First Internet Bancorp (INBK) Q2 2020 Earnings Report, Transcript and Summary

Good day and welcome to the First Internet Bancorp's Earnings Conference Call for the Second Quarter of 2020. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Larry Clark from Financial Profiles. Please go ahead, Mr. Clark.

Thank you, Sean. Good day, everyone and thank you for joining us to discuss First Internet Bancorp's financial results for the second quarter of 2020. The company issued its earnings press release yesterday afternoon and it's available on the company's website at www.firstinternetbancorp.com. In addition, the company has included a slide presentation that you can refer to during the call. You can also access these slides on the website. Joining us today from the management team are Chairman, President and CEO, David Becker and Executive Vice President and CFO, Ken Lovik. David will provide a company update and Ken will discuss the financial results. Then we'll open the call up to your questions. Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial conditions of First Internet Bancorp that involve risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement but not substitute the most comparably - directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. At this time, I'd like to turn the call over to David.

Thank you, Larry. Good afternoon everyone and thank you for joining us today. We are very pleased with our results in the second quarter, especially given the ongoing challenges as we navigate through the COVID-19 pandemic. Our thoughts are with the families and businesses who have been most impacted, as well as the healthcare professionals and first responders. Our top priority continues to be the health of our team and clients. And I would like to thank the entire First Internet team for the resilience and hard work during these challenging times. Our team delivered quarterly net income of $3.9 million and quarterly diluted EPS of $0.40. Earnings for the quarter included a provision for loan losses of $2.5 million, which drove an increase in the allowance for loan losses to total loans of 82 basis point or 84 basis points excluding loans related to the SBA's Paycheck Protection Program. Furthermore, our asset quality remains solid with NPAs to total assets of only 24 basis points. From an operating perspective, our cost of interest bearing deposits continue to decline, decreasing 30 basis points from the first quarter to 1.94%. While, we did experience a decline in net interest margin during the quarter, due primarily to the impact of the Federal Reserve rate cuts in March, on earning asset yields, we expect asset yields to stabilize and when combined with continued deposit repricing opportunity we'd have over the next 12 months. We should have the ability to significantly grow net interest margin and net interest income for the balance of 2020 and into 2021. Our direct to consumer mortgage business had another strong quarter, as we were well positioned to capitalize on the ongoing refinancing and sales activity across the country, driven by historically low mortgage rates. We expect residential mortgage originations to remain strong in the continued low risk rate environment. Our loan growth during the quarter was primarily driven by our participation in the SBA PPP program. Loan balances were up $82 million or 2.8%, which included $59 million of PPP balances. We did not sell any portfolio loans during the quarter as market conditions were not as favorable as we would have liked. However, we did sell $11.5 million of SBA 7(a) guaranteed loans at a net gain of $800,000 as we continue to grow this line of business. I'd like to give you a brief update on the status of our SBA business. As we have discussed in the past, we see great potential in this space with attractive opportunities on both sides of our balance sheet. And we have made tremendous progress in building out payments truly as a nationwide platform. In fact, during the second quarter, we took advantage of market disruption among some of the competitors in the SBA space and have added sales and operations personnel to our already strong and talented team of professionals in this division. We are about six months ahead of our original hiring plan and are very excited about the near-term outlook for this business over the remainder of 2020 and into 2021. Our original forecast for 2020 included about $60 million of originations for the year with $100 million annual run rate by the end of the fourth quarter. Excluding PPP, our current expectations for 2020 originations are now closer to $100 million reflecting significant growth in the second half of the year and forecasting originations of $200 million to $225 million for 2021. It's hard to believe that 18 months ago we were barely a player in the SBA world and today we are a rising force that has been able to attract top talent as we build a leading national small business lending platform. As a reminder, our primary focus is SBA 7(a) program lending where we will sell the guaranteed balances in the secondary market, which are generally 75% to 90% of the total originated balances. This generates fee revenue and increases profitability with minimal balance sheet growth. Let me now take a few minutes to update everyone on the status of our loan deferral programs. As our last call of July 17, we had $366 million of loan balances on deferral or just under 13% of the total portfolio, basically back to where we were three months ago. This is down from a peak of $647 million in late May, which was about 22% of the portfolio. Generally, we have seen a significant decline in deferrals across most of our portfolios and all the borrowers coming off deferral programs have resumed making loan payments without any delinquency. We have been particularly pleased with the performance in the consumer portfolios as the percentage of mortgage deferrals is significantly lower than the national mortgage forbearance rates and less than 1% of the balances in our specialty RV and trailer volumes are on deferrals. As you can see from the loan deferral information we've provided on Slide 13 in the presentation, the level of deferrals in the healthcare finance portfolio is down significantly from April and May. In mid-May, nearly 80% of our healthcare balances were on a payment deferral plan. Now two months later, that number has dropped to 15%. Of the $58 million still currently on deferral plans, about 40% represent balances that were granted a second deferral period. These are generally granted to lenders operating in states where they were late in reopening or have not yet reopened. Additionally, the majority of healthcare finance loans still on deferral plans are expected to roll off in the next 30 days. Our largest portfolio with deferrals is single-tenant lease financing with $277 million in balances on deferral programs or about 28% of the STL portfolio. As a reminder, all of our single tenant borrowers made their April payments. So the deferrals did not start until May. Therefore, the vast majority of these borrowers are expected to resume making payments in August. A large portion of the loans on deferral are related to restaurant properties and, of those, approximately two-thirds of the dollar balance consists of full service restaurants and the remaining are quick serve. Furthermore, the current weighted average loan-to-value ratio on single tenant deferrals is 55%, which is relatively consistent with the portfolio as a whole. Over the course of the quarter, borrowers representing about $50 million in balances chose to terminate their deferral agreements early and a similar number continued making some level of principal and interest payments even while on at deferral program. Additionally, we have not experienced any delinquencies for the performing single-tenant loans that are not under a deferral program. Overall credit quality remained strong and we are cautiously optimistic about our future outlook. There is still a tremendous amount of uncertainty regarding the economy due to the pandemic. We are monitoring our loan portfolio very closely and responding to the needs of our clients as they bridge the gap to a recovery. In doing so, we are deepening our connections with existing clients, which we believe will lead to stronger and broader relationships over the long term. Heading into the second half of 2020 and into 2021, we have many reasons to feel optimistic about our performance going forward. While we had to deal with the uncertainty of the pandemic along with everyone else in the banking industry, our digital business model minimized operational disruptions and we continue to serve our clients without missing a beat. As others in the industry are now questioning the need for all of their physical locations and are struggling with the process to reopen branches, we can remain focused on our core lines of business and building the pathway towards greater earnings and profitability. I would like to thank the entire First Internet team for their resilience and hard work during these challenging times. As you've heard me say many times, our people are our greatest asset and the key to our long term success. Their dedication and efforts have been very much appreciated. With that I'd like to turn the call over to Ken to discuss our financial results for the quarter.

