Mercantile Bank Corporation (MBWM) Q2 2020 Earnings Report, Transcript and Summary

Good morning. Welcome to the Mercantile Bank Corporation Second Quarter 2020 Earnings Results Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Tyler Deur from Investor Relations. Please go ahead.

Thank you, Kate. Good morning everyone, and thank you for joining Mercantile Bank Corporation’s conference call and webcast to discuss the Company's financial results, for the second quarter 2020. I'm Tyler Deur, with Lambert IR, Mercantile’s Investor Relations firm. And joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer and Ray Reitsma, President of Mercantile Bank, Michigan. We'll begin the call with management's prepared remarks and presentation to review the quarter's results, then open up the call to questions. However, before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the Company's business. The Company's actual results could differ materially from any forward-looking statements made today, due to the factors described in the Company's latest Securities and Exchange Commission filings. The Company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the second quarter 2020 press release and presentation deck issued by Mercantile today, you can access it at the Company's website ir.mercbank.com. At this time, I'd like to turn the call over to Mercantile’s President and Chief Executive Officer, Bob Kaminski. Bob?

Thanks, Tyler and good morning, everyone. On the call this morning, we’ll provide you with detailed information on the company's performance in the second quarter, as well as an update on the activities, specifically related to COVID-19. First of all, I want to recognize the efforts of the Mercantile team, for allowing us to continue maneuvering through the many challenges brought about by the pandemic, since the start of the crisis earlier this year. Our employees have risen to the occasion, quite often working remotely, to allow Mercantile to successfully serve our customers and fulfill their banking needs. Mercantile demonstrated a solid performance in the second quarter with per share earnings of $0.54, which included the strong provision building we foreshadowed at the end of the first quarter. We also announced that our Board has declared our regular cash dividend for the third quarter of $0.28 per share, furthering our achievement of ongoing financial strength, amongst the challenging environment. As one might expect, there are many moving parts in our financial statements during the quarter, and Chuck will provide much more detail on our performance momentarily. As we discussed during our call in April, the safety of our employees and customers is our top priority. The vast majority of our staff was working from home, until early June, after some physical and social distancing modifications could be made to our facilities, and was deemed safe for them to return to their offices and workstations. Mercantile Bank lobbies remain close to walk-in customer traffic until June 26. During the time our facilities were closed, our team and clients adapted extremely well to alternative methods of engagement to perform their banking activities. The full time line of COVID-related activities can be viewed on Slide 4. The Paycheck Protection Program dominated much of the attention of the lending team during the second quarter, as our bank was extremely successful and originated a significant volume of SBA loans for businesses in our markets. The focus regarding PPP is now shifted to the forgiveness phase of the program, as we work to assist loan recipients in the gathering and submitting of the required information, to allow the rendering of a forgiveness determination. Through the efficient work of our lending groups on the PPP program, we have engaged numerous potential new relationship opportunities, from businesses that approach or were referred to Mercantile, when the incumbent banks were slow with their PPP applications. We will provide you with an update later on this call on the portfolio performance, and information regarding customers receiving assistance through our Payment Deferral Programs. The metrics of our bank’s asset quality remained very strong, when we have worked with those clients impacted by COVID-19, to provide relief via payment deferments within the framework of appropriate accounting guidelines. Our customers are working diligently to position their businesses, so they can withstand the impact of revenue and expense challenges with the various closures, mandated to help to stop the spread of the virus. The performance of our retail mortgage team in the second quarter was extremely strong. Customers were able to take advantage of low interest rates and refinance their existing mortgages, but also with the reopening of the Michigan economy, new purchase activity was also very good. The combination of those trends when added to the tireless work of our lending and operation teams, allowed our company to achieve record mortgage production during the second quarter. Ray and Chuck will have more detail on this in their comments. Operationally, in late June, Mercantile announced the closure of three branch locations. These decisions were made in part as part of our ongoing efficiency efforts, to ensure the best allocation of our resources. We anticipate nominal attrition as the customers of these branches will be serviced by other Mercantile branches. Since the beginning of 2016, with the ongoing deployment of technology as an alternative delivery channel, Mercantile has been able to reduce its number of locations in 53 to what will be 37, once these locations are closed later this year. We continue to engage our customers so we can fully understand their needs, and how patterns and preferences of interaction with us are evolving, especially in view of the challenges brought up by COVID-19. As we discussed at the end of first quarter, Michigan experienced a higher level of infections than many states, and therefore, the governor has taken an aggressive approach for containment, including stay-at-home order and a period of widespread closure of all the essential businesses and industries. As the incidence of new infections dropped during May and most of June, the state implemented a phased reopening of consumer and business activity, which has allowed the economy to slowly be reenergized. A recent increase in cases towards