Sterling Bancorp
Q2 2020 Earnings Call Transcript

Published: 23 Jul 2020

[Operator:]

Good day, and welcome to the Sterling Bancorp, 2Q 2020 Conference Call. Today's conference is being recorded. At this time I would like to turn the call over to Mr. Jack Kopnisky, President and CEO. Please go ahead.

[Jack Kopnisky:]

Good morning, everyone, and welcome to our second quarter 2020 earnings call. Joining me on the call is Luis Massiani, our Chief Financial Officer and Bank President; and Rob Rowe, our Chief Credit Officer. On our website you will find the slides we are referencing in our presentation. I’d like to first recognize the fantastic efforts of our extraordinary team. They have adjusted admirably to this extremely difficult operating environment and continue to perform at an outstanding level during a particularly challenging period for the banking industry, and the broader economy. Our company's culture emphasizes change and adaptation, traits that have served us well in these times. Our colleagues have consistently gone above and beyond for our clients and each other. For the second quarter of 2020 we reported adjusted EPS of $0.29 and grew our tangible book value per share 6.2% to $13.17 from $12.83 last quarter. We continue to build our allowance for credit losses given the downward revisions through economic forecast, though our conservative assumptions last quarter reduced requiring provisioning for this quarter. We are particularly encouraged by our ability to grow tangible equity and tangible book value per share in the face of this challenging economic environment. We continue to service our existing clients and grow our business in targeted loan portfolios. In addition to the $650 million in PPP balances we originated this quarter, our commercial portfolios grew $85 million over the last quarter, spread across several portfolios. While we continue to see meaningful new business opportunities, current volumes are approximately 50% of historic production, which is reflected in our updated loan growth outlook. Portfolios that grew this quarter are likely to be future drivers of growth, including traditional C&I, CRE, affordable housing and public sector finance. We are shifting capital away from national transaction based businesses that do not provide opportunities for full relationships and that are not meeting our targeted risk adjusted returns in current market conditions. Deposit growth was also strong. Core deposits were up nearly 6% over last quarter despite a 2% drag from seasonal runoff in the municipal portfolio. We're optimistic we can continue to exhibit solid deposit growth in the current environment, driven by our commercial and business banking teams. We are augmenting our traditional growth channels through technology enabled banking initiatives, including the direct banking product we launched last year and our recently announced banking as a service program. We view these as efficient ways to grow and diversify our funding sources, fee income and total revenue. The pandemic has accelerated client adoption of technology and validated our investment in digital banking platforms. The accelerated adoption of technology will also enable us to perform more efficiently in the future, as we reevaluate our real-estate footprint and leverage automated processes that have been tested and enhanced over recent months. We are pleased with our pre-tax, pre-provision net revenue performance, although we experience pressure in several businesses related to the pandemic. Net interest income excluding accretion income was $206 million, an increase of $2 million over the prior quarter. Fee income was lower than expected due to lower transaction volumes in deposit fees, wealth management, factory and receivable volumes and other loan commissions. We expect these volumes will rebound as the economy recovers and customer activity resumes and we have started to see positive trends in volumes over the past 60 days. Regarding expenses, we incurred $3.8 million in expenses to support our colleagues at the outset of the pandemic, that should not repeat in the third quarter. Among those expenses was a $1.5 million charitable contributions via the Sterling Foundation that supported communities affected by the pandemic. We also had costs of $9.8 million to exit FHLB borrowings and $1.5 million of OREO expenses to accept properties held on our balance sheet. We maintained our core net interest margin flat to last quarter at 305 basis points, despite recognizing lower short term interest rates in the early part of the quarter. Our team did an outstanding job in lowering the funding costs, which were down 35 basis points, well exceeding the 10 to 15 basis points quarterly reductions we were expecting to achieve this quarter, and we ended the quarter on an upward trajectory for the core net interest margin in the month of June. We continue to believe we can achieve a total cost of funding liabilities of 35 to 40 basis points, if not lower in the current interest rate environment, which should help support net interest margin near current levels. We anticipate generating positive operating leverage through the remainder of the year as reprising of liabilities outpaces pressure on asset yields, transaction activity and volumes begin normalizing, and we focus on efficiency initiatives and growing our most profitable businesses. This progress should be evident in the third quarter where we expect each component of core PPRNR [ph] to improve. Moving on to credit, we added another $39 million to our allowance for credit losses this quarter, taking the allowance to portfolio loans to 164 basis points, as deterioration in the macro outlook increased our estimate of losses. Our CECL model assumes the unemployment rate averages in excess of 9% through full year 2021 with GDP not reaching breakeven until early 2021. Aside from the adjustments related to the macro outlook, credit performance was generally reflective of our expectations as of last quarter. NPLs were effectively flat the last quarter, the increase in charge-offs to $17.6 million or 32 basis points of loans annualized reflects our efforts to quickly resolve these credits we moved to non-accrual late last quarter. On slides 14 and 15 of our presentation, we provide an update on COVID impacted portfolios we highlighted last quarter and provide incremental detail on the portfolios that comprise the bulk of deferrals. We have deferred principal on interest on 8% or $1.7 billion of loans. Deferrals are most commonly for 90 days with an additional 90 day deferral period at our option. Over the past 45 days we have received few new request for deferral and are actively working with all borrowers as their initial deferral periods begin expiring in late July and August. I want to detail our current view of each of the impacted portfolios next. First, we are comfortable with our traditional C&I portfolio, which is generally well secured on a borrowing base and we have seen low request for our payment modifications with the exception of a relatively small franchise finance portfolio whose underlying business fundamentals has held up relatively well over the past quarter and will improve as the economy opens. Secondly, our National Commercial Finance portfolio has also performed at or better than expected. The equipment finance portfolio was more highly impacted by the downturn initially, particularly in the transportation and construction sectors, but we are starting to see a pickup in shipping and general transportation volumes. We have seen relatively low volumes of deferrals in our other national portfolios. Lastly, commercial and multi-family real-estate is performing as expected and we anticipate that our relatively low loan to values of approximately 50% across the entire portfolio will provide substantial support to the long term performance of these assets. We are working through the higher impacted sectors of hospitality, retail and office, where we will continue to work with borrowers in providing working capital relief given our strong collateral position and debt service coverage prior to the pandemic. Multi-family is performing well in our loan to values and debt service coverage of that portfolio also provide a strong degree of credit protection. We will be pragmatic about each loan portfolio and will take aggressive action to recognize and resolve issues directly and expeditiously. I noted at the outset of my prepared remarks that we were able to grow our tangible book value per share over the last quarter and strengthen our capital ratios. Our TCE ratio increased 8 basis points to 8.82% and our Tier 1 leverage at the holding company increased 10 basis points to 9.51%. We continue to be on a self-imposed pause of our share repurchase plan. We expect we will continue to grow both our capital ratios and tangible book value per share through the remainder of the year. On page 16 we update our outlook for the year. We continue to be comfortable with our net interest margin and core expense outlooks for the year. We reduced our fee income expectation given some of the near term headwinds caused by the pandemic and expect loan growth to come at the lower end of our previous guide at $500 million of growth for the year. We also expect to incur a lower tax rate through the remainder of the year. There are still many unknowns in the economy given the potential lasting effects from the pandemic. We will continue to be aggressive with our operating model to address the financial impacts. Our primary focus in this environment is two-fold. First, to produce strong earnings streams driven by revenue gains that enable us to build capital; and secondly, to recognize and resolve credit issues early with strong levels of reserve in capital. Now, let's open up the line for questions.

