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EX-32.2 - EXHIBIT 32.2 - PINNACLE FINANCIAL PARTNERS INCex32203312018.htm
EX-32.1 - EXHIBIT 32.1 - PINNACLE FINANCIAL PARTNERS INCex32103312018.htm
EX-31.2 - EXHIBIT 31.2 - PINNACLE FINANCIAL PARTNERS INCex31203312018.htm
EX-31.1 - EXHIBIT 31.1 - PINNACLE FINANCIAL PARTNERS INCex31103312018.htm
EX-10.42 - EXHIBIT 10.42 - PINNACLE FINANCIAL PARTNERS INCexhibit1042.htm
EX-10.41 - EXHIBIT 10.41 - PINNACLE FINANCIAL PARTNERS INCexhibit1041.htm
EX-10.40 - EXHIBIT 10.40 - PINNACLE FINANCIAL PARTNERS INCexhibit1040.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission File Number: 000-31225

pnfplogoa04.jpg, Inc.
(Exact name of registrant as specified in its charter)
Tennessee
 
62-1812853
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
150 Third Avenue South, Suite 900, Nashville, Tennessee
 
37201
(Address of principal executive offices)
 
(Zip Code)
(615) 744-3700
(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.
Yes  x
No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).
Yes  x
No o
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):
Large Accelerated Filer x
Accelerated Filer o
Non-accelerated Filer  o
(do not check if you are a smaller reporting company)
Smaller reporting company o  
 
Emerging growth company o  

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. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  o
No x

As of May 1, 2018 there were 77,868,340 shares of common stock, $1.00 par value per share, issued and outstanding.



Pinnacle Financial Partners, Inc.
Report on Form 10-Q
March 31, 2018

TABLE OF CONTENTS
Page No.
 
 
PART I – Financial Information:
Item 1. Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
 
 
PART II – Other Information:
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Signatures

2


FORWARD-LOOKING STATEMENTS

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 and Section 21E of the Exchange Act. The words "expect," "anticipate," "intend," "plan," "believe," "aim","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) deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses; (ii) continuation of the historically low short-term interest rate environment; (iii) the inability of Pinnacle Financial, or entities in which it has significant investments, like Bankers Healthcare Group, LLC ("BHG"), to maintain the historical growth rate of its, or such entities', loan portfolio; (iv) changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; (v) effectiveness of Pinnacle Financial's asset management activities in improving, resolving or liquidating lower-quality assets; (vi) the impact of competition with other financial institutions, including pricing pressures (including those resulting from the Tax Cuts and Jobs Act) and the resulting impact on Pinnacle Financial’s results, including as a result of compression to net interest margin; (vii) greater than anticipated adverse conditions in the national or local economies including in Pinnacle Financial's markets throughout Tennessee, North Carolina, South Carolina and Virginia,  particularly in commercial and residential real estate markets; (viii) fluctuations or unanticipated changes in interest rates on loans or deposits or that affect the yield curve; (ix) the results of regulatory examinations; (x) the ability to grow and retain low-cost core deposits and retain large, uninsured deposits; (xi) a merger or acquisition; (xii) risks of expansion into new geographic or product markets; (xiii) any matter that would cause Pinnacle Financial to conclude that there was impairment of any asset, including intangible assets; (xiv) 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 resulting from the Tax Cuts and Jobs Act) or otherwise to attract customers from other financial institutions; (xv) further deterioration in the valuation of other real estate owned and increased expenses associated therewith; (xvi) 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 Financial's level of applicable commercial real estate loans continues to exceed percentage levels of total capital in guidelines recommended by its regulators; (xvii) risks associated with litigation, including the applicability of insurance coverage; (xviii) the risk of successful integration of the businesses Pinnacle Financial has recently acquired with its business; (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 Financial 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 costs as a result of increased regulatory oversight, 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 the terms of our agreement with them; (xxii) 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 risk that the cost savings and any revenue synergies expected from Pinnacle Financial's merger with BNC may not be realized or take longer than anticipated to be realized; (xxv) disruption from Pinnacle Financial's merger with BNC with customers, suppliers, employee or other business partners relationships; (xxvi) the risk of successful integration of Pinnacle Financial's and BNC's businesses; (xxvii) reputational risk and the reaction of the parties' customers, suppliers, employees or other business partners to Pinnacle Financial's merger with BNC; (xxviii) the risk that the integration of Pinnacle Financial's and BNC's operations will be more costly or difficult than expected; (xxix) inability to grow our commercial and industrial loan portfolio at rates necessary to cause our levels of non-owner occupied commercial real estate and multifamily loans (including construction and land development loans) as a percentage of total capital to fall below levels included in guidelines recommended by our regulators; (xxx) the availability and access to capital; (xxxi) adverse results (including costs, fines, reputational harm and/or other negative effects) from current or future litigation, regulatory examinations or other legal and/or regulatory actions; and (xxxii) 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 Securities and Exchange Commission ("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.


3


Item 1.
Part I. Financial Information
PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands)
 
March 31, 2018
 
December 31, 2017
ASSETS
 
 
 
Cash and noninterest-bearing due from banks
$
128,855

 
$
176,553

Interest-bearing due from banks
238,029

 
496,911

Federal funds sold and other
1,879

 
106,133

Cash and cash equivalents
368,763

 
779,597

 
 
 
 
Securities available-for-sale, at fair value
2,960,624

 
2,515,283

Securities held-to-maturity (fair value of $20,603 and $20,830 at March 31, 2018 and December 31, 2017, respectively)
20,677

 
20,762

Consumer loans held-for-sale
100,231

 
103,729

Commercial loans held-for-sale
18,625

 
25,456

 
 
 
 
Loans
16,326,017

 
15,633,116

Less allowance for loan losses
(70,204
)
 
(67,240
)
Loans, net
16,255,813

 
15,565,876

 
 
 
 
Premises and equipment, net
269,439

 
266,014

Equity method investment
226,704

 
221,667

Accrued interest receivable
60,918

 
57,440

Goodwill
1,808,300

 
1,808,002

Core deposits and other intangible assets
54,012

 
56,710

Other real estate owned
23,982

 
27,831

Other assets
767,086

 
757,333

Total assets
$
22,935,174

 
$
22,205,700

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

Deposits:
 