Thanks David. Despite the continued challenges created by the pandemic, we were relatively happy with the performance for the quarter. As David mentioned, our asset quality metrics remain strong and we are particularly pleased by the positive trends with respect to our loans on deferral. The balance sheet increased about $157 million during the quarter due to continued strong deposit inflows, some of which were used to fund loan growth, while the rest added to our already strong liquidity position. Looking at Slide 4, loans outstanding at the end of the second quarter totaled $3 billion, an increase of $81.6 million or 2.8% from the first quarter. Commercial loans increased $98.9 million or 4.3% compared with the first quarter due primarily to the $59 million of PPP loan originations, as well as higher public finance and construction balances. This growth was partially offset by lower commercial and industrial loan balances as borrowers paid down balances on lines of credit or paid off term loans. Consumer loans decreased $16.2 million or 3% compared to the first quarter, due primarily to increased prepayment activity in the residential mortgage loan portfolio. We did not sell any portfolio loans during the second quarter due to less than optimal market conditions resulting from the pandemic. While the loan sale market was opened during the quarter, pricing was a bit lower than what we are used to seeing and we did not feel the need to force a sale as loan production was down and we knew overall portfolio growth would be modest. We do expect to resume selling portfolio loans in the second half of 2020 as these sales are a key component of our balance sheet management strategy. Moving on to deposits on Slide 5. Deposits at the end of the second quarter totaled $3.4 billion, an increase of $202 million or 6.4% from the first quarter. Like the rest of the industry, we were not immune from the flight to safety as consumers, small businesses and commercial clients looked to conserve cash in the face of an uncertain environment. Money market deposits increased by $311 million or 33% to $1.2 billion and now make up 37% of our total deposits, up from 20% one year ago. The increase in money market deposits included a $219 million contribution from small business. The strong money market deposit growth in the quarter was partially offset by declines of $161 million in higher cost CD and broker deposit balances. Compared to the first quarter, the cost of funds related to interest-bearing deposits decreased by 30 basis points with the cost of money market deposits declining 43 basis points as we continue to reduce our pricing throughout the second quarter. At the beginning of the quarter, our rate on all money market products was 1.6%. At the end of the quarter our rate on the consumer money market product was 1%, and on small business and all other commercial money market products, was 90 basis points. Furthermore, we have lowered all money market rates another 10 basis points so far in July. The cost of CDs and broker deposits decreased by 18 basis points as rates paid on new CD production remained well below the rates on maturing CDs. The continued shift in the deposit mix from CDs to money market accounts also favorably impacted deposit costs. During the second quarter, new CDs and brokered deposits were originated at a weighted average cost of 1.08% whereas maturing deposits rolled off at 2.64%, a positive spread of 156 basis points. Included in the maturing deposits were two higher cost broker deposit balances totaling $117.5 million and having a weighted average cost of 2.97%, which rolled off at the very end of the second quarter. Looking forward, we have approximately $1 billion of CDs with a weighted average cost of 2.18% maturing in the next 12 months versus current production in the range of 100 to 105 basis points. Turning to net interest income and net interest margin on Slide 6. Net interest income on both a GAAP and fully taxable equivalent basis declined compared to the linked quarter as a decline in earning asset yields driven by lower short-term rates following the Federal Reserve rate cuts in March more than offset funding cost reductions. Looking at the quarterly net interest margin progression on the next slide, Slide 7, the fully taxable equivalent net interest margin declined 15 basis points from the first quarter. Loan yields negatively impacted the fully taxable equivalent net interest margin by 24 basis points and lower yields on securities and cash balances, each, had a negative impact of 7 basis points. However, those pressures were partially offset by lower deposit costs, which had a positive impact of 23 basis points. Given the current interest rate environment and our expectation that interest rates will likely remain lower for an extended period of time, we see a significant opportunity to reprice deposits lower in the second half of the year, potentially saving $2 million to $4 million per quarter and we anticipate 2021 annual interest expense savings to be in the range of $17 million to $20 million. We are also expecting yields on earning assets to stabilize going forward. In the second quarter, we felt the full impact of the Fed's rate cuts on our variable-rate loans and securities, as well as non-cash balances. However, the vast majority of our earning assets are fixed rate including over 85% of our loan portfolio and as the pace of short-term rate declines is slowing, we are forecasting earning asset yields to remain flat over the remainder of 2020. The impact of the deposits repricing combined with stabilized asset yields provides us a significant opportunity to increase the net interest income and net interest margin during the second half of 2020 and throughout 2021. During the quarter, monthly net interest margin hit a low in May. However, June's margin was up substantially compared to May's results. So we are