[Operator:]

Thank you. [Operator Instructions]. We will now go to our first question that comes from Casey Haire with Jefferies. Please go ahead.

[Casey Haire:]

Yeah, thanks. Good morning guys.

[Jack Kopnisky:]

Good morning.

[Casey Haire:]

A couple of questions on the credit quality front. The deferrals, it sounds like they have slowed. You know we have seen from peers you know some decent cure rates, you know just some color that you can provide as these deferrals hit their 90 day terms. You know based on your conversations with them, how do you expect that to trend in another three months and your appetite to extend another 90 days?

[Luis Massiani:]

Sure, so I think – you know consistent with what we talked about in the first quarter Casey, I think that you know from an appetite perspective, we're going to continue to work with borrowers where we see that there's a long term viability to the business and where we think that there's a good opportunity to have a full relationship long term. But our strategy is going to be the same, which is you know we're not going to provide extensions or new referrals to just anybody who asks for it. So one of the reasons again and just a reminder in the first quarter that we had some migration credit, is that the strategy has been identified, who have long term viability, work with those borrowers, that’s where the appetite is, and then if we don't see that there is a long term viability to it, then you know we decide to move the – and get the relationship moving in a different direction. So the appetite remains the same. Now from where – you know the early feedback and you know Jack alluded to in his remarks. Late July and August is when the majority of those initial 90 day periods start coming due, so we're going to know a lot more in the next 30 to 45 days. With that said, early feedback across several portfolios like equipment finance, like franchise finance is pretty good and we are – you know we feel good that there's going to be a substantial amount of those initialed deferrals that are going to move to some form of either full payment or some modified payments steam, are going to begin cash flowing again. You know is it 40%, 50%, 60%, we don't know yet, but we feel very good that the early feedback in many of those sectors is quite positive. Places where you're going to see you know the majority of the, I’ll call it rig [ph] extensions is hotel and lodging. You know the entirety of our portfolio in hotel and lodging is pretty much concentrated in the New York area. That industry is not back yet, so you are going to see extensions there. You're also going to see extensions in CRE retail. So those are the two sectors where we see the majority of the extensions happening or kind of referring to the second 90 days, and on aggregate you’re talking of approximately $300 million to $400 million or so of P&I deferrals that you see in those – and the payment deferrals that you see in those two sectors. So those are the two places that we are focusing on the most, and then not to say that in others you're not going to have you know a fair amount of retentions as well, but those are the places we’re good. Those two sectors where we see the most amount of additional 90 day periods going forward.

[Jack Kopnisky:]

To just add a little more color on this too. When we're granting deferrals, we are asking for updated financials, projections, things like that. We are not – what we’re not doing is, we're not blanketing any deferrals, that’s one of the advantage of this single point of contact structure we have with the teams. This is one by one, and they have to – the borrower has to justify the deferral based on their projections and all that. So we are not saying just a category, we’re moving forward on that. Second thing is, if we’re – we also are addressing those that don't have viability going forward. So we're not going to sit back and watch things and wait and defer things until, and hope and pray that something good's going to happen. If there is an issue we're going to address it right up front and we're going to take the – you know one of the things we’ve learned over many, many years of doing this is the sooner that you know your best outcome is, your soonest outcome when you take action on this. So we've tried to be aggressive and if there is an issue and there's not viability out there, that moving forward and addressing the situation up front.