the end of June, and continuing into July has paused, that caused a pause in the further progression for the phases, as we try to understand the evolution, transmission and ramifications of the virus. The state and local governments and business leaders alike, and our state are continually working keep citizens healthy, while allowing them to return to work and businesses to safely reopen. Should number of infections continue to increase, the government has indicated that the current phase of the state's plan may need to be downgraded, with more restrictions reinstituted on the activities of businesses and consumers. As mentioned earlier, the safety of our employees and customers will continually be our top priority. I’ll end my comments by touching on additional events that have occurred around this nation, capturing the attention and focus of its citizens. The effects of systemic racism, manifest themselves in many ways, and most recently, in the form of violence against people of color. The management, staff and Board of Mercantile Bank are appalled by these tragedies and are committed to working together with our community partners, to address and correct the underlying causes. Internally, Mercantile team is having ongoing conversations about racism, the healthy institution of real change in our communities. We are committed to listening, learning and making a difference. Those are my introductory remarks, I’ll now turn it over to Ray.

Thanks, Bob. Our loan portfolio increased $432 million in the second quarter of 2020, which consisted of over 2,000 Paycheck Protection Program loans totaling $550 million. Noted on Slide 8, and offset by $109 million in reduced outstanding under commercial lines of credit. Professional manner in which team administered the origination of these loans have resulted in significant opportunities to grow our base of commercial relationships. Additionally, our construction pipeline remain solid, $78 million of commitments in commercial construction and development loans, which we expect to fund over the next 12 to 18 months. Further details on payments relief systems for commercial retail borrowers can be found on Slide 6 and 7. Our asset quality remains strong, as non-performing assets totaled just $3.4 million, or less than one-tenth of a percent of total assets at June 30, 2020. This breakdown can be found in the financial portion of our presentation on Slide 23. Partial past due loans at quarter end are nominal in dollar terms totaling $464,000, representing 12 borrowers. Overall past due information can be found on Slide 12 and 13. However, given the uncertainty of the economic environment, we elected to record a provision for loan losses of $7.6 million. This amount was generated entirely through qualitative factors, supporting the analysis as opposed to reserves against specific credits. These actions bring the allowance for loans to -- I'm sorry the allowance for losses to total loans to 1.16%, but excluding the impact of PPP loans. Payment deferrals numbered 705 for the quarter end represented $718 million in exposure, $23 million of deferred payments. As of July 17, sanctions in place beyond June 30, numbered 33, represented $130 million of exposure and $4 million of deferred payments. We expect more requests in the near-future, however, these relatively modest numbers combined with our expectations for future requests, and our pass due performance are positive indicator. The risk rating process depicts a portfolio with strong characteristics, reflecting the strength of the pre-crisis economy. Maintaining the accurate risk ratings will remain a key focus in the upcoming quarters, as our borrowers report results impacted by the crisis. We continue to monitor the financial condition and performance of credits, particularly in the following segments: automotive dealerships, hotels and lodging, assisted living, restaurants, construction, movie theatres, and retail. None of these individual segments account for more than 5% of commercial loans. Acquisition of these segments can be seen on Slide 10. We recognized non-interest income during the second quarter of nearly $11 million, up $5.9 million or nearly 118% prior year second quarter, excluding $1.3 million in non-recurring items related to that quarter. That can be seen on Slide 16. This improved level of non-interest income was largely driven by increased mortgage banking income, reflecting the success of ongoing strategic initiatives designed to increase market share, a higher level of refinance activities stemming from historically low rates, and increased share in the purchase market and an increased percentage of loans sold. For the second quarter of 2020, purchased mortgage loans originated were up 38% over the comparable quarter in the prior year, while refinance activity increased 469%. June applications and backlog suggests that refinance opportunities will persist into the near-future, and purchase applications are at record levels. Continuing to enhance mortgage banking income to increase market share, including an increased share in the purchase market remains the priority. We continue to hire proven mortgage loan originators as we're able. Non-interest income from payroll services grew 4.2%, despite high levels of unemployment during the quarter, relative to the prior year comparable quarter. Service charges on accounts and credit, debit card income each fell by approximately 9%, as activity within the accounts was diminished overall during the period. However, recent activity has shown a rebound, although, still less than the previous quarter. The exercise of discipline-related overhead costs as we focus on efficient delivery systems and all of our lines of businesses remains the priority, as evidenced by the decision to close three branches where Mercantile locations are available on close proximity of the facility. The onslaught of the COVID-19 virus and its ongoing impact is providing an opportunity to demonstrate the value of community banking, combining high service levels with strong capabilities. Our electronic banking capability coupled with the availability of drive through facilities, allowed us to close our branch lobbies on March 25, contributed to the ability to have 75% of our employees work-from-home, until resumption of normal activities [Indiscernible]. That concludes my comments, I will now turn the call over to Chuck.