 
 

Noninterest-bearing
$
4,274,213

 
$
4,381,386

Interest-bearing
3,040,154

 
2,987,291

Savings and money market accounts
6,615,562

 
6,548,964

Time
2,572,980

 
2,534,061

Total deposits
16,502,909

 
16,451,702

Securities sold under agreements to repurchase
131,863

 
135,262

Federal Home Loan Bank advances
1,976,881

 
1,319,909

Subordinated debt and other borrowings
465,550

 
465,505

Accrued interest payable
13,592

 
10,480

Other liabilities
95,076

 
114,890

Total liabilities
19,185,871

 
18,497,748

Stockholders' equity:
 

 
 

Preferred stock, no par value; 10,000 shares authorized; no shares issued and outstanding

 

Common stock, par value $1.00; 90,000 shares authorized; 77,853 and 77,740 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively
77,853

 
77,740

Additional paid-in capital
3,115,990

 
3,115,304

Retained earnings
591,680

 
519,144

Accumulated other comprehensive loss, net of taxes
(36,220
)
 
(4,236
)
Total stockholders' equity
3,749,303

 
3,707,952

Total liabilities and stockholders' equity
$
22,935,174

 
$
22,205,700

See accompanying notes to consolidated financial statements (unaudited).

4


PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(dollars in thousands, except per share data)
 
Three months ended
March 31,
 
2018
 
2017
Interest income:
 
 
 
Loans, including fees
$
191,214

 
$
93,218

Securities:
 

 
 

Taxable
11,222

 
6,433

Tax-exempt
7,285

 
1,678

Federal funds sold and other
1,807

 
814

Total interest income
211,528

 
102,143

 
 
 
 
Interest expense:
 

 
 

Deposits
23,981

 
8,119

Securities sold under agreements to repurchase
130

 
50

Federal Home Loan Bank advances and other borrowings
12,946

 
5,207

Total interest expense
37,057

 
13,376

Net interest income
174,471

 
88,767

Provision for loan losses
6,931

 
3,651

Net interest income after provision for loan losses
167,540

 
85,116

 
 
 
 
Noninterest income:
 

 
 

Service charges on deposit accounts
5,820

 
3,856

Investment services
5,107

 
2,822

Insurance sales commissions
3,119

 
1,859

Gain on mortgage loans sold, net
3,744

 
4,155

Gain on sale of investment securities, net
30

 

Trust fees
3,117

 
1,705

Income from equity method investment
9,360

 
7,823

Other noninterest income
13,886

 
8,162

Total noninterest income
44,183

 
30,382

 
 
 
 
Noninterest expense:
 

 
 

Salaries and employee benefits
63,719

 
38,352

Equipment and occupancy
17,743

 
9,675

Other real estate expense (income)
(794
)
 
252

Marketing and other business development
2,247

 
1,879

Postage and supplies
2,039

 
1,197

Amortization of intangibles
2,698

 
1,196

Merger related expense
5,353

 
672

Other noninterest expense
15,575

 
8,831

Total noninterest expense
108,580

 
62,054

Income before income taxes
103,143

 
53,444

Income tax expense
19,633

 
13,791

Net income
$
83,510

 
$
39,653

Per share information:
 

 
 

Basic net income per common share
$
1.08

 
$
0.83

Diluted net income per common share
$
1.08

 
$
0.82

Weighted average shares outstanding:
 

 
 

Basic
77,077,957

 
48,022,342

Diluted
77,365,664

 
48,517,920


See accompanying notes to consolidated financial statements (unaudited).

5


PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(dollars in thousands)

 
 
Three months ended
March 31,
 
 
2018
 
2017
Net income
 
$
83,510

 
$
39,653

Other comprehensive (loss) income, net of tax:
 
 

 
 

Change in fair value on available-for-sale securities, net of tax
 
(33,541
)
 
(808
)
Change in fair value of cash flow hedges, net of tax
 
1,579

 
(143
)
Net gain on sale of investment securities reclassified from other comprehensive income into net income, net of tax
 
(22
)
 

Total other comprehensive (loss) income, net of tax
 
(31,984
)
 
(951
)
Total comprehensive income
 
$
51,526

 
$
38,702


See accompanying notes to consolidated financial statements (unaudited).

6


PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
(dollars and shares in thousands)


 
Common Stock
 
 
 
 
 
 
 
 
 
Shares
 
Amounts
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comp. Income (Loss), net
 
Total Stockholder's Equity
Balance at December 31, 2016
46,359

 
$
46,359

 
$
1,083,491

 
$
381,073

 
$
(14,227
)
 
$
1,496,696

Exercise of employee common stock options and related tax benefits
149

 
149

 
2,812

 

 

 
2,961

Common dividends paid

 

 

 
(7,025
)
 

 
(7,025
)
Issuance of restricted common shares, net of forfeitures
119

 
119

 
(119
)
 

 

 

Issuance of common equity, net of costs
3,220

 
3,220

 
188,974

 

 

 
192,194

Restricted shares withheld for taxes and related tax benefit
(57
)
 
(57
)
 
(3,869
)
 

 

 
(3,926
)
Compensation expense for restricted shares

 

 
3,474

 

 

 
3,474

Net income

 

 

 
39,653

 

 
39,653

Other comprehensive loss

 

 

 

 
(951
)
 
(951
)
Balance at March 31, 2017
49,790

 
$
49,790

 
$
1,274,763

 
$
413,701

 
$
(15,178
)
 
$
1,723,076

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
77,740

 
$
77,740

 
$
3,115,304

 
$
519,144

 
$
(4,236
)
 
$
3,707,952

Exercise of employee common stock options
87

 
87

 
1,529

 

 

 
1,616

Common dividends paid

 

 

 
(10,974
)
 

 
(10,974
)
Issuance of restricted common shares, net of forfeitures
106

 
106

 
(106
)
 

 

 

Restricted shares withheld for taxes and related tax benefit
(80
)
 
(80
)
 
(5,185
)
 

 

 
(5,265
)
Compensation expense for restricted shares

 

 
4,448

 

 

 
4,448

Net income

 

 

 
83,510

 

 
83,510

Other comprehensive loss

 

 

 

 
(31,984
)
 
(31,984
)
Balance at March 31, 2018
77,853

 
$
77,853

 
$
3,115,990

 
$
591,680

 
$
(36,220
)
 
$
3,749,303


See accompanying notes to consolidated financial statements (unaudited).