[Casey Haire:]

Great! Thanks for that color. The retail CRE on slide 14, that's obviously a big concern among many banks. What can you tell us about that bucket, $1.3 billion? Qualitatively how much of it is what you think is viable going forward, be it an essential retailer versus stuff that you're worried about. Just a little color on the retail CRE bucket, which is a little bit bigger than most on that slide for you.

[Luis Massiani:]

Well as we’ve discussed in the past, we do not have exposure to regional malls. So from that perspective, you know that's a good thing. When you think about our CRE retail, it's community based. I mean you could say it strips, but it really is a lot of community based. I think about 80% of the portfolio, the borrower amounts would be $10 million or less, okay. So it's really consistent with Sterling supporting its businesses and supporting stuff in the communities. And so we all could I guess conclude however we want to. Our view is pretty strong that after the pandemic that people would go back to shopping in their community based shopping centers, because that's what they've done for a long time, and that's not really where online is necessarily attacking. But certainly to your point, today because of the pandemic, the tenants themselves are being challenged probably about 25% to 30% and we’re having a hard time paying our borrowers, and so that's why you see the deferral rates and what it is.

[Jack Kopnisky:]

And then for the most part, these are also founded in essential business. So the majority of all the retail are grocery stores, pharmas, banks, along the way. So we're comfortable with the loan to values versus how people are paying now and we would assume that it will get better over time. But we are pretty comfortable about the – you know kind of the equity we have in those properties and the types of tenants they have in those properties.

[Luis Massiani:]

Yeah given the LTV, we have a case even you know in the scenario of which you know the probability of default increases, loss given default when you have 50% or 55% LTV is not to say that you're not going to lose some – you know you're not going to have some charge offs, but loss give default, given you had true equity, substantial equity under you. Because again these are not large regional mall, these are not institutional kind of retail credits where you have mezzanine tranches and other sorts of kind of junior capital stacks that creates very little equity under you or true equity. So these are, you know these are going to be, this isn’t – in any scenario we don't see this as a from one quarter to the next thing's going bad across a substantial chunk of the portfolio, because this is the livelihood of a lot of these owners. This is where they have the network. So this is going to be a longer drawn out, you know to the extent that when some of these go bad, it'll be a longer progression that are happening and we'll be able to you know kind of work our way through it over time. But to kind of anchor it all, this is the fact that this is conservative, low LTV and that gives you know, it will give us options as to how we either work with the borrower or work out of these credits over time.

[Casey Haire:]

Very good. Last one for me, just the charger-off rates at 32 bips and there was some migration. Should we expect charge offs to sort of – you know what's the near term charge-off outlook? Should we expect it to kind of hold this level going forward or did you just do some clean up this quarter?

[Luis Massiani:]

We're going to be aggressive in cleaning up. So there’s still clean up to do. We have – where there’s obviously, MTLs are $250 million or so, you know in particular related to specific portfolio credit or portfolios in residential mortgage and some small amount, small amounts of equipment loans. We are going to continue to address those you know very aggressively going forward, so you should anticipate that we will have charge off, but a vast majority of those are already covered with the reserves that we have, and have been identified in our CECL modeling. And again, the position that we talked about since the first quarter, which is the faster we get these things out here and we get – you know we focus on kind of the parts of the business that we want to long term, the better it is. So yes, you should anticipate the charge off activities going to continue in the third and fourth quarter. Is it going to be 30 basis points or 40 you know, 30 to 40 basis points? Not a 100% sure yet, but yes, we do – we are going to continue to aggressively manage out of MPLs.

[Jack Kopnisky:]

Yeah, you know one of the things that we all kind of forget in the last 10 years, that our credit quality has been so pristine that you know everybody's used to having charge off levels of less than 20 basis points. Normalized charge off ratios based on over many, many years is more in the 20 to 50 basis point range. So we don't think this is – we think this is becoming more of a normalized environment where you have certain risks and you have certain vital positions and all that. So that's, I think that's the guidance for the future. This is more normal charge off levels. This is an abnormal time, but that level of charge-offs are more normalized.

[Luis Massiani:]

Now we think about it Casey as more of a timing issue. So this is a good example of what we were talking about before. A substantial amount of the credit migration that you have seen had been driven by you know the equipment finance book, the small balance group finance book and some of the residential components or residential mortgage. Those are all loans that we could have modified or differed if we wanted to and essentially dealt with them later on in the year or early next. But that is the type of the business that we're talking about, where we see that there isn't really a long term viability to it. So might as well just clean it up now, rather than have to deal with it and to charge-off later on. So that's a perfect example of we think about it as more of the loss content in aggregate would be the same, and this is just a matter of how quickly you get behind you, you reserve for it, you get it behind you and again just from a timing perspective it's just you know how the charge off come off. But we're very confident that over nearly a two year stretch, we are going to see that the credit quality from an annualized charge-off perspective on accumulative rates is going to hold up very, very well.

[Casey Haire:]

Great! Thank you.

[Jack Kopnisky:]

You got it.

[Operator:]

Thank you. We will now go to our next caller that is Alex Twerdahl with Piper Sandler. Please go ahead.

[Alex Twerdahl:]

Hey, good morning guys.