beginning to move in the right direction. Turning to non-interest income on Slide 8. Non-interest income for the second quarter declined by $1.2 million to $5 million as compared to the linked quarter. The decrease was driven primarily by a $1 million decrease in gain on sale of loans during the quarter and a $300,000 decrease in revenue from mortgage banking activities. The decline in gain on sales revenue was due primarily to not conducting any portfolio loan sales during the quarter. However, as David mentioned earlier, we did sell $11.5 million of SBA 7(a) guaranteed loans for a gain of $800,000, which was an increase of $300,000 from the first quarter when we sold $5.6 million of loans at a gain of $500,000. In terms of mortgage banking, our direct to consumer mortgage business is experiencing strong demand, fueled by the decline in mortgage rates and refinance activity. Although our mortgage business experienced some market volatility, which negatively impacted revenues late in the first quarter and early in the second quarter, it rebounded in the latter half of the quarter and the pipeline remains very strong heading into the third quarter. With respect to non-interest expense shown on Slide 9, the decrease of $200,000 from the first quarter to $13.2 million was due primarily to decreases in consulting and professional fees, loan expenses, and deposit insurance premium, partially offset by an increase in other expense. The decrease in consulting, and professional services reflected seasonal costs incurred during the first quarter related to the filing of our annual report and proxy statement. The decrease in loan expenses is related to costs incurred during the first quarter associated with nonperforming loans. And the decrease in deposit insurance premium was due to declines in the balance of broker deposits in year-over-year asset growth, both of which positively impact the formula used to calculate deposit insurance expense. The increase in other expenses was due primarily to a $250,000 charitable contribution to assist small businesses and nonprofits to address the economic challenges of the COVID-19 pandemic. Now let's turn to asset quality on Slide 10. The allowance for loan losses increased to $24.5 million, up 7% on modest loan growth excluding PPP balances resulting in an increase in the allowance to total loans to 82 basis points or 84 basis points, excluding PPP loans. The linked quarter increase was due primarily to additional adjustments to qualitative factors in our allowance model to reflect the continued economic uncertainty resulting from the COVID-19 pandemic. Of note, there were no new specific reserves taken on individual loan balances during the quarter. Net charge-offs of $900,000 were recognized during the quarter resulting in net charge-offs to average loans of 12 basis points compared to 6 basis points for the first quarter. The net charge-offs for the quarter included a $740,000 charge-off in our healthcare finance portfolio, which is the first loss that we have ever experienced in that line of business and one that had some unique circumstances associated with them. Nonperforming loans increased by $800,000 in the second quarter to $8.2 million, due primarily to a $700,000 owner-occupied CRE loan that was placed on non-accrual status during the quarter. However, the ratios of nonperforming loans to total loans and non-performing assets to total assets remained relatively consistent with the prior quarter. While there is much that we still don't know about the longer term implications of COVID-19 on the economy and on our borrowers, our credit metrics remains strong to date, and we continue to take comfort in the low LTVs on our real estate secured loans and our overall conservative approach to underwriting, as reflected in our low levels of both nonperforming loans and net charge-offs. With respect to liquidity and capital, as shown on Slide 11, our overall capital levels remain healthy due in part to balance sheet actions we have taken over the last several quarters to manage and preserve capital. Our tangible common equity to tangible assets ratio decreased to 7.01% in the second quarter from 7.22% in the first quarter, primarily due to the asset growth associated with our continued strong deposit inflows, most of which was held in cash or to fund the PPP loans. Excluding growth in cash and PPP balances, the tangible common equity ratio would have been 35 basis points higher. Additionally, tangible book value per share increased to $30.92. Overall, our regulatory capital ratios at the holding company and the bank remains strong and we have more than sufficient on-balance sheet liquidity supplemented by access to additional funding sources to manage the current economic impact of the COVID-19 crisis. In terms of capital and overall balance sheet growth going forward, our intent is to reduce the size of the balance sheet over the second half of 2020 through continued deposit repricing and a lower, but still prudent, level of cash balances. As a result, we expect capital levels to increase meaningfully with improved earnings on a smaller balance sheet. Looking ahead, we are extremely excited about our prospects moving into the second half of 2020 and 2021. We believe the trends we have experienced to date with respect to our loans on deferrals speak to the quality of the loan portfolio. Our stabilizing asset yields, coupled with the opportunity to significantly lower deposit costs over the next 18 months are expected to drive substantial increases in net interest income and net interest margin. Fee income in the near term from our mortgage business should remain solid while gain on sale revenue from our small business lending division has the potential to become a significant source of revenue and drive increased profitability. With that, I will turn it back to the operator so we can take your questions. Operator?