7


PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(dollars in thousands)
 
Three months ended
March 31,
 
2018
 
2017
Operating activities:
 
 
 
Net income
$
83,510

 
$
39,653

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Net amortization/accretion of premium/discount on securities
4,775

 
1,978

Depreciation, amortization and accretion
(6,181
)
 
(429
)
Provision for loan losses
6,931

 
3,651

Gain on mortgage loans sold, net
(3,744
)
 
(4,155
)
Investment gains on sales, net
(30
)
 

Stock-based compensation expense
4,448

 
3,474

Deferred tax expense
8,513

 
8,699

Losses (gains) on dispositions of other real estate and other investments
(481
)
 
80

Income from equity method investment
(9,360
)
 
(7,823
)
   Dividends received from equity method investment
4,324

 
2,450

Excess tax benefit from stock compensation
(2,681
)
 
(3,760
)
Gain on other loans sold, net
(936
)
 
(187
)
Other loans held for sale:
 

 
 

Loans originated
(80,193
)
 
(36,888
)
Loans sold
87,960

 
44,308

Consumer loans held for sale:
 

 
 

Loans originated
(247,025
)
 
(179,473
)
Loans sold
254,266

 
160,740

Increase in other assets
(4,639
)
 
(136
)
Decrease in other liabilities
(13,901
)
 
(24,386
)
Net cash provided by operating activities
85,556

 
7,796

Investing activities:
 

 
 

Activities in securities available-for-sale:
 

 
 

Purchases
(590,328
)
 
(334,875
)
Sales
14,454

 

Maturities, prepayments and calls
81,737

 
50,445

Activities in securities held-to-maturity:
 

 
 

Maturities, prepayments and calls

 
145

Increase in loans, net
(683,710
)
 
(193,557
)
Purchases of software, premises and equipment
(8,806
)
 
(11,446
)
Proceeds from sales of software, premises and equipment
164

 

Purchase of bank owned life insurance policies

 
(25,000
)
Increase in other investments
(836
)
 
(640
)
Net cash used in investing activities
(1,187,325
)
 
(514,928
)
Financing activities:
 

 
 

Net increase in deposits
52,039

 
521,563

Net decrease in securities sold under agreements to repurchase
(3,398
)
 
(14,549
)
Advances from Federal Home Loan Bank:
 

 
 

Issuances
762,000

 

Payments/maturities
(105,014
)
 
(225,020
)
Increase (decrease) in other borrowings, net
(30
)
 
50,000

Principal payments of capital lease obligation
(39
)
 
(36
)
Proceeds from common stock issuance, net

 
192,194

Exercise of common stock options and stock appreciation rights, net of repurchase of restricted shares
(3,649
)
 
(966
)
Common stock dividends paid
(10,974
)
 
(7,025
)
Net cash provided by financing activities
690,935

 
516,161

Net increase (decrease) in cash and cash equivalents
(410,834
)
 
9,029

Cash and cash equivalents, beginning of period
779,597

 
183,645

Cash and cash equivalents, end of period
$
368,763

 
$
192,674


See accompanying notes to consolidated financial statements (unaudited).

8


PINNACLE FINANCIAL PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Summary of Significant Accounting Policies

Nature of Business — Pinnacle Financial Partners, Inc. (Pinnacle Financial) is a bank 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 49% interest in Bankers Healthcare Group, LLC (BHG), 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 11 primarily urban markets within Tennessee, the Carolinas and Virginia. In addition to the offices in those primary markets, Pinnacle Financial has recently opened loan production offices in Indiana and Texas.

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 Pinnacle Financial consolidated financial statements and related notes appearing in Pinnacle Financial's Annual Report on Form 10-K for the year ended December 31, 2017 (2017 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 12. Subordinated Debt and 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.

Use 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 loan losses, determination of any impairment of intangible assets and the valuation of deferred tax assets. There have been no significant changes to Pinnacle Financial's significant accounting policies as disclosed in the 2017 10-K.

Cash Flow Information — Supplemental cash flow information addressing certain cash and noncash transactions for each of the three months ended March 31, 2018 and March 31, 2017 was as follows (in thousands):
 
For the three months ended
March 31,
 
2018
 
2017
Cash Transactions:
 
 
 
Interest paid
$
34,909

 
$
13,667

Income taxes paid, net
425

 
230

Noncash Transactions:
 

 
 

Loans charged-off to the allowance for loan losses
8,669

 
5,162

Loans foreclosed upon and transferred to other real estate owned
232

 
1,498

Loans foreclosed upon and transferred to other assets
392

 
3


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 shares outstanding is attributable to common stock options, common stock appreciation rights, restricted share awards, and restricted share unit awards. The dilutive effect of outstanding options, common stock appreciation rights, restricted share awards, and restricted share unit awards is reflected in diluted EPS by application of the treasury stock method.


9


The following is a summary of the basic and diluted net income per share calculations for the three months ended March 31, 2018 and 2017 (in thousands, except per share data):
 
 
Three months ended
March 31,
 
 
2018
 
2017
Basic net income per share calculation:
 
 
 
 
Numerator - Net income
 
$
83,510

 
$
39,653

 
 
 
 
 
Denominator - Weighted average common shares outstanding
 
77,078

 
48,022

Basic net income per common share
 
$
1.08

 
$
0.83

 
 
 
 
 
Diluted net income per share calculation:
 
 

 
 

Numerator – Net income
 
$
83,510

 
$
39,653

 
 
 
 
 
Denominator - Weighted average common shares outstanding
 
77,078

 
48,022

Dilutive shares contingently issuable
 
288

 
496

Weighted average diluted common shares outstanding
 
77,366

 
48,518

Diluted net income per common share
 
$
1.08

 
$
0.82


On January 27, 2017, Pinnacle Financial completed the issuance and sale of 3,220,000 shares of common stock (including 420,000 shares issued as a result of the underwriter exercising its over-allotment option) in an underwritten public offering, which shares are included in the share count above. The net proceeds of the offering, after deducting the underwriting discount and estimated offering expenses, were approximately $192.2 million. Also, Pinnacle Financial issued 27,687,100 shares of common stock in conjunction with the acquisition of BNC on June 16, 2017.