[Jack Kopnisky:]

Good morning, Alex.

[Alex Twerdahl:]

First off, I was just hoping as we look at the reserve here, could you remind us, at 164 you know I think last quarter you kind of gave the adjustment for what the reserve could have been if you had excluded the purchase accounting adjustments or included the purchase accounting adjustments in the overall number?

[Jack Kopnisky:]

Yeah, there's still another, from an absolute dollar amount the $365 million of ACL, the fair value adjustments on loans are still about $30 million, so $30 million to $35 million. So the $365 million would be closer, just under $400 million.

[Alex Twerdahl:]

Okay, that's helpful. And then how should we think about and sort of taking what you said, you know in your last response to net charge off levels, and as we think about the reserve build versus higher charge off levels, and I think your comment was that a lot of the charge offs are already incorporated in the CECL model. How should we be thinking about the reserve from here in terms of building, some releasing, things like that, you know in the contracts of CECL and the charge off, etc.

[Jack Kopnisky:]

Well, more so in the charge offs I think that the reserve build is going to be driven near term by the progression of the deferrals and that we were talking about before, right. So to the extent that we start seeing meaningful improvement that are causing it to, in the sector that we're talking about, the reserving requirements will essentially start coming down in lock step with that, right. So we feel very good about credits that are able to continue to at a minimum play, you know pay interest and stay current through this, right. So if you've identified a commercial real estate or C&I borrower that either has not requested a payment deferral or has essentially been able to continue to meet obligations and pay interest and so forth, then you know those are credits that we feel very good about, because they demonstrated that they can withstand you know a pretty significant and unforeseen impact at their business model. So the focus is on the deferrals. To the extent that you see deferral rates that stay level, the decreasing, either you are not going to see a large reserve build, to the extent that you see either deferrals that in the second go around, you know don't really come down or for whatever reason start creasing, which we don't think that would be the case, because as rob alluded to in his prior response, we've seen a pretty substantial – you know we really have seen a slowdown for the last 30 to 45 days in new client requests on that front, then we feel pretty good that, you know that again you should be able to maintain that reserve. We know if you don’t see that increasing, then that means that the portfolio is holding up better than what the models are anticipating or what the models are estimating today. So you know kind of short, you know is it more driven by charge offs? No, this is more driven by what we're seeing from the perspective of those deferrals and then once these kind of these deferral period ends, what happens from a migration and credit at that point. So as a reminder, right now for all these loans that are in deferral, you are not migrating them from a credit perspective. So that would be the bigger driver of a reserve build as -- because these models and payment deferrals come off deferrals and they do not return to payment status in the third, fourth quarter. That would be a driver for getting reserves up.

[Alex Twerdahl:]

Great! Thanks for that color. And then just a final question you know in the guidance of the things like the margin and loan growth, are you including or what are your assumptions for PPP in terms of loan balances and how you accounting for the fees for PPP in terms of the amortization schedule?

[Luis Massiani:]

You know 80%, so three things there. First one, we only originated PPP loans to existing clients, so we have we think a pretty good visibility, because through our commercial banking teams and business bankers we've been able to reach out to a pretty much substantial majority of all these folks to understand what their intentions are regarding prepayment or forgiveness process. So we feel good that we have a good estimate of what the waterfall of forgiveness and payment is going to be. We think that by the end of the year, over you know close to 80% and not more will have been fully forgiven, and you can – that we think that that is going to be more weighted to the third quarter versus the fourth quarter. So from here to the end of the year, our $650 million of balances will be closer to $150 million, call it $200 million if not lower and then a good chunk of that, let's say about two thirds of that would be forgiven in the third quarter and then the remainder of it in the fourth quarter. So you're only going to have a tale of about $150 million that goes into 2021.

[Alex Twerdahl:]

Okay, and are you advertising the fees on a two year schedule until they get prepaid?

[Luis Massiani:]

Yeah, so we are [Cross Talk] yeah, you got it.

[Operator:]

Great! We will go next to David Bishop with D.A. Davidson. Please go ahead.

[David Bishop:]

Hey, good morning gentlemen.

[Jack Kopnisky:]

Good morning, David.

[David Bishop:]

Looking at you know obviously the multi-family rent collection efforts remain in the news of the national media, local media. Just curious, maybe you can update us what you're seeing in terms of the ability to collect across the different segments within multi-family.

[Jack Kopnisky:]

Yeah, generally our multi-family business is in the boroughs of the city. So we have very low sort of macro, very low deferral levels on multi-family. We also have low loan to values. In the boroughs we are seeing kind of in the 65% to 70% rent collection range is the feedback we are getting from this. So folks have continued to make current principal and interest payments out of that. So there is enough buffer in terms of cash flows out there. These are also for the most part rent controlled buildings, so there is some stability that way, so the rents are lower than obviously market rents.

[Luis Massiani:]

You know, I would add to that. We have heard from our borrowers that the tenant pay-through improved through June and they expect it to improve some more in July as unemployment rates had come down.

[David Bishop:]

Got it. And then just turning to the – Jacky, you noted in terms of loan guidance, most of its going to be traditional CRE, traditional C&I or so, maybe a migration maybe from the national platforms. In terms of maybe just what the credit performance, any surprises here in the equipment finance and some of the other specialty finance portfolios that you know obviously you don’t purchase these expecting a pandemic, but just curious in terms of just the overall credit supplies, credit outlook and maybe just you know longer term holistic view for some of those business.