[Operator Instructions] Your first question today will come from Michael Perito with KBW. Please go ahead.

A couple of questions from me. Thanks for the time. Ken, I wondered if you could maybe put some numbers around that NIM trajectory intra-quarter from May to June, I guess, for starters.

Yes, we had a low in May. It was in the kind of the lower 1.40%. I mean April was down a bit relative - kind of flattish with March and in May we really hit the floor. But then in June it was back up into the mid-to-high 1.50%. So we kind of got the trajectory back on track. And as I said, we really felt the full impact of the Fed rate cuts in the first part of the - in the first part of the quarter, but asset yields stabilized. And I think with the deposit repricing opportunity going forward, there is a pretty solid upward trajectory for net interest margin here going forward.

Is there any timing we should be mindful of around the repricing and anything else on the asset side or do you think the third quarter could start to show some of that positive trajectory?

Yeah, I mean, I would probably argue that we showed a positive trajectory in the second quarter. We were up - we were down about $1.4 million or so and that's just going to compound here - not compound but it will - it is expected to increase, because one thing that you kind of have to keep in mind is that we're a bit - we are a bit tied to the schedule of CD maturities and some months have chunkier maturities than others. But we're starting to pick up the impact of the maturities from the earlier part of the year and obviously we still have a nice spread to pick up throughout the remainder of the year. But I think you'll - at least as far as what we're forecasting today, that dollar pick up will be much more significant in the third and fourth quarters. I think as I mentioned in the prepared remarks that we're looking at $2 million to $4 million of additional savings per quarter here throughout the rest of the year.