Recently Adopted Accounting Pronouncements    In August 2017, the FASB issued Accounting Standards Update No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The amendments in this ASU make more financial and non-financial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. The amendments will be effective for public companies for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. Pinnacle Financial early adopted this standard in early 2018 and subsequently entered into two derivative contracts under this standard, as noted in Note 9. Derivative Instruments.

In March 2017, the FASB issued Accounting Standards Update No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendment in this ASU shortens the amortization period for certain callable debt securities held at a premium to the earliest call date. The amendment does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those periods. Early adoption is permitted with modified retrospective application. Pinnacle Financial elected to early adopt this standard in the first quarter of 2018 with no material impact to its financial statements.

In August 2016, the FASB issued  Accounting Standards Update 2016-15, Statement of Cash Flows (Topic 230) intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. The guidance is effective for public companies for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted with retrospective application. Pinnacle Financial adopted this standard in the first quarter of 2018 with no material impact to its financial statements, with the exception of dividends received from our equity method investments which were reclassified from cash flow from investments to operating cash flow.

In January 2016, the FASB issued Accounting Standards Update 2016-01 Financial Instruments – Overall (Subtopic 825-10) which, among other things, (i) requires equity investments, excluding those accounted for under the equity method or that result in consolidation, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial

10


statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. ASU 2016-01 became effective for Pinnacle Financial in the first quarter of 2018 and did not have a material impact on our financial statements. See Note 10. Fair Value of Financial Instruments for disclosure of the fair value of financial instruments based on an exit price notion as required by ASU 2016-01.

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606 ) developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU's core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued  Accounting Standards Update 2015-14, which deferred the effective date by one year (i.e., interim and annual reporting periods beginning after December 15, 2017). Early adoption is permitted, but not before the original effective date (i.e., interim and annual reporting periods beginning after December 15, 2016). The ASU may be adopted using either a modified retrospective method or a full retrospective method. Pinnacle Financial adopted the ASU during the first quarter of 2018, as required, using a modified retrospective approach. The majority of Pinnacle Financial's revenue stream is generated from interest income on loans and deposits, which are outside the scope of Topic 606. Pinnacle Financial’s sources of income that fall within the scope of Topic 606 include service charges on deposits, investment services, insurance sales commissions, trust fees, interchange fees and gains and losses on sales of other real estate, all of which are presented within noninterest income. Pinnacle Financial has evaluated the effect of Topic 606 on these fee-based income streams and concluded that adoption of the standard did not materially impact its financial statements. The following is a summary of the implementation considerations for the revenue streams that fall within the scope of Topic 606:

Service charges on deposits, investment services, trust fees and interchange fees — Fees from these services are either transaction based, for which the performance obligations are satisfied when the individual transaction is processed, or set periodic service charges, for which the performance obligations are satisfied over the period the service is provided. Transaction based fees are recognized at the time the transaction is processed, and periodic service charges are recognized over the service period. The adoption of Topic 606 had no impact on Pinnacle Financial's revenue recognition practice for these services.

Insurance sales commissions — Insurance commissions are received from insurance companies in return for the placement of policies with customers. While additional services, such as claims assistance, may be provided over the term of the policy, the revenues are substantially earned at the time of policy placement. The only contingency in earning the revenue relates to the potential for subsequent cancellation of policies. Accordingly, revenue is recognized at the time of policy placement, net of an allowance for estimated policy cancellations. The adoption of Topic 606 had no impact on Pinnacle Financial's revenue recognition related to insurance sales commissions.

Gains on sales of other real estate — ASU 2014-09 creates Topic 610-20, under which a gain on sale should be recognized when a contract for sale exists and control of the asset has been transferred to the buyer. Topic 606 list several criteria which must exist to conclude that a contract for sale exists, including a determination that the institution will collect substantially all of the consideration to which it is entitled. This presents a key difference between the current and new guidance related to the recognition of the gain when the institution finances the sale of the property. Rather than basing recognition on the amount of the buyer's initial investment, which was the primary consideration under prior guidance, the analysis is now based on various factors including not only the loan to value, but also the credit quality of the borrower, the structure of the loan, and any other factors that may affect collectability. While these differences may affect the decision to recognize or defer gains on sales of other real estate in circumstances where Pinnacle Financial has financed the sale, the effects would not be material to its financial statements.

Subsequent Events  Accounting Standards Codification (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 March 31, 2018 through the date of the issued financial statements. Following early adoption of ASU 2017-12 as noted above, Pinnacle Financial entered into a derivative transaction on April 10, 2018 that has been more fully disclosed in Note 9. Derivative Instruments. Other than the above-noted transaction, no other subsequent events were noted.

On April 17, 2018, Pinnacle Financial's shareholders approved an amendment to Pinnacle Financial's Charter to increase the number of authorized shares of capital stock from 100,000,000 to 190,000,000 shares, in both instances 10,000,000 of which are reserved for issuance as preferred stock.


11



Note 2. Acquisitions
 
BNC Bancorp. On June 16, 2017, Pinnacle Financial consummated its merger with BNC. Pursuant to the terms of the Agreement and Plan of Merger, dated as of January 22, 2017, by and between Pinnacle Financial and BNC, BNC merged with and into Pinnacle Financial, with Pinnacle Financial continuing as the surviving corporation (the BNC Merger). On that same day, Pinnacle Bank and Bank of North Carolina, BNC's wholly-owned bank subsidiary, merged, with Pinnacle Bank continuing as the surviving entity.