[Jack Kopnisky:]

Yeah, you know it's interesting. The things that we thought would be problems going into this are the ones that are problems. We really have not been surprised about any of the portfolios, you know things like you know hotel or some of the small ticket equipment finance stuff., you know some of that hospitality related, that restaurants and things like that, tourist related things. We really have not been surprised about any of the categories. Kind of given the situation, they are performing as we would have expected. The ones that have held up a little bit better, the National Commercial Finance businesses outside of equipment have generally held up pretty well also. You know we have relatively low deferrals on everything outside of kind of the equipment space and maybe a little bit of AABL out there. But generally the rest of it's held up pretty well, C&I, traditional C&I’s held up extremely well. You know in our book, we tend to be a middle market C&I lender, maybe lower middle market. We don't have a big business banking concentration. My own personal view is one of the bigger challenges is if you had kind of micro business banking lending platforms with big portfolios, we do not. So those are longer tail kind of workouts out there. So in the end, I don’t think there is anything necessarily that surprised us out there. From a growth standpoint, you know there are sectors definitely on the C&I side, definitely in the public finance piece, but I think as the country spends more money on infrastructure, public finance will continue to become a bigger and bigger lending opportunity. The CRE side of it, you know there are going to be specific areas where we can land anything, distribution, warehouse, frankly medical healthcare related certain types of those types of facilities will lend themselves to opportunities going forward. But on the flip side of it, there are areas where we're just not going to get the right risk adjusted returns out of and have not for the last year or so. Places white [ph] like some sectors of equipment finance, some ABL is in our view mispriced right now; mortgage warehouses getting close to being mispriced as a result of the yields coming in those areas. Still good business and good opportunity, but there are sectors, especially on a national basis where we have walked capital away from. So long answer to your question, but one, I know there's no surprises; two, there’s – you know there's still some good opportunities going forward. All that said, we are being more cautious. I mean we want to lend, but the volumes are about half of what they have been in the past, in part because of demand, but in part because we're just being more cautious given the situation and the unknowns with the pandemic.

[David Bishop:]

Great, I appreciate the color.

[Jack Kopnisky:]

Sure.

[Operator:]

Our next question will come from Collyn Gilbert with KBW. Please go ahead.

[Collyn Gilbert:]

Thanks. Good morning guys.

[Jack Kopnisky:]

Good morning, Collyn.

[Collyn Gilbert:]

Just on the credit side, so if you think about kind of your strategy here, how you've managed the book; you know it obviously right the strategy here is to get aggressive early, you know kind of differentiate between some of the transactional relationships versus not, and as you indicated Jackie, that was a pretty good handle on the book and it's performing as you would've expected, blah, blah, blah. What do you think...

[Jack Kopnisky:]

I like your blah, blah, blah… thank you.

[Collyn Gilbert:]

No, it’s all good, it’s very eloquent. What are your – I mean in terms of the trends here, I guess on losses right, because you've already identified that you know the LTV’s on the core book are a little low. Just trying to reconcile your aggressiveness early, with the fact that you still really haven't seen stress yet in the overall economic environment, you know from the loan credit loss standpoint, so you know and you indicated normalized losses in the 250 basis points. I mean are you sitting with the book that’s you know going to see peak losses more than 1% or do you really not see that even being a possibility.

[Jack Kopnisky:]

Well, a couple of things. So one, no one knows really what's the future of it, until someone can tell me when the pandemic's going to be solved, the healthcare crisis is going to be solved, everybody, every economist, accountant, consultant, investment banker, you know they are – we're just trying to work our way through this thing. So there's a big unknown out there for everyone, so that's one. For what we see today – I mean you're only good for what we see today. We don't believe that we're going to get the, you know anywhere close to the 1% charge off ratios, things like that. We think that you know we're working – from what we see today in that cash flows with clients through a variety of the portfolios, you know our estimates are there. So for example Collyn, I should ask you a question. In your model you have about $200 million of reserve build in 2021. Right now we don't see that there for us. We don't see that kind of estimate, but you know until the healthcare, health crisis gets solved, that has caused the economic crisis, you know no one’s going to be absolutely, us included on this. The estimates we're giving you is what we see today. We are trying to be aggressive, do charge offs. If people aren’t going to make it, we're addressing this now, taking the charge now and moving forward. We’re working with the clients on the deferrals and as Luis said, as the deferrals turn and whether it's the end of the first round or the second round, we figure out that you know they're not going to make it, we're going to be aggressive with not addressing that.

[Luis Massiani:]

And Collyn, part in here – aggressiveness is part of the proactive working with our customers. As an example in the hospitality space, all but one of those loans have guarantors and those guarantors, many of them have significant net worth and significant liquidity, and so we work with them and say, ‘Listen, you pay us interest. Maybe we’ll give you something on the principal side to get you through the next year or so of the pandemic, but you have a good fundamental asset.’ They agree with that and there’s a guarantee in place. So right, you don't – there you're not going to try to take a big loss on anything right away. There's no reason to for our perspective or no reason for the borrower's perspective.