One of the things that will help us out immensely, Mike, like most institutions across the country, the consumer was saving every day, and they have through the second quarter. Our cash on hand jumped up to $612 million on June 10 was our high during the quarter. We've now lowered that as of this morning, we're down to $465 million. So we continue to bring - we think we peaked during the second quarter, we brought it down significantly and we hope by year-end to have that down in the $200 million to $250 million range. So that along with the decrease in cash loans at its rock bottom and the deposits' continuing decline should show tremendous increase and then between that and year-end.

And then on the - can you expand a little on the - what drove kind of the lower mortgage production in the early part of the quarter? You're not - I mean, it seems like pipelines are strong today and based on kind of some of the peer performances from other banks, I would have thought a little bit of a pretty big quarter on the mortgage unit. I mean it still was sizable but it seems like there were something that kind of hampered you guys out of the gates a little bit. Can you expand on what occurred?

I'll try and then let Ken fill it in. We did not drop off in units and sales, but we had - we hedged the volume coming through the door and the market just blew up at the end of March, early part of April. We lost $2 million in revenue due to this fluctuation in market pricing on the hedges. So we moved to best efforts position, got back into hedging here in July. So to - at the quarter, we had solid volume actually a record volume for the bank in the history of originations. Our pipeline today, we're sitting on 375 loans. Last year, we originated 1,360 loans total. So the numbers are great. The units are great, but the craziness in the market when people worried about massive non-payment and all of the agencies running into trouble just crossed our yield the last two weeks in margin for the month of April.

And then just lastly for me. On the credit side of things, what do - it's obviously a challenging environment, but - and I know the LTVs on your STL book are low, but at the same time, are there any concerns on your end about kind of the ultimate value of some of these properties that you're using as collateral, as kind of a lot of the restaurants and other retail businesses are seemingly under pressure, which I know is a lot of worthy exposure in this portfolio?

I don't know that we have tremendous concerns. We're talking to the clients, we are talking - we have the two large chains that we have the largest volume in are Red Lobster and Bob Evans. Bob Evans is back and going strong. In fact, they had asked our clients for deferrals up to year-end and they've started making payments already. Now, if there is a second wave and the states come through and shutdown stuff again, that could impact them, but they seem to be rock solid. Red Lobster is still trying to get their arms around some kind of a carry-out or remote delivery capability, which they have never had in the history of the restaurant chain. That kind of impacted them probably a little tougher. Bob Evans got it set up early on in the program and rolling. So we're not seeing issues with the quick service restaurants that we have. They are not missing a beat. All of them are going solid. You obviously read or heard about the large Wendy's Pizza Hut franchisee that filed for bankruptcy. He's just doing - using that as a tool to kind of do some housecleaning. I think we had - four of our Wendy's are part of his portfolio and they're all paying and processing fine. So, we're in contact with these folks, Mike, generally on a daily basis and talking to them and both from the customer level and they're obviously talking to the restaurant owners and right now we're not seeing any major cracks. If we go into a full nationwide shutdown again, obviously, a lot of restaurants have brought people back, they've bought inventory, they've restarted, that's going to be a double whammy to them. That could impact folks more so than anything else. But if things stay where they're at, don't get any worse, we think we're going to sail through in really good shape.

And the next question will come from George Sutton with Craig-Hallum. Please go ahead.

This is James for George. Two from me here. Within the CRE and STL books, I mean, are you taking additional reserves for borrowers in states that have been imposing the tighter restrictions or you're not looking at it on that level of granularity?

We're - in terms of what we reserve in the portfolio, it's more of a portfolio level reserve. I mean, our credit team has worked very closely with the CRE team to go through the portfolio on a loan-by-loan basis and try - identify areas where there may be more risk or reaching out to borrowers to touch base and see how things are going. I guess, the good thing for us is that we have a pretty diversified portfolio across the country and [indiscernible] the locations within those geographies are pretty good. I mean, we certainly keep our eye on again geographic factors, the things developing with tenants, as David talked about earlier, things overall and whether that's a quick service industry. I mean we keep on top of all of that stuff. But no, we're not reserving. We're not going to that level of detail on reserving in the portfolio.