The following summarizes the consideration paid and presents a preliminary allocation of purchase price to net assets acquired (in thousands):
 
Number of Shares
 
Amount
Equity consideration:
 
 
 
Common stock issued
27,687,100

 
$
1,858,133

Total equity consideration
 
 
$
1,858,133

Non-equity consideration:
 
 
 
Cash paid to redeem common stock
 
 
$
129

Total consideration paid
 
 
$
1,858,262

Allocation of total consideration paid:
 
 
 
Fair value of net assets assumed including estimated identifiable intangible assets
 
 
$
601,509

Goodwill
 
 
1,256,753

 
 
 
$
1,858,262

 
Pinnacle Financial recorded costs incurred in connection with the issuance of Pinnacle Financial common stock resulting from the BNC Merger of $7.2 million, net of related tax benefits, as a reduction to additional paid in capital. Certain merger-related charges resulting from cultural and systems integrations, as well as stock-based compensation expense incurred as a result of change-in-control provisions applicable to assumed equity-based awards were recorded as merger-related expense.

Goodwill originating from the BNC Merger resulted primarily from anticipated synergies arising from the combination of certain operational areas of the businesses of BNC and Pinnacle Financial as well as the purchase premium inherent in buying a complete and successful banking operation. Goodwill associated with the BNC Merger is not amortizable for book or tax purposes. Adjustments totaling $83.2 million were recorded to goodwill to appropriately reflect the valuation of the loan portfolio, OREO acquired, and certain liabilities assumed and have been included in the table below.

Pinnacle Financial accounted for the BNC Merger 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 assumed as of the date of merger.

The following purchase price allocations on the BNC Merger are preliminary and will be finalized upon the receipt of final valuations on certain assets and liabilities. Upon receipt of final fair value estimates, which must be received within one year of the BNC Merger date, Pinnacle Financial will make any final adjustments to the purchase price allocation and prospectively adjust any goodwill recorded. Information regarding Pinnacle Financial's loan discount and related deferred tax asset, core deposit intangible asset and related deferred tax liability, as well as income taxes payable and the related deferred tax balances recorded in the BNC Merger, may be adjusted as Pinnacle Financial refines its estimates. 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. Fair value adjustments based on updated estimates could materially affect the goodwill recorded on the BNC Merger. Pinnacle Financial may incur losses on the acquired loans that are materially different from losses Pinnacle Financial originally projected.


12


(in thousands)
As of June 16, 2017
 
BNC
Historical Cost Basis
 
Fair Value Adjustments (1)
 
As Recorded by Pinnacle Financial
Assets
 
 
 
 
 
Cash and cash equivalents
$
155,271

 
$

 
$
155,271

Investment securities
643,875

 
1,667

 
645,542

Loans (2)
5,782,720

 
(181,430
)
 
5,601,290

Mortgage loans held for sale
27,026

 

 
27,026

Other real estate owned (3)
20,143

 
645

 
20,788

Core deposit and other intangible (4)

 
50,422

 
50,422

Property, plant and equipment (5)
156,805

 
(3,341
)
 
153,464

Other assets (6)
320,988

 
53,614

 
374,602

Total Assets
$
7,106,828

 
$
(78,423
)
 
$
7,028,405

 
 
 
 
 
 
Liabilities
 
 
 

 
 

Interest-bearing deposits (7)
$
5,003,653

 
$
4,355

 
$
5,008,008

Non-interest bearing deposits
1,199,342

 

 
1,199,342

Borrowings (8)
183,389

 
(6,412
)
 
176,977

Other liabilities (9)
35,729

 
6,840

 
42,569

Total Liabilities
$
6,422,113

 
$
4,783

 
$
6,426,896

Net Assets Acquired
$
684,715

 
$
(83,206
)
 
$
601,509


Explanation of certain fair value adjustments:
(1)
The amount represents the adjustment of the book value of BNC's assets and liabilities to their estimated fair value on the date of acquisition. Fair value adjustments are updated subsequent to the merger date based on the results of finalized valuation assessments.
(2)
The amount represents the adjustment of the net book value of BNC's loans to their estimated fair value based on interest rates and expected cash flows as of the date of acquisition, which includes estimates of expected credit losses inherent in the portfolio of approximately 2.6% of the 3.1% mark on the acquired loan portfolio.
(3)
Although not complete, this adjustment reflects the Day 1 value of OREO properties subsequently sold.
(4)
The amount represents the fair value of the core deposit intangible asset representing the intangible value of the deposit base acquired and the fair value of the customer relationship intangible assets representing the intangible value of customer relationships acquired.
(5)
The amount represents the adjustment of the net book value of BNC's property, plant and equipment to estimated fair value based on market values of similar assets.
(6)
The amount represents the deferred tax asset recognized on the fair value adjustment of BNC's acquired assets and assumed liabilities.
(7)
The amount represents the adjustment necessary because the weighted average interest rate of BNC's deposits exceeded the cost of similar funding at the time of acquisition. The fair value adjustment will be amortized to reduce future interest expense over the life of the portfolio.
(8)
The amount represents the combined adjustment necessary because the weighted average interest rate of BNC's subordinated debt issuance exceeded the cost of similar funding at the time of acquisition and because the weighted average interest rate of BNC's trust preferred securities issuances was lower than the cost of similar funding at the time of acquisition. The combined fair value adjustments will be amortized to increase future interest expense over the lives of the instruments.
(9)
The amount represents the adjustment to accrue obligations that existed but had not been recorded as of the acquisition date and the fair value of BNC lease obligations.

Supplemental Pro Forma Combined Results of Operations
The supplemental proforma information below for the three months ended March 31, 2017 gives effect to the BNC acquisition as if it had occurred on January 1, 2017. These results combine the historical results of BNC into Pinnacle Financial's consolidated statement of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments, they are not indicative of what would have occurred had the BNC Merger taken place on the indicated date nor are they intended to represent or be indicative of future results of operations. In particular, no adjustments have been made to eliminate the amount of BNC's provision for credit losses for the first three months of 2017 that may not have been necessary had the acquired loans been recorded at fair value as of the beginning of 2017. Additionally, these financial statements were not adjusted for non-recurring expenses, such as merger-related charges incurred by either Pinnacle Financial or BNC. Pinnacle Financial expects to achieve operating cost savings and other business synergies as a result of the acquisition which are also not reflected in the proforma amounts.