[Jack Kopnisky:]

Yeah, you know that portfolio is a perfect example. It’s probably our highest at-risk portfolio. There we have guarantors that are very, very liquid, that will step up and have already stepped up to make payments. There are a couple of properties that have reinvented themselves and have used it for housing healthcare workers and have used it for you know some of the homeless shelters. There are some that are – you know it will be a challenge, because they may want to walk away from this and we don't want them to walk away from this. So that sequence, that portfolio boils down the borrower by borrower and where we have supporting guarantors and liquidity you know for a very comfortable start. Our comments come from that accumulation of all that. We will have probably problems in that portfolio. I don't think that you know we have good loan to values and we can repurpose some of that. I think the majority of that portfolio will end up being okay because of the liquidity of the borrowers and the loan to values and the re-purposing of those things. But being able to look into each client and each situation and being aggressive and being proactive with them allows us to have – make the comments that we've made. Again, the giant asterisk on this is, you know tell me how long the economic crisis are going to last and I’ll tell you exactly what our charge-offs are going to look like in 2021 and ‘22 and beyond.

[Collyn Gilbert:]

Okay, that's great color, very helpful. Shifting to the news, so Luis you’ve given you know guidance obviously on the NIM and where you think funding costs will go. Can you just talk about kind of how you're seeing the asset side trend over time and kind of again, kind of a longer term structural thought on what – where that NIM ultimately settles out or bottoms out.

[Jack Kopnisky:]

Yeah, sure. So you know I think that they have you know positives and negatives there right. On the positive side we have now felt the vast majority of the pain on the floating rate loans and so one of the good things that we saw is that the you know NIM associated with all of our one month, you know our prime one month and three month LIBOR based portfolios, the asset yields in the month of June actually held in very nicely relative with what they were in April and May. So you know when you think about the asset based lending portfolio, the warehouse lending portfolio, substantial chunks of traditional C&I, all of those you've seen a pretty steep decline in the late first quarter, into the early part of the second quarter and then now that has largely abated. So as long as the one month LIBOR stays at, you know call it 15 to 18 basis points where it’s been harboring for the past you know kind of 30 or 45 days or so and that continues to progress over and then stays stable for the course of the year, you know the credit spreads are staying or hanging in very nicely in those portfolios and so therefore we should have seen the vast majority of the near term floating rate loan pressure already being you know impacting asset deals; that’s the positive side. The negative side on the asset yields is that you're now going to be – you know we're going to be in the same position that we were at 2013, ’14, etc., where the existing fixed rate book of loans, which today has you know call it somewhere between a 3.75% to 4.5% yield on it, you'll see in our slide deck that we had won origination deals in this quarter of about 3.5%. So you're going to start running into as you see greater prepayment activity, as you see greater refi activity. The existing fixed rate book will run off at some you know kind of lower rate deal. The new book of business will come on at some lower rate than that existing book of business that runs off, but that is not something that impacts NIM quarter-to-quarter or even you know through the back half of this year. That's the longer term progression that we had, have been kind of the two or three year window of 2012 to 2015 where you just continue to get to that point where you know new origination yields are going to be 25 to 50 basis points lower than what the existing book of business rolls off. So a much longer term impact to asset yields from that perspective. So we think that for the back half of this year we're going to be around 375 to 380 for earning asset yields. You're going to see that the cost of funds was about – the spot cost of funds as of June 30 was about 12 basis points lower than the weighted average cost of funds. So we already started the quarter with about a 12 basis point difference for cost of funding and that will continue to trend down because we are still reprising deposits, we still have CD's that are maturing, we still have FHLB bonds that are maturing, you get a full quarter of the senior notes that we paid off now being off the books. So you're going to continue to see the liability side moving the right direction. So we're guiding to 300 to 310 in the month of June. We were slightly over that 310 so we feel pretty good that you're going to have a NIM stability despite the increasing NIM for the second half of this year.

[Collyn Gilbert:]

Okay, that's great, super helpful. And then just one last housekeeping questions. So I just want to make sure, the guide that you guys are giving in your OpEx on the slides. I know that's our amortization expense, but I just want to make sure that the cost, the amort expense related to the least acquisition expense, is that – do we back that out of the OpEx guide as well?

[Luis Massiani:]

Yes, that is correct.

[Collyn Gilbert:]

Okay, and what’s was that number again?

[Luis Massiani:]

It’s about $3.5 million to $4 million bucks a quarter roughly. So if we go to the – in our press release there is a – in the press release, in the GAAP reconciliation tables in the back you've got a full reconciliation of how that OpEx is calculated. You can see the – but it's about $4 million on the lease expense.

[Collyn Gilbert:]

Okay, got it. Alright, that’s it. Alright, thanks guys. I appreciate it.

[Jack Kopnisky:]

Thanks Collyn.

[Operator:]

Thank you. We will next go to Matthew Breese with Stephens. Please go ahead.

[Matthew Breese:]

Hey, good morning.

[Jack Kopnisky:]

Good morning, Matt.

[Matthew Breese:]

Just practically speaking, you know for the loans that go up for redeferral in late July and early August, if they don't cure, how are you going to handle those from a NPL or classified loan perspective? Should we expect those that don't cure due to start moving into traditional, you know non-performing asset quality buckets?