And then on the public finance bucket, assuming there'd be some demand for borrowings to fill some of the budget deficits, what's sort of your approach to underwriting within that segment?

Yes, actually we're - James, we don't have a tremendous amount of growth in that area at the current time. We've been through that portfolio top to bottom, obviously with the concerns of some of the states in collection of income tax, property taxes, etc. And we're, again, very, very comfortable. There is a lot of different levers to pull in that area. We don't have any single loan that we're worried about at the current time. In fact, we actually have an upside value to that portfolio. We have about $200 million that we estimate we could sell in the secondary market right now at probably at 103 to 104 premium. And we've opted not to do that till we - again we need loan income more than we need extra cash coming back in. So again we're very comfortable the way they're - those loans are set up and the quality. A lot of it's Midwest-based here in our backdoor in Indiana, not in Illinois. So we're very comfortable with that portfolio kind of top to bottom. I don't - got anything to add, Ken?

No, I think we're - our team, I think, as David mentioned, our team did kind of a bottoms-up analysis on just about - on every loan in the portfolio and really did a deep dive on the source of repayments for all the borrowers and beat it up pretty good and came away feeling pretty good about the portfolio.

Just for everybody's clarification on the phone today, we just completed this past month - we had Crowe Horwath come in and do a loan review for us and obviously, right in the midst of the crisis in the play and at the end of the day, they had no adjustments. They had a couple of suggestions of things for us to look at due to the crisis in play, but they really had no concerns and questions whatsoever on the portfolio, the underwriting, and the way we're processing. So we're very comfortable that we are doing everything we can, and then some, to stay on top of the whole lending side of the operation.

Good to hear. And then given your position, sort of, I'll call it a digital-centric bank, is there a surge in digital banking and just seeing how successful some of the fintech lenders have been in distributing the PPP loans sort of influence your strict strategic priorities at all?

Yes, I think the PPP loan side of things - it was an interesting exercise for us. We had kind of, as most institutions did, are all hands on deck. We had people from every department doing it because we originated more PPP loans in a 10-day period than we normally do loans in a calendar year. So it was an interesting exercise. We stayed to just our existing clients and as this program has kind of morphed over the last 60 days, we are very thankful that we did that. We definitely don't want to put a lot of 1% loans on the books for five years now with the repayment terms. We have looked at the outside services that are willing to buy the PPP loans and take them off our hands with sincere existing clients our fear is - it's kind of when you get to the very background, although they're being fronted by four or five different people, the background operation buying the PPP loans, it's the same organization and they're going to have billions of dollars and thousands upon thousands of people to deal with over the next six to nine months. And we don't want the quality of service to blow up. If they move forward with proposed plans now to basically forgive every loan under $150,000, that would take up over 80% of the loans we originated. So we can get out of this thing in the next three months with virtually no hangover. Obviously, that revenue recognition would move forward. So that's kind of a face in the hole that could be a good opportunity. I can tell you we have really solidified our position with a lot of our clients, helping them through the PPP process and getting them some cash to really take the edge off and particularly, if that's forgiven, we'll be heroes for them for years and years. So, it's an interesting time, and in the marketplace and I think we're very well positioned to take advantage. The great part, as you say, a lot of institutions, there's estimates that 5 million to 10 million consumers across the United States were forced into the electronic world over the last 90 days that probably would never have touched online banking, in their life, and that's a tremendous opportunity for customers that most of them are a little further up in the age category. They - a lot of them living on fixed incomes, once they get through the dust and realize this thing really works, without a lot of marketing effort, I think we'll pick up significant client count over the next few months. And we're already seeing it on the small business side of things.

And the next question will come from Nathan Race with Piper Sandler. Please go ahead.

I wanted to touch based on just the loan sale expectations out of - outside of SBA going forward. It sounds like you guys expect to kind of prune the portfolio in the back half of this year. So I just wondered if you can kind of size up the expectation there in terms of loan sales.

We're probably - it's probably in the range of maybe $25 million to $35 million, $45 million in a quarter. Maybe a little bit more in the fourth quarter but starting to look at putting together a potential transaction in single-tenant for this quarter and then perhaps a single-tenant and a public finance deal in the fourth quarter. So probably somewhere - if you're going to take them all together, probably somewhere in the neighborhood of $50 million to $75 million.