13


 
 
Three Months Ended March 31,
 
(dollars in thousands)
 
2017
 
Revenue (1)
 
$
219,665

 
Income before income taxes
 
$
74,999

 
______________________
(1) 
Net interest income plus noninterest income.

Note 3. Equity method investment

A summary of BHG's financial position as of March 31, 2018 and December 31, 2017 and results of operations as of and for the three months ended March 31, 2018 and 2017, were as follows (in thousands):
 
As of
 
March 31, 2018
 
December 31, 2017
Assets
$
340,760

 
$
330,030

 
 
 
 
Liabilities
232,978

 
224,837

Membership interests
107,782

 
105,193

Total liabilities and membership interests
$
340,760

 
$
330,030


 
 
For the three months ended
March 31,
 
 
2018
 
2017
Revenues
 
$
43,750

 
$
34,235

Net income
 
$
19,003

 
$
16,012


At March 31, 2018, technology, trade name and customer relationship intangibles, net of related amortization, totaled $12.7 million compared to $13.4 million as of December 31, 2017. Amortization expense of $693,000 was included for the three months ended March 31, 2018 compared to $832,000 for the same period in the prior year. Accretion income of $742,000 was included in the three months ended March 31, 2018 compared to $806,000 for the same period in the prior year.

During the three months ended March 31, 2018, Pinnacle Financial and Pinnacle Bank received dividends from BHG of $4.3 million in the aggregate compared to $2.5 million for the same period in the prior year. Earnings from BHG are included in Pinnacle Financial's consolidated tax return. Profits from intercompany transactions are eliminated. No loans were purchased from BHG by Pinnacle Bank for the three month periods ended March 31, 2018 or 2017, respectively.


14


Note 4.  Securities

The amortized cost and fair value of securities available-for-sale and held-to-maturity at March 31, 2018 and December 31, 2017 are summarized as follows (in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
March 31, 2018:
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
31,002

 
$

 
$
56

 
$
30,946

U.S. government agency securities
176,305

 
43

 
2,905

 
173,443

Mortgage-backed securities
1,302,274

 
4,393

 
29,394

 
1,277,273

State and municipal securities
1,206,777

 
3,890

 
18,202

 
1,192,465

Asset-backed securities
204,800

 
377

 
505

 
204,672

Corporate notes and other
81,860

 
868

 
903

 
81,825

 
$
3,003,018

 
$
9,571

 
$
51,965

 
$
2,960,624

Securities held-to-maturity:
 

 
 

 
 

 
 

State and municipal securities
$
20,677

 
$
46

 
$
120

 
$
20,603

 
$
20,677

 
$
46

 
$
120

 
$
20,603

December 31, 2017:
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
30,505

 
$

 
$
60

 
$
30,445

U.S. government agency securities
182,500

 
67

 
1,766

 
180,801

Mortgage-backed securities
1,270,625

 
5,318

 
12,124

 
1,263,819

State and municipal securities
774,949

 
12,251

 
2,588

 
784,612

Asset-backed securities
173,346

 
262

 
316

 
173,292

Corporate notes and other
81,615

 
1,346

 
647

 
82,314

 
$
2,513,540

 
$
19,244

 
17,501

 
$
2,515,283

Securities held-to-maturity:
 

 
 

 
 

 
 

State and municipal securities
$
20,762

 
$
114

 
$
46

 
$
20,830

 
$
20,762

 
$
114

 
$
46

 
$
20,830

 
At March 31, 2018, approximately $1.4 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 March 31, 2018, repurchase agreements comprised of secured borrowings totaled $131.9 million and were secured by $131.9 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.

The amortized cost and fair value of debt securities as of March 31, 2018 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):
 
Available-for-sale
 
Held-to-maturity
March 31, 2018:
Amortized
Cost
 
Fair
Value
 
Amortized Cost
 
Fair
Value
Due in one year or less
$

 
$

 
$

 
$

Due in one year to five years
96,941

 
97,087

 
7,496

 
7,489

Due in five years to ten years
177,898

 
177,231

 
10,385

 
10,316

Due after ten years
1,221,105

 
1,204,361

 
2,796

 
2,798

Mortgage-backed securities
1,302,274

 
1,277,273

 

 

Asset-backed securities
204,800

 
204,672

 

 

 
$
3,003,018

 
$
2,960,624

 
$
20,677

 
$
20,603



15


At March 31, 2018 and December 31, 2017, 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
 
Total Investments with an
Unrealized Loss
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized
Losses
At March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
30,697

 
$
56

 
$

 
$

 
$
30,697

 
$
56

U.S. government agency securities
145,967

 
2,904

 
248

 
1

 
146,215

 
2,905

Mortgage-backed securities
779,194

 
17,392

 
297,735

 
12,002

 
1,076,929

 
29,394

State and municipal securities
863,010

 
15,987

 
47,894

 
2,335

 
910,904

 
18,322

Asset-backed securities
79,428

 
449

 
9,482

 
56

 
88,910

 
505

Corporate notes
31,880

 
754

 
11,697

 
149

 
43,577

 
903

Total temporarily-impaired securities
$
1,930,176

 
$
37,542

 
$
367,056

 
$
14,543

 
$
2,297,232

 
$
52,085

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2017
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
29,948

 
$
60

 
$

 
$

 
$
29,948

 
$
60

U.S. government agency securities
173,677

 
1,766

 

 

 
173,677

 
1,766

Mortgage-backed securities
607,408

 
5,042

 
285,561

 
7,082

 
892,969

 
12,124

State and municipal securities
115,403

 
1,408

 
50,083

 
1,226

 
165,486

 
2,634

Asset-backed securities
68,742

 
198

 
14,136

 
118

 
82,878

 
316

Corporate notes
22,168

 
547

 
11,944

 
100

 
34,112

 
647

Total temporarily-impaired securities
$
1,017,346

 
$
9,021

 
$
361,724

 
$
8,526

 
$
1,379,070

 
$
17,547


The applicable dates for determining when securities were in an unrealized loss position were March 31, 2018 and December 31, 2017. As such, it is possible that a security had a market value that exceeded its amortized cost on other days during the past twelve-month periods ended March 31, 2018 and December 31, 2017, 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 March 31, 2018, Pinnacle Financial had approximately $52.1 million in unrealized losses on $2.30 billion of securities. The unrealized losses associated with these investment securities are driven by changes in interest rates and are not due to the credit quality of the securities.  These securities will continue to be monitored as a part of Pinnacle Financial's ongoing impairment analysis. 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. Because Pinnacle Financial currently does not intend to sell those securities that have an unrealized loss at March 31, 2018, 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 does not consider these securities to be other-than-temporarily impaired at March 31, 2018.