[Jack Kopnisky:]

Not in this second go around. So under the regulatory guidance, in this – again depending and to the point that Jack and Rob made before, each one of these cases we are getting updated financials and business model projections and so forth and so to the extent that you continue to determine that this is a near term or short term impact because of the pandemic, where the business has liability post this - post this period and where you see the ability to put them back on some, on a current payment status after the second referral, you would not migrate it. Now to the extent that – so you have another 90 day window before that would happen, right, of essentially starting to migrate that credit down. Realistic, you know what's going to happen realistically here is that you're going to – now that we have the benefit of what I’ll call a little bit more – you know a longer time frame to being able to make that decision, which is very different than the first go around, where essentially everybody was in a mad dash to – everybody was kind of losing a little bit, you know everybody was in a mad dash to get these deferrals approved and so forth. In this go around you have the benefit of having a much more kind of educated decision to make based on the updated conversations with clients and the updated information that you're getting from clients as to how their businesses are doing. So you should start to see some migration of credit in the third quarter, but I don't think that you're going to see that holistically until the fourth quarter once the second go around of the deferral period is over, which if you think about a loan that comes off that deferral in the month of August, if you have to extend it for another 90 days, that takes you into October, that's why I think that it's for the vast majority of these more of a fourth quarter events than a third quarter event, but you should start seeing some migration based on updated under writing analysis that we’ll do in the second go around.

[Matthew Breese:]

Now after that 180 days, you know we've learned from a number of your peers that it seems like you have a tremendous amount of flexibility to extend deferrals well into 2021 if they need it. Are you going to pursue that option at all or do you want to essentially wind down the deferred book and put in its work out categories by the end of 2020.

[Luis Massiani:]

By the end of 2020 you're going to wind this down and put him into deferral. You know for the types again Jack alluded to, we’re in the – you know we do lower middle market to the extent that a lower middle market doesn't have access to you know capital markets financing, doesn't have access to large, committed lines of credit, right, to the extent that you have a lower middle market clients that has the 180 to 270 days of not being able to kind of open and get back to some sense of normalcy. I don't think that that's a situation in which you don't have like a credit that starts migrating. These are not going to be borrowers that have that amounts of financial flexibility to be able to withstand you know close to year of not being back to normal activity. So that's not even a – I don't think that that's necessarily a decision or an option that we’re going to have, because you're going to see that at that point, businesses will have to start moving more towards other forms of either bankruptcy or something like that. So I don't think that that is – I don't think that there's as much flexibility as you're alluding to Matt.

[Jack Kopnisky:]

Yeah Matt, it’s our understanding that it will all revert back to the traditional type of rating for those credits. The only place that banks will be given a lot of – at this point it could change, it would be on the residential side, right, and that could be up to a year. But no, for the commercial side, that's not our expectation nor is it what we understand it to be today at all.

[Luis Massiani:]

Yeah, that’s not what we are planning. We're going to essentially get these things off deferral and we've got to put them to work out we will.

[Matthew Breese:]

And right now, what percentage of deferrals are paying you something, IO or modified payment versus no payment. And is that a decent way to look at you know bucketing these into low risk versus high risk loans?

[Luis Massiani:]

Yeah, so the numbers that we put in the, you know in the press release, you know that represents the P&I deferrals, which is the vast majority of our deferrals, and you know the – again, to the extent that there is an interest only deferral or modified payment deferral, you know where the vast majority of the payment is being made, we feel good about those credits and those were more of defensive modifications. We won't really caller it a deferral. It would be defensive modification that were done, where we anticipate that the vast majority of all those get back to some form of, actually will get back to current payment status if they haven't already. We have some components of the residential mortgages that are in P&I deferrals, that are right now in a P&I deferral buckets, so about 15% of that has continued to make payments. But on the commercial side of the house those P&I deferrals are P&I deferrals at this point.

[Matthew Breese:]

Okay, and then going back to expenses, you know your bank in particular hasn't been shy about you know cutting branches, cutting physical office space. As you’ve gone through COVID and I'm sure there's been some illuminating moments in terms of what you can do digitally and work from home and all that. You know as you reassess the branch count and the branch network sits around 80 branches today, where might you take that in the out years. Have you taken a look at that and could it come down substantially?

[Jack Kopnisky:]

Yeah, you know we are going to continue to make investments in technology and so if you would, there's a kind of a trade-off in the amount of money that we're going to put into technology and digital. So the partnerships we have with Deloitte, banking as a service, the online banking side of this thing, being able to automate everything in the company are the investments that we're making. In a direct way you kind of pay for that, because through the downsizing of the physical distribution system. So being able to have clients that demand for digital services as you know this period of time as you said Matt, you know proved a point once and for all that clients want to do business digitally on the transaction part of it. It's also proven once and for all that clients need advice and counsel from their relationship team. So the team’s strategy that we've had have worked incredibly well and the digital platform that we have has worked pretty well, incredibly well. So the net answer to that is we’ll continue to downsize the physical distribution, where our consumer banking teams are moving to more of a segment approach anyhow and they're doing a great job with that, but we’ll continue take real estate costs out and reallocate people costs from one kind of bucket to another bucket.

[Matthew Breese:]

And then last one from me – Oh! I’m sorry Jack, go ahead.

[Jack Kopnisky:]

I was saying, the net effect of that is, there is still room to take cost.

[Luis Massiani:]

Matt had had enough of your answer.

[Jack Kopnisky:]

I know. Go ahead, go Matt.

[Matthew Breese:]

My apologies, that's not what I meant at all. In terms of the Moody's forecasts, could you just give us an idea of how the updates kind of progress for the quarter and if you've gotten any updates in July. I know as those move and the GDP unemployment, the length of the recession, those factors change, it can really move the needle on the provision. Have you started to see more stability out of those forecasts and should that imply anything for the provision on our side?

