Darren415
Pinnacle Financial Partners (NASDAQ:PNFP) has been an underperformer since my last update on this fast-growing Southeastern bank. While sentiment on banks in general hasn’t been great, and several notable growth banks (First Republic (FRC), Signature (SBNY), and SVB Financial (SIVB)) have seen even worse performance, the nearly 15% decline in Pinnacle is disappointing in the context of ongoing execution of a well-founded model with a long runway for growth.
I can come up with at least a few reasons for some weakness in Pinnacle shares – the bank’s above-average deposit beta, aggressive opex spending growth, and dependence on loan growth among them – but even against a tougher backdrop for 2023/24, I think the shares still look attractive for growth-oriented investors willing to take on additional risk in pursuit of above-average returns.
Exceptional Growth Remains The Story
Comparing Pinnacle to other banks of similar market cap is of limited utility, given that Pinnacle is pursuing a distinctly different model. Even so, 16% qoq net interest income in the third quarter stands out, though the 13% growth in pre-provision profits isn’t as impressive and is a byproduct of weaker fee income and ongoing investment in the business through expanded hiring – the bank added another 53 revenue-producers in the third quarter after hiring 37 in the second quarter.
Pinnacle’s greater than 4% sequential growth in average earning assets was unusual, well above the sub-1% average for banks of similar size, and is a testament to the ongoing above-average growth here. Loans rose more than 5% qoq on an end-of-period basis and over 6% on an average balance basis, roughly double the average of its peer group (again, depending upon how you define those peers).
C&I lending remains quite strong, growing more than 5% sequentially, and so too with commercial real estate lending, which rose almost 5% (I define CRE lending differently than management, including owner-occupied real estate and excluding multifamily and construction). Multifamily lending grew almost 10%, and this could be an important growth driver for years to come given the housing shortages in many growth areas Southeast markets. Construction lending grew about 5% and is now around 12% of total lending – high relative to many similarly-sized banks.
Pinnacle’s skew toward commercial lending is also driving higher realized loan yields, as yields on commercial lending (which are typically floating-rate) are outpacing consumer loan yields. Overall loan yields rose 60bp yoy and 66bp qoq to 4.73%.
Costs Are A Concern
In a market environment where investors are contemplating peak banking earnings in 2023, as well as the risk of declines in 2024 and a shift from the Fed tightening to easing again, the market is rewarding banks with stronger operating leverage, lower deposit betas, and less reliance on loan growth. None of that suits Pinnacle particularly well.
Management guided to mid-to-high-teens expense growth in 2023, well above Street expectations of around 10%, and operating leverage is not a near-term priority of management as it builds the business. I argue that the bank’s share gains in its core markets (both loan and deposits) like Tennessee and North Carolina, as well as good initial results in newer markets like Atlanta, Birmingham, and Washington, D.C., make these expenditures worth it for the long term, but nervous markets don’t really credit the long-term potential of growth investments.
On the deposit beta side, Pinnacle is already in the-30%’s, above the low-20%’s of a broader selection of banks. This is part of what has undermined other banks like Signature and SVB Financial at least to some extent – lacking adequate low-cost core deposit franchises, these banks are facing fast-rising costs to fund that loan growth they’re pursuing. Pinnacle saw its total cost of deposits roughly triple from the second quarter, and at 0.66%, the bank is paying quite a bit more than its less growth-focused peers. While management thinks that deposit beta will plateau in the 40%’s, and I have a high regard for Pinnacle’s management team, I have maintained from the start of this cycle that deposit costs were likely to surprise analysts and bank executives and come in higher than they expect.
Last comes the bank’s reliance on loan growth. Pinnacle’s net interest income growth was almost double its peer group average in Q3’22, but the 30bp qoq improvement in net interest margin (to 3.47%) was almost exactly in line with those peers – meaning that Pinnacle got a bigger lift from growth in earning assets (loans, mainly). Pinnacle isn’t particularly asset-sensitive, given its high deposit beta and its somewhat high loan/deposit ratio, and so it needs loan growth to fuel the growth engine.
So far, the data for Q4’22 have been positive – loan growth has kept up a pace similar to Q3’22 and credit quality remains healthy. Still, the rate hikes and other macro factors do seem to be hitting business confidence surveys, and businesses are starting to pull back on their expansion plans. With less need to finance inventory growth to deal with supply chain risks and with orders turning negative, I think demand is going to moderate in 2023.
There’s more to Pinnacle’s loan growth story than just the macro backdrop, though. The bank has been gaining share by hiring productive loan officers from other banks and focusing relentless on customer service and satisfaction (as seen in an excellent net promoter score), and I believe those share gains can continue. As other banks try to boost earnings by cutting costs (and, by extension, service quality in many cases), Pinnacle could stand out even more in a market where borrowers become more selective. Likewise, I see room for Pinnacle to expand its business in many lending categories (multifamily, franchise finance, equipment finance), as well as leverage the growth in Bankers Healthcare Group (PNFP owns 49% and accounts for it as income from equity investments).
The Outlook
Pinnacle has outperformed my expectations in 2022 both in terms of reported financial results (including loan originations) and new hires, leading me to higher earnings expectations for 2022 and 2023. I do expect some moderation in 2024, though, and that’s largely due to my macro outlook. Longer term, very little changes – I’m still expecting over 10% core earnings growth over the next five and 10 years.
Based on that core growth and the recent underperformance of the shares, the potential long-term annualized return potential climbs to the mid-teens. Short-term valuation approaches are trickier to use. ROTCE-driven P/TBV doesn’t work all that well for most growth banks, and while P/E valuation is straightforward, the question of the right multiple to use can undermine the approach – I believe a forward multiple of 14.25x is reasonable given what the market has paid for similar situations in the past, but other investors may well argue for a different multiple.
The Bottom Line
I think Pinnacle is undervalued below $100, but I also think that the setup of a weakening macro, nervous investors, and aggressive ongoing reinvestment in the business (hiring more talent away from other banks) isn’t ideal. I think Pinnacle’s moves will drive strong growth over the longer term, but in a market that seems more inclined to favor defense over offense, investors will have to have some patience with Pinnacle or try to buy in closer to a positive shift in sentiment towards growth-oriented banks.
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