Thanks, Ray, and good morning, everyone. As noted on the Slide14, this morning we announced net income of $8.7 million, or $0.54 per diluted share for the second quarter of 2020, compared with net income of $11.7 million, or $0.71 per diluted share for the second quarter of 2019. Net income during the first six months of 2020 totaled $19.4 million, or $1.19 per diluted share, compared to $23.5 million or $1.43 per diluted share during the first six months of 2019. Proceeds from a bank-owned life insurance claim increased net income in the previous second quarter by $1.3 million, or $0.08 per diluted share. Excluding the impact of this transaction, diluted earnings per share decreased $0.09 or about 14% during the current year's second quarter, compared to the respective prior year period. Proceeds from bank-owned life insurance claims and a gain on the sale of a former branch facility, increased net income in the first six months of 2019 by $3.1 million or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased $0.05 or 4% during the first six months of 2020, compared to the respective prior year period. Turning to Slide 15, interest income on loans declined in 2020 periods compared to the 2019 period, primarily due to FOMC rate cuts aggregating 225 basis points since the beginning of the third quarter of 2019, with 150 basis point of those cuts occurring in March of this year. Interest income on security during the 2020 periods benefited from accelerated discount accretion from called U.S. government agency bonds, totaling $0.9 million during the second quarter and $2.7 million during the first six months of 2020. In total, interest income declined $2.7 million during the second quarter of 2020, compared to the second quarter of 2019, and was down $3.4 million during the first six months of 2020, compared to the first six months of 2019. Interest expense declined in all categories during the 2020 periods compared to the 2019 periods, reflecting the decline in interest rate environment. In total interest expense declined $2.1 million during the second quarter of 2020, compared to the second quarter of 2019, and was down $2.5 million during the first six months of 2020, compared to the first six months of 2019. Net interest income declined $0.5 million during the second quarter of 2020, compared to the second quarter of 2019, and was down $0.9 million during the first six months of 2020, compared to the first six months of 2019. Provision expense increased significantly in the 2020 periods compared to the 2019 periods, primarily reflecting the coronavirus pandemic and its impact on economic environment. Provision expense totaled $7.6 million during the second quarter of 2020, and $8.4 million during the first six months of 2020, compared to $0.9 million and $1.8 million during respective 2019 periods. The large provision expense recorded during the second quarter of 2020, was primarily comprised of an allocation associated with the newly created COVID-19 pandemic environmental factor, and an increased allocation related to the existing economic conditions environmental factor. The COVID-19 factor was added to address the unique challenges and economic uncertainties resulting from the pandemic and its potential impact on the collectability of the loan portfolio. We elected to postpone the adoption of CECL permitted by the CARES Act. However, we are running our CECL model concurrently with our incurred loss model. Based on preliminary results, we do not believe the loan loss reserve balance determined by the CECL model, is materially different than the loan loss reserve balance, as determined by an incurred loss model as of June 30, 2020. Turning to Page 16, fee income increased in the 2020 periods compared to the 2019 periods, primarily reflecting significantly higher mortgage banking income, which more than offset reductions in certain other fee income categories. Excluding a bank-owned life insurance claim during the second quarter of 2019, fee income during the second quarter increased $5.9 million or 118%, when compared to the second quarter of 2019. Excluding bank-owned life insurance claims and the gain on the sale of former branch facility during the first six months of 2019, fee income during the first six months of 2020, increased $7.7 million or 79% when compared to the first six months of 2019. Reflecting increased refinance activity and the successful implementation of several strategic initiatives, mortgage banking income was substantially higher during the 2020 periods, compared to the 2019 periods. Second quarter 2020 mortgage banking income was $6.3 million higher in the second quarter of 2020, and income during the first six months of 2020 was $7.9 million higher than during the first six months of 2019. Credit and debit card income was lower during the 2020 periods when compared to the 2019 periods, reflecting lower transaction volume during the second quarter, especially during the first-half of the