Got it. That's helpful. Appreciate that, Ken. And then just turning to credit. Just curious if you guys have kind of the rent collection data for the single-tenant portfolio over the course of the second quarter. Just trying to get a sense of how that's trended across your investor base.

We haven't talked to - we haven't gone specific to ask folks on that. We're gauging it by the payment status in play. We do know Red Lobster, I believe, ask for some amount of rebate between now and year-end. Bob Evans had come back and said, we'd like to go half payments until we reopen and virtually all of those restaurants are reopened today. Those are the only two kind of big players that we know directly came in and asked the owners for some kind of rental abatement. But all of that was being deferred, it wasn't asked as a giveaway. They anticipate, like with Red Lobster, they'd make a payment and a half once they get back up and running full steam till they get caught up. So - and I think the majority outside of the restaurant area, I think, all the others, it's business as usual. They're getting monthly payments and we're not hearing anybody or any complaints. And even on the quick service they're chugging along. They're all doing good.

Okay, great. It's great to hear. And then just staying within credit. Just thinking about the reserve build going forward, it sounds like the provision this quarter was largely a function of just qualitative inputs. But I guess kind of looking ahead and within the context of the second quarter trends in terms of charge-offs - I'm sorry, in terms of classified migration, so forth, just any sense, what you saw in terms of precise classified trends in the quarter and just maybe how you see that maybe be evolving into the third quarter as well.

Yes, I would say that the level of classified criticized has remained relatively flat. I would say that we have not seen significant or substantial negative migration at all so far. I mean, obviously, as we've said, it's in single-tenant and healthcare and some of these portfolios that have large - or had at one point, large deferrals. We stay on top of these portfolios and try to stay in touch with the borrowers, and we track the payments. We track our payments coming in the door on these loans on a daily basis. But I would say, so far, have not seen a lot of - have not seen any negative migration that's - you'd consider out of the norm.

Actually on the other side of it, Nate, we've got about $1.5 million that are 90-day plus delinquency to business owner operated properties currently that are getting refinanced. All indications are that they'll be done in off the delinquency list by the end of the third quarter. So, yes, we're not seeing any specific reserves, any issues just because of what's going on. In anticipation, we'll probably take fairly close to $2.5 million reserve again during the third quarter and then we'll kind of reevaluate where we're at during the fourth quarter, if things can stabilize across the country, the bump up is purely based on unknown factors. As Ken said, it's not specific to single loans and there is no specific reserves out there. So, we even absorbed the one loan that kind of got squarely in the healthcare facility. We just took a hundred cents on the dollar loss on that one during the second quarter. We're going to get 7% to 8% of that back and selling the equipment and stuff in the secondary market, but we're not seeing - and I'd say that the things that help me sleep at night is the fact that absolutely every loan that has come off deferral has now made a payment. And so we're not seeing any push from people getting back into business with business operating as usual.

And I guess, just curious if that healthcare charge-off, was that a function of just what's going on environmentally with the pandemic, or was that just kind of a more one-off operational issue, so to speak?

Combination of the two. It was a single client in California when they did not release the - did not allow him to reopen. He just - and he's a relatively new operator. He just lost it. Sent a note to all of his clients. He was going out of business, filed bankruptcy, packed up his family and left town, literally. So it was just a one-off. Combination, I think, of business inexperience and frustration and concern about the pandemic. So I don't know - we, I think, could have come out of that hole, had he given us a week or two to find somebody to work with him, but he just panicked and nothing we could do about it.

And then just a couple of housekeeping questions from me, and I apologize if you touched on it, Ken. But just kind of the operating expense run rate from here. Any thoughts? Could that kind of get back up to 13.5% like we saw in the first quarter or how does that kind of trend in the back half of this year?

Yes, I would say, all things equal, that's probably - probably 13.5% is probably an okay number. But as David talked about in his comments, I mean, we have - we've been able to pull forward our SBA hiring about six months. I mean, we were at the end of the - at the end of June, we were - we had the budgeted number of BDOs on board that we had originally forecasted for the end of this year. So what that means is that they've been able to hit the ground running and started to get out there and originate business. So we'll probably see - again as long as we're hitting our forecasted number on originations in the SBA space, which are up significantly from three months ago, we'll probably see some increase in the compensation line item because of the increased level. The increased level of originations are going to translate into increased commissions. So that's kind of the, call it, a wildcard for lack of a better term, but as long as we're hitting - as long as we're hitting the origination targets that we've set, you're probably going to see that bottom line non-interest expense creep up as well. Obviously it's well - far more than offset by fee revenue on the gain on sale side. But that would be the one piece that kind of increases non-interest expense throughout the course of the year.