[Luis Massiani:]

We have seen a lot more stability – especially in the – through the second half of the second quarter. We saw substantially greater stability and kind of an orderly progression of what the Moody’s folks were anticipating, particularly in their baseline scenarios, particularly related to the longer tail part of the assumptions where you have seen a substantial amount, where the forecasts are now changing mostly than the short part, right. So if you kind of recall the third, fourth quarter and early part of 2021 where there still is – you know every time that one of these comes out, it’s essentially based on whatever the latest and greatest numbers that are being touted from the unemployment gain you know kind of coming back, not coming back. So GDP and unemployment rate has assumptions very substantially from forecast to forecast on the short part of the forecast or kind of the near term part of the forecast. But the longer ended tail assumptions of how the economy recovers, and so how long it takes and when you get back to pre-COVID levels has stayed generally very consistent with each one of the new update that has come out. Since the mid-April forecast that we used for the first quarter provisioning, we have been looking at the assumptions that have a, what I’ll call some sort of a modified Nike swoosh type of recovery to it, which is a recovery that starts at the end of this year, but a recovery that takes a very long period of time to get back to pre-COVID levels. And so as you see in our slide deck that we put there, we don't get back to pre-COVID levels until end of 2022, early part of 2023, which is slightly worse than we were in April, but it's only worse by about a quarter or two. So that part is not extending out. The longer ended tail kind of risk of assumptions getting worse has not been there in the latest go arounds of the Moody’s assumptions.

[Matthew Breese:]

Understood, okay. And that implies provisioning – you know reserve levels are adequate and provisioning should reflect growth in charge-offs, correct?

[Jack Kopnisky:]

Yes, that is correct.

[Matthew Breese:]

Got it. Okay, that’s all I had. Thank you.

[Jack Kopnisky:]

Appreciate it.

[Luis Massiani:]

Thank you.

[Operator:]

Thank you. [Operator Instructions]. We will take our next question from Steve Moss with B. Riley FBR. Please go ahead.

[Steve Moss:]

Good morning guys.

[Jack Kopnisky:]

Hi Steven.

[Steve Moss:]

I want to follow up on that, just on the CECL modeling and kind of curious you know as to the sensitivity regarding your provision and reserve. You know you have GDP’s – unemployment sorry is around probably 15%. Kind of if we see something in the low double digit, you know above your 9% forecast in the next six months, what does that do with regard to your reserve?

[Jack Kopnisky:]

Yeah, that's a good question. So it's a good question, and at the same time a very difficult question to answer, because you know the models literally have thousands of assumptions in it, right, and so just a kind of isolating the impact of just moving one assumption isn't really the right way to think about it, because there is – no, that would have a vast majority of implications for a bunch of others, right. So you know it's a difficult question to answer and I couldn’t give you a specific number that says, for each one percent of this, it makes it go to that. You know that I couldn’t really provide you, because it wouldn’t be a fair way to think about how we are thinking about the estimate or loss. What I will tell you is that a substantial chunk of the CECL reserve continued to be driven by qualitative factors and not just quantitative. And so some of the things that we do from a qualitative perspective, when we think about the various portfolios, is that we do exactly what you're suggesting to be, which is what – yeah okay, so the models are saying this, we realize the models are not perfect. Where are the portfolios that we are seeing, where we are seeing the more kind of the bigger stress and what we're seeing more of you know kind of deferral question and so forth and then let's use qualitative factors to cover things like, what happened if the unemployment rate gets worse for you know residential mortgage for example. So if you'll see, our reserve requirements on or our CECL reserve on residential mortgages, if you look at the slide deck, the detail that we have in the back is about 175 basis points. Why is that? Our models are not assuming that there's 175 basis points of losses and the quantitative model is not assuming that. We're making qualitative overlay based on exactly that, which is what happens of the models are wrong and how do we defer exactly that, you know in key assumptions and then let’s essential allocate more from a qualitative perspective to the portfolios where we see there’s a greater risk on kind of major assumptions getting worse. And so that way, I hate to use the word, the smoothing, because I know my external auditors are listening to this call as well. But that’s exactly what the qualitative factors are there to do, which is you are essentially reserving today and so the mix and shit between a qualitative versus the quantitative component of an individual asset class would likely change, because you're essentially already reserving for some model uncertainty on the qualitative factor.

[Steve Moss:]

Alright, that was my one question. Thank you very much. I appreciate it.

[Jack Kopnisky:]

Thank you.

[Luis Massiani:]

Hope that answered it.

[Operator:]

Thank you. This concludes today's question-and-answer session. Mr. Kopnisky, at this time I will turn the conference back to you for any closing remarks.

[Jack Kopnisky:]

Hey, so thanks for following us. You know if you step back a little bit, this is probably the most unique period of time I think we've all lived through, so we are working through coming out of this. Again, the two things that we're focused on is resolving the credit challenges as we go through and working through that. And secondly, produce strong earnings driven by revenue, the pre-provision net revenue where we are pretty comfortable that each component will continue to improve. So net interest income, the fee portion of it, and the expense side of this thing given a number of the one-time items we took to take care of our folks and the communities in this quarter. So I appreciate you following. Thanks a lot. Have a great day!

[Operator:]

Thank you all for your attention. This concludes today's conference. You may now disconnect.