quarter. Activity volumes have been increasing over the past six to eight weeks. Service charge income was also lower during the second quarter of 2020, compared to the second quarter of 2019, and is almost the same when comparing the first six months of 2020, with the first six months of 2019. The lower level primarily reflects less transactions from business customers, and high average deposit balances from individual customers that alleviated certain monthly service charges. Continuing on Slide 17, overhead cost increased in the 2020 periods compared to 2019 periods, primarily reflecting higher compensation cost, especially related to residential mortgage lending activities. Salary and benefit costs were up $0.8 million or 6% during the second quarter of 2020 when compared to the second quarter of 2019, and up $1.4 million or about 5% during the first six months of 2020, when compared to the first six months of 2019. Occupancy, furniture and equipment costs were up a combined $0.5 million during the second quarter of 2020, when compared to the second quarter of 2019, and up a combined $0.9 million during the first six months of 2020, when compared to the first six months of 2019, and large part reflecting the fall of 2019 completion of our main office expansion. Continuing on Page 18, our net interest margin was 3.17% during the second quarter of 2020, down 46 basis points from the first quarter of 2020, and down 52 basis points when compared to the second quarter of 2019. The yield on earning assets declined 69 basis points during the second quarter of 2020, when compared to the first quarter of this year, while the cost of funds declined 23 basis points during the same time period. When comparing the second quarter of 2020 with the second quarter of last year, the yield on earning assets declined 100 basis points while the cost of funds declined 38 basis points. The yield on loans was down 51 basis points during the second quarter compared to the first quarter, and down 100 basis points when compared to a year ago. And large part reflecting the Fed’s aggregate 225 basis point reduction, and the targeted federal funds rate mentioned earlier. We are recording the origination fees and direct origination cost of PPP loans, equating to a $14.7 million net increase to interest income on commercial loans using the level yield method. Second quarter 2020 net accretion totaled $2.8 million. Assuming no forgiveness transactions, we expect to record net accretion of $2.9 million, and $2.5 million during the third and fourth quarters of 2020, respectively, and $2.1 million, $1.6 million, $1.2 million and $0.8 million during the first, second, third and fourth quarters of next year, respectively, with the remainder during the first-half of 2022. The yield on securities during the second quarter of 2020 and the first six months of 2020, benefited from accelerated discount accretion called U.S. Government Agency Bonds. Accelerated discount accretion totaled $0.9 million during the second quarter of 2020, positively impacting the quarter’s net interest margin by 10 basis points. The accelerated discount accretion totaled $2.7 million during the first six months of 2020, positively impacting the periods net interest margin by 15 basis points. Negatively impacting our net interest margin during the 2020 period, and especially the second quarter of this year is a significant volume of excess on balance sheet liquidity depicted by low yielding deposits with the Federal Reserve Bank of Chicago and a correspondent bank. The excess funds are primarily a product of federal government stimulus programs, as well as lower business and consumer investing in it and spending. Overnight deposits averaged $247 million during the second quarter of 2020, and just shy of $200 million during the first six months of the year, compared to our typical average balance of $50 million to $75 million. We expect a level of overnight deposits to stay at elevated levels for at least the remainder of 2020. The cost of funds has also been on a declining trend, primarily reflecting the following interest rate environment, but in terms of magnitude and scale, not to the degree we experienced on our yield on loans. For our net interest margin for the remainder of 2020, assuming no forgiveness activity on PPP loans, and a steady level of excess funds as we depicted as of June 30, we expect our net interest margin to be in a range of 2.85% to 2.90%. Under normal excess funds, which again we do not expect, but if we did have normal excess funds, our core margin if you will, would be 3.10% to 3.15%. On the next few slides, we talk about mortgage banking. Mortgage loan originations increased substantially during the 2020 periods, and especially during the second quarter of 2020, and large part reflecting significant refinance activity stemming from the decreased interest rate environment, coupled with the ongoing success of strategic initiatives that were designed to