To give you an idea of the growth and the magnitude of the SBA opportunity out here, at the beginning of the year, we had a standard pipeline of about $10 million. Right now, that pipeline is $100 million. So it's grown ten-fold over what we were doing at the first part of the year. And as Ken said, we've got a great opportunity to really knock some numbers out of the park here in the second half and then double down on that or more in 2021.

That's encouraging here and congrats on that hiring. So just one last one for me. Ken, any thoughts on tax rate going forward?

It's - tax rate is always a bit of a moving target for us. I think we're probably - I think as we - some of it obviously has to do with the percentage, the percentage of taxable income. But as long as long as mortgage is solid and we pick up more revenue from SBA going forward, that's going to increase the level of taxable or pre-tax income. So, I mean, I think, and I know we had a negative provision this quarter but we'd probably still model internally somewhere in the range of 8% to 9%.

And the next question will come from John Rodis with Janney. Please go ahead.

Ken, I know there's a lot of moving parts just with the margin, but I'm just sort of trying to put pencil to paper here and assuming you're shrinking the balance sheet some too and given the CD repricing, I mean, do you think the margin can get close to 2% over the next few quarters? Or is that too aggressive?

No, I think, we can. I think we definitely have the trajectory to get there. I think the - I'm not - we're not going to put out a formal guidance or something because there's just too many unknowns out there right now. And, again, we're trying to keep the cash - run the cash balances down a bit. Obviously, we'll probably keep them a little bit higher than we have on a historical basis just because of the uncertainty of the pandemic, but lower those cash balances, lower deposits. But I can tell you, we certainly see a pathway to a 2% NIM here probably over the, call it, the next two to three to four quarters. Given kind of the forecast that we have for kind of what we're thinking about with the balance sheet, we're - we'll have, at the end of the year, a smaller balance sheet kind of targeting that $4.1 billion size by the end of the year with cash balances - reduced cash balances being the largest contributor to the decrease in size. But yeah, there is certainly a pathway that we're looking at to a NIM in the range of 2% over the next two to three to four quarters.

No, I just wanted to make sure I wasn't too aggressive or - okay, I think we're on the same page. And, Dave, just to follow up on your comment on SBA. So I think you said for next year, you said loan production on the SBA side of $200 million to $225 million. Is that correct?

Correct.

Just sort of in the current environment, what sort of revenues, I guess, on loan sales do you think that could throw off based - just sort of based on current pricing and stuff, if everything goes right?

The piece that we just sold - we've got just a little under 10%. We were in the, I think, low - some of them were in the 10% to 11% and a couple of them were in the 9% range and I think we balanced out to about 9%. And with all the charges and stuff we take out of it, we probably net, after fees, somewhere in that 7%, 7.5% range. So if you take the 225 times 75% to 80% and by 7.5% - and that rate has stayed consistent, John, as every other market went upside down, the SBA's has stayed very stable. And obviously, I mean, I know there's a big crunch kind of at year-end of folks buying, that's - premiums could jump during the fourth quarter, but if you take a kind of a 7.5% net on those sales, that's probably a pretty good figure to work with.

So just to be clear, Dave, the 2%, 2.5% or 2% or 3% difference that net, that's basically accounting for the expenses that would flow through for you guys?

Yes. Loan fees, commissions, things that we're paying out on the outside line that we're - we're modeling at about a 7.5% net on those sales.

Okay.

Yes, I mean, I would say that top-line gain of sale premiums, at least in our experience in the stuff we've sold, it's kind of helm in at that $110 million. I mean, we've gotten, I think, pretty decent pricing overall. But, yeah, you just got to - you got to net out the FAS 91 deferred loan fees and - or deferred cost and then any other costs you incur.

This will conclude today's question and answer session. I would now like to turn the conference back over to Mr. Becker for any closing remarks.

Okay, I would like to thank all of you for joining on our call today. We know it's a pretty crazy times out here and we hope everyone remains healthy and safe during these challenging times. And have a great day. We appreciate your time. Thank you.

The conference is has now concluded. Thank you for attending today’s presentation. You may now disconnect.