of not meeting, minimum regulatory capital adequacy ratios.Recent supplements to this guidance reiterate the need for bank holding companies to inform their applicable reserve bank sufficiently in advance of the proposed payment of a dividend in certain circumstances.
In addition, subject to certain exceptions, the terms of our subordinated debentures, including the subordinated debentures we assumed upon the consummation of the BNC merger, prohibit us from paying dividends on shares of our capital stock at times when we are deferring the payment of interest on such subordinated debentures.
The Series B preferred
stock constitutes an equity security and ranks junior to all of our and our subsidiaries’ existing indebtedness and will rank junior to our and our subsidiaries’ future indebtedness.
Shares of the Series B preferred stock are equity interests in Pinnacle Financial and do not constitute indebtedness. Accordingly, shares of the Series B preferred stock and the related depositary shares are and will be junior in right of payment to any existing and all future indebtedness and other non-equity claims of Pinnacle Financial with respect to assets available to satisfy claims on us, including in a liquidation of Pinnacle Financial. In the event of our bankruptcy, liquidation, dissolution or winding-up, our assets will be
available to pay obligations on the Series B preferred stock and any parity stock only after all of our liabilities have been paid and any obligations we owe on any securities that rank senior to the Series B preferred stock then outstanding, if any, have been satisfied. In case of such bankruptcy, liquidation, dissolution or winding-up, the Series B preferred stock will rank equally with any parity stock in the distribution of our assets. Holders of the depositary shares may be fully subordinated to
interests held by the U.S. government in the event of a receivership, insolvency, liquidation or similar proceeding. In addition, our existing and future indebtedness
may restrict payment of dividends on the Series B preferred stock.
The Series B preferred stock and the depositary shares representing the Series B preferred stock effectively rank junior to any existing and all future liabilities of our subsidiaries.
We are a financial holding company and conduct substantially all of our operations through our subsidiaries. Our right to participate in any distribution of the assets of our subsidiaries upon any liquidation, reorganization, receivership or conservatorship of any subsidiary (and thus the ability of the
holder of the Series B preferred stock and the holders of the depositary shares to benefit indirectly from such distribution) will rank junior to the prior claims of that subsidiary’s creditors. In the event of bankruptcy, liquidation or winding-up, there may not be sufficient assets remaining, after paying our and our subsidiaries’ liabilities, to pay amounts due on any or all of the Series B preferred stock and the depositary shares representing the Series B preferred stock then outstanding.
We, together with Pinnacle Bank, own 49% of the outstanding equity interests of BHG. Our right to participate in any distribution of the assets of BHG upon its liquidation, reorganization, receivership or conservatorship (and thus the ability of the holders of the Series B preferred stock and the holders of the depositary
shares to benefit indirectly from such distribution) will rank junior to the prior claims of BHG’s creditors. Moreover, our 49% ownership interest in BHG and minority board representation on BHG’s board means that we, and Pinnacle Bank, cannot cause BHG to make distributions to us and Pinnacle Bank that could be used to pay dividends on the Series B preferred stock. In addition, BHG is a party to various loan agreements pursuant to which BHG’s ability to make distributions to us may be limited.
The Series B preferred stock and the depositary shares representing the Series B preferred stock places no restrictions on our business or operations or on our ability to incur indebtedness or engage in any transactions, subject only to the limited voting rights of the shares of Series B preferred stock. The holders of the Series B preferred stock, and therefore the holders of the depositary shares representing
the Series B preferred stock, have limited voting rights.
Dividends on the Series B preferred stock are non-cumulative and discretionary. If we do not declare dividends on the Series B preferred stock, holders of the depositary shares will not be entitled to receive related distributions on their depositary shares.
Dividends on the Series B preferred stock are non-cumulative and discretionary, not mandatory. Consequently, if our board of directors does not authorize and declare a dividend for any dividend period, the holder of the Series B preferred stock, and therefore the holders of the depositary shares, will not be entitled to receive a dividend for such period, and such undeclared dividend will not accrue and be payable. We will have no obligation to pay dividends for such dividend period, whether or not dividends are
authorized and declared for any subsequent dividend period with respect to the Series B preferred stock. Our board of directors may determine that it would be in our best interests to pay less than the full amount of the stated dividends on the Series B preferred stock or no dividend for any dividend period even if funds are available. Factors that would be considered by our board of directors in making this determination include our financial condition, liquidity and capital needs, the impact of current and pending legislation and regulations, economic conditions, including worsening economic conditions resulting from the COVID-19 pandemic, our ability to service any equity or debt obligations senior to the Series B preferred stock, any credit agreements to which we are a party, tax considerations and such other factors as our board of directors may deem relevant.
Unlike indebtedness, where principal
and interest would customarily be payable on specified due dates, in the case of preferred stock like the Series B preferred stock dividends are payable only when, as and if authorized and declared by our board of directors or a duly authorized committee of the board and as a Tennessee corporation, we are subject to restrictions on payments of dividends out of lawfully available funds as described elsewhere in this report.