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. 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 first quarter of 2018 available-for-sale securities of approximately $14.5 million were sold and net unrealized gains, net of tax, of $22,000 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. 



16


Note 5. Loans and Allowance for Loan 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 five loan categories: commercial real estate mortgage, consumer real estate mortgage, construction and land development, commercial and industrial, and consumer and other.
Commercial real estate mortgage loans. Commercial real estate mortgage loans are categorized as such based on investor exposures where repayment is largely dependent upon the operation, refinance, or sale of the underlying real estate. Commercial real estate mortgage also includes owner occupied commercial real estate which shares a similar risk profile to Pinnacle Financial's commercial and industrial products.
Consumer real estate mortgage loans. Consumer real estate mortgage consists primarily of loans secured by 1-4 residential properties, including home equity lines of credit.
Construction and land development loans. Construction and land development loans include loans where the repayment is dependent on the successful 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.
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, credit cards and loans to finance education, among others.

Commercial loans receive risk ratings assigned by a financial advisor and approved by a senior credit officer 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.  Pinnacle Financial believes that its categories follow those used by Pinnacle Bank's primary regulators.  At March 31, 2018, approximately 81.1% 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.
 
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 that every risk rated loan of $1.0 million or more be subject to a formal credit risk review process by the assigned financial advisor. 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.
 
The following table presents Pinnacle Financial's loan balances by primary loan classification and the amount within each risk rating category. Pass rated loans include all credits other than those included in special mention, substandard, substandard-nonaccrual and doubtful-nonaccrual which are defined as follows:

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 sound worth and paying 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.


17


The following table outlines the amount of each loan classification categorized into each risk rating category as of March 31, 2018 and December 31, 2017 (in thousands):
 
Commercial real estate - mortgage
Consumer real estate - mortgage
Construction and land development
Commercial and industrial
Consumer
and other
Total
March 31, 2018
 
 
 
 
 
 
Pass
$
6,628,989

$
2,533,268

$
2,081,071

$
4,360,699

$
362,599

$
15,966,626

Special Mention
76,856

11,661

4,149

33,524

746

126,936

Substandard (1)
63,343

17,307

7,037

74,491

75

162,253

Substandard-nonaccrual
25,100

18,530

3,618

22,172

782

70,202

Doubtful-nonaccrual






Total loans
$
6,794,288

$
2,580,766

$
2,095,875

$
4,490,886

$
364,202

$
16,326,017

December 31, 2017
 
 
 
 
 
 
Pass
$
6,487,368

$
2,503,688

$
1,880,704

$
4,014,656

$
351,359

$
15,237,775

Special Mention
94,134

18,356

8,148

46,898

1,177

168,713

Substandard (1)
72,044

21,053

13,468

62,529

79

169,173

Substandard-nonaccrual
16,064

18,117

5,968

17,258

48

57,455

Doubtful-nonaccrual






Total loans
$
6,669,610

$
2,561,214

$
1,908,288

$
4,141,341

$
352,663

$
15,633,116


(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 the impact of nonaccrual loans and troubled debt restructurings. Potential problem loans, which are not included in nonaccrual loans, amounted to approximately $158.1 million at March 31, 2018, compared to $164.0 million at December 31, 2017.

Loans acquired with deteriorated credit quality are recorded pursuant to the provisions of ASC 310-30, and are referred to as purchase credit impaired loans. The following table provides a rollforward of purchase credit impaired loans from December 31, 2017 through March 31, 2018 (in thousands):
 
Gross Carrying Value
Accretable
Yield
Nonaccretable
Yield
Net Carrying
Value
December 31, 2017
$
74,324

$
(132
)
$
(31,537
)
$
42,655

Acquisition




Year-to-date settlements
(5,298
)
23

1,491

(3,784
)
March 31, 2018
$
69,026

$
(109
)
$
(30,046
)
$
38,871


Certain of these loans have been deemed to be collateral dependent and as such, no accretable yield has been recorded for these loans. 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.
 
For the three months ended March 31, 2018, the average balance of impaired loans was $105.0 million compared to $41.1 million for the same period in 2017. Pinnacle Financial's policy is that 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 the above mentioned loans were placed on nonaccrual status, Pinnacle Financial reversed all previously accrued interest income against current year earnings. Pinnacle Financial's policy is that 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 no interest income from cash payments received on nonaccrual loans during the three months ended March 31, 2018 compared to approximately $49,000 during the three months ended March 31, 2017. Had these nonaccruing loans been on accruing status, interest income would have been higher by $1.4 million for the three months ended March 31, 2018 compared to $640,000 higher for the three months ended March 31, 2017.


18


The following table details the recorded investment, unpaid principal balance and related allowance of Pinnacle Financial's impaired loans at March 31, 2018 and December 31, 2017 by loan classification (in thousands):
 
At March 31, 2018
 
At December 31, 2017
 
Recorded investment
Unpaid principal balances
Related allowance
 
Recorded investment
Unpaid principal balances
Related allowance
Collateral dependent impaired loans:
 
 
 
 
 
 
Commercial real estate – mortgage
$
36,258

$
43,809

$
778

 
$
33,073

$
40,771

$
38

Consumer real estate – mortgage
5,166

7,233


 
6,314

8,560

115

Construction and land development
5,939

11,537


 
8,513

14,115

6

Commercial and industrial
8,716

14,374

1,262

 
2,812

8,435

362

Consumer and other



 



Total
$
56,079

$
76,953

$
2,040

 
$
50,712

$
71,881

$
521

 
 
 
 
 
 
 
 
Cash flow dependent impaired loans:
 

 

 
 

 

 

Commercial real estate – mortgage
$
6,808

$
9,106

$
93

 
$
5,944

$
8,237

$
95

Consumer real estate – mortgage
20,200

23,370

296

 
19,904

23,387

411

Construction and land development
1,017

1,883

13

 
3,222

4,184

12

Commercial and industrial
23,451

26,595

152

 
21,852

26,058

1,278

Consumer and other
782

810

210

 



Total
$
52,258

$
61,764

$
764

 
$
50,922

$
61,866

$
1,796

 
 
 
 
 
 
 
 
Total impaired loans
$
108,337

$
138,717

$
2,804

 
$
101,634

$
133,747

$
2,317


The following table details the average recorded investment and the amount of interest income recognized on a cash basis for the three months ended March 31, 2018 and 2017, respectively, on Pinnacle Financial's impaired loans that remain on the balance sheets as of such date (in thousands):
 
 
For the three months ended
March 31,
 
 
2018
2017
 
 
Average recorded investment
Interest income recognized
Average recorded investment
Interest income recognized
Collateral dependent impaired loans:
 
 
 
 
 
Commercial real estate – mortgage
 
$
34,666

$

$
2,100

$

Consumer real estate – mortgage
 
5,740


2,216


Construction and land development
 
7,226


2,078

49

Commercial and industrial
 
5,764


6,312


Consumer and other
 




Total
 
$
53,396

$

$
12,706

$
49

 
 
 
 
 
 
Cash flow dependent impaired loans:
 
 

 

 

 

Commercial real estate – mortgage
 
$
6,376

$

$
2,597

$

Consumer real estate – mortgage
 
19,941


9,393


Construction and land development
 
2,120


3,288


Commercial and industrial
 
22,669


12,440


Consumer and other
 
487


689


Total
 
$
51,593

$

$
28,407

$

 
 
 
 
 
 
Total impaired loans
 
$
104,989

$

$
41,113

$
49

 

19


At March 31, 2018 and December 31, 2017, there were $6.1 million and $6.6 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 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 months ended March 31, 2018 and 2017 (dollars in thousands):
 
 
Three months ended
March 31,
2018
 
Number
of contracts
 
Pre Modification Outstanding Recorded Investment
 
Post Modification Outstanding Recorded Investment, net of related allowance
Commercial real estate – mortgage
 

 
$

 
$

Consumer real estate – mortgage
 

 

 

Construction and land development
 

 

 

Commercial and industrial
 

 

 

Consumer and other
 

 

 

 
 

 
$

 
$

 
 
 
 
 
 
 
2017
 
 

 
 

 
 

Commercial real estate – mortgage
 

 
$

 
$

Consumer real estate – mortgage
 

 

 

Construction and land development
 

 

 

Commercial and industrial
 
1

 
3,457

 
3,457

Consumer and other
 

 

 

 
 
1

 
$
3,457

 
$
3,457


During the three months ended March 31, 2018 and 2017, Pinnacle Financial did not have any troubled debt restructurings that subsequently defaulted within twelve months of the restructuring.

At March 31, 2018 and 2017, the allowance for loan losses included no allowance and $44,000, respectively, specifically related to accruing troubled debt restructurings, which are classified as impaired loans pursuant to U.S. GAAP, but which loans continued to accrue interest at contractual rates at those dates.

In addition to the loan metrics above, 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 25% of Pinnacle Bank's total risk-based capital to borrowers in the following industries at March 31, 2018 with the comparative exposures for December 31, 2017 (in thousands):
 
March 31, 2018
 
 
 
Outstanding Principal Balances
 
Unfunded Commitments
 
Total exposure
 
Total Exposure at December 31,
2017
Lessors of nonresidential buildings
$
2,879,195

 
$
691,591

 
$
3,570,786

 
$
2,810,951

Lessors of residential buildings
929,097

 
275,564

 
1,204,661

 
884,244

Hotels (except Casino Hotels) and Motels
678,619

 
195,623

 
874,242

 
628,991


Additionally, 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 March 31, 2018 and December 31, 2017, Pinnacle Bank’s construction and land development loans as a percentage of total risk-based capital were 96.1% and 89.4%, respectively. Non-owner occupied commercial real estate and multifamily loans (including construction and land development loans) as a percentage of total risk-based capital were 306.2% and 297.1% as of March 31, 2018 and December 31, 2017, 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

20


require an increased level of monitoring in these lending areas by bank management.  At March 31, 2018 Pinnacle Bank slightly exceeded the 300% guideline and has established what it believes to be appropriate controls to monitor Pinnacle Bank's lending in this area.

The table below presents past due balances by loan classification and segment at March 31, 2018 and December 31, 2017, allocated between accruing and nonaccrual status (in thousands):
 
Accruing
 
Nonaccruing
 
 
March 31, 2018
30-89 days past due and accruing
 
90 days or more past due and accruing
 
Total past due and accruing
 
Current and accruing
 
Purchase credit impaired
 
Nonaccrual (1)
 
Nonaccruing purchase credit impaired
 
Total loans
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
3,805

 
$
5

 
$
3,810

 
$
2,398,599

 
$
4,430

 
$
19,935

 
$
1,172

 
$
2,427,946

All other
6,678

 
132

 
6,810

 
4,343,636

 
11,903

 
1,206

 
2,787

 
4,366,342

Consumer real estate – mortgage
13,367

 
19

 
13,386

 
2,544,825

 
4,024

 
11,336

 
7,195

 
2,580,766

Construction and land development
606

 
3

 
609

 
2,088,310

 
3,339

 
381

 
3,236

 
2,095,875

Commercial and industrial
9,262

 
589

 
9,851

 
4,458,161

 
702

 
22,090

 
82

 
4,490,886

Consumer and other
4,816

 
383

 
5,199

 
358,221

 

 
781

 
1

 
364,202

Total
$
38,534

 
$
1,131

 
$
39,665

 
$
16,191,752

 
$
24,398

 
$
55,729

 
$
14,473

 
$
16,326,017

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
6,772

 
$
104

 
$
6,876

 
$
2,435,819

 
$
4,820

 
$
11,395

 
$
1,105

 
$
2,460,015

All other
16,559

 

 
16,559

 
4,177,454

 
12,018

 
704

 
2,860