The holders of the Series B preferred stock, and therefore the holders of the depositary shares representing the Series B preferred stock, have limited voting rights.
Until and unless we are in arrears on our dividend payments on the Series B preferred stock for six quarterly dividend periods, whether consecutive or not, the holders of the Series B preferred stock, and therefore the holders of the depositary
shares, have no voting rights with respect to matters that generally require the approval of voting shareholders, except with respect to certain fundamental changes in the terms of the Series B preferred stock, and except as may be required by the rules of any securities exchange or quotation system on which the Series B preferred stock is listed, traded or quoted or by Tennessee law. If dividends on the Series B preferred stock are not paid in full for six dividend periods, whether consecutive or not, the holders of Series B preferred stock, voting together as a class with any other equally ranked series of preferred stock that have similar voting rights then outstanding, if any, will have the right, at the first annual meeting or special meeting held thereafter and at subsequent annual meetings, to elect two directors to our board. The terms of the additional directors so elected will end upon the payment or setting
aside for payment by us of continuous noncumulative dividends for at least four dividend periods on the Series B preferred stock and any other equally ranked series of preferred stock then outstanding, if any.
Holders of the depositary shares must act through the depositary to exercise any voting rights of the Series B preferred stock. Although each depositary share is entitled to 1/40th of a vote, the depositary can only vote whole shares of Series B preferred stock. While the depositary will vote the maximum number of whole shares of Preferred Stock in accordance with the instructions it receives, any remaining fractional votes of holders of the depositary shares will not be voted.
The price of our capital stock may be volatile or may decline.
The
trading price of our capital stock may fluctuate as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could adversely affect the market price of our capital stock. Among the factors that could affect the trading prices of our capital stock are:
•actual or anticipated quarterly fluctuations in our results of operations and financial condition;
•changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts;
•failure to meet analysts’ revenue or earnings estimates;
•speculation in the press or investment community;
•strategic
actions by us or our competitors;
•actions by institutional shareholders;
•fluctuations in the stock price and operating results of our competitors;
•general market conditions and, in particular, developments related to market conditions for the financial services industry;
•market perceptions about the innovation economy, including levels of funding or "exit" activities of companies in the industries we serve;
•proposed or adopted regulatory changes or developments;
•changes in the political climate;
•market reactions to social media messages or posts;
•anticipated or pending investigations, proceedings or
litigation that involve or affect us; and
•domestic and international economic and social factors unrelated to our performance.
The trading price of the shares of our common stock and depositary shares representing fractional interests in our Series B preferred stock and the value of our other securities will further depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, our ability to pay dividends and future sales of our equity or equity-related securities. In some cases, the markets have produced downward pressure on trading prices of capital stock and credit availability for certain issuers without regard to those issuers’ underlying financial strength. A significant decline in the trading price of our capital stock could result in substantial
losses for individual shareholders and could lead to costly and disruptive securities litigation, as well as the loss of key employees.
An investment in our capital stock is not an insured deposit and is not guaranteed by the FDIC.
An investment in our capital stock is not a bank deposit and, therefore, is not insured against loss or guaranteed by the FDIC, any other deposit insurance fund or by any other public or private entity. An investment in our capital stock is inherently risky for the reasons described herein and our shareholders will bear the risk of loss if the value or market price of our capital stock is adversely affected.
(1)During
the quarter ended June 30, 2020, 49,982 shares of restricted stock or performance-based vesting restricted stock units previously awarded to certain of the participants in our equity incentive plans vested. We withheld 13,988 shares to satisfy tax withholding requirements associated with the vesting of these awards.
(2)On November 13, 2018, Pinnacle Financial announced that its board of directors authorized a share repurchase program for up to $100.0 million of Pinnacle Financial’s outstanding common stock that expired on March 31, 2020. On October 15, 2019, Pinnacle Financial's board of directors approved and additional $100.0 million share repurchase program that
commenced upon the exhaustion of the original $100.0 million repurchase program. The additional share repurchase program will expire on December 31, 2020. Pinnacle Financial repurchased 1,015,039 shares of its common stock at an aggregate cost of $50.8 million in the quarter ended March 31, 2020. Share repurchases may be made from time to time, on the open market or in privately negotiated transactions, at the discretion of the management of Pinnacle Financial, after the board of directors of Pinnacle Financial authorizes a repurchase program. The approved share repurchase programs do not obligate Pinnacle Financial to repurchase any dollar amount or number of shares, and the programs may be extended, modified, suspended, or discontinued at any time. Stock repurchases generally are affected through open market purchases, and may be made through unsolicited negotiated transactions.
The timing of these repurchases will depend on market conditions and other requirements. Pinnacle Financial has chosen to suspend its repurchase program in light of uncertainty regarding the length and severity of the COVID-19 pandemic. No shares were purchased in the quarter ended June 30, 2020.
The
cover page from the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in Inline XBRL (included in Exhibit 101)
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
, Inc.