expand market penetration, enhance gain activities and operate more efficiently. Mortgage loan originations totaled $275 million during the second quarter of 2020, compared to $80 million during the second quarter of last year, an increase of almost 250%. Mortgage loans originations totaled $408 million during the first six months of 2020, compared to $125 million during the first six months of last year, an increase of about 225%. Almost 80% of the mortgage volume during the second quarter of this year consisted of refinanced applications, compared to about 48% last year's second quarter. Approximately 82% of the mortgage loan originations during the second quarter of this year has been or will be sold on the secondary market, up from about 62% during the second quarter of 2019. In recent weeks we have seen an increase in the origination of purchased mortgage loans, and as Ray mentioned earlier, the pipeline of purchased mortgage applications is currently at a record level. On the next couple of Pages, Slides 22 and 23, we talk about asset quality. The standard quality metrics of the loan portfolio remained very strong, with continued low levels of non-performing loans and loan charge-offs. Non-performing loans as a percent of average loans equal only 10 basis points at the end of second quarter. The balance of other real estate-owned was less than $200,000 at quarter end. Gross loan charge-offs totaled $300,000 during the second quarter of 2020, while recoveries of prior period loan charge-offs totaled about $150,000. The resulting net loan charge-offs of less than $200,000 equated to just 2 basis point of average total loans annualized. Additions to non-performing assets totaled just over $200,000 during the second quarter of 2020, with a net reduction of about $300,000 recorded in non-performing assets on an overall basis during the quarter. As shown on Slide 24, we remain in a strong and well-capitalized regulatory capital position. The bank’s Tier 1 leverage capital ratio was 10%, and a total risk based capital ratio was 13.5%, as of June 30 2020. The total risk based capital ratio was over $113 million above with minimum threshold we categorized, as well capitalized. There was no share repurchase activity during the second quarter of 2020, as in late March we elected to temporarily cease share repurchase activity to preserve capital for lending and other purposes, due to the uncertainties surrounding the COVID-19 pandemic. We currently have about $10 million available in our current repurchase plan. Concluding on Slide 25, I want to make couple of comments on our forecast considerations for the remainder of 2020. Due to the high degree of uncertainty that currently exists, we will not be providing earnings performance guidance as we've done on past conference calls. However, we are able to offer key considerations that should be factored into any earnings forecasts of our company. These include on net interest income, PPP loan and PPP LF volume. PPP loan portfolio totaled $549 million at the end of the second quarter, while still originating new PPP loans, maybe one to three a day, aggregating less than about $100,000 each day. We expect that trend to continue until the planned deadline slated right now for early August. We did borrow about $44 million in late April under the PPP LF program, however, due to a large and growing volume of on balance sheet liquidity, the PPP LF advance was fully paid off in early June. Given current and expected ongoing excess on the balance sheet liquidity, it is likely the PPP LF program will not be as excess in future periods. However, we currently have over $450 million in borrowing capacity if need be. In regards to PPP loan forgiveness, net deferred SBA loan origination fees and direct loan origination costs will be accreted into interest income on loans over the life of loans and a level yield method, as I detailed earlier. The vast majority of PPP loans were underwritten for a 24 month period, the degree to which PPP loans are forgiven and the loans are effectively paid off by the SBA net deferred loan be accretion may be impacted. And of course, any volume of -- any increase in volume of non-accrual loans, the degree to which an increase to non-accrual loans is experienced, loan interest income may be negatively impacted. Provision expense may be impacted in future quarters by items, such as net loan growth, the degree to which loans are downgraded in accordance with our loan grading paradigm, the degree to which loans become impaired due to be in placed to non-accrual or TDR status, and the qualitative environmental or reserve allocation factors are formally reviewed at the end of each quarter, and certainly any changes may have an impact on the required reserve calculation. In regards to fee income, mortgage loan originations for the purchase of homes has been steadily increasing over the past couple of months. And the current pipeline of applications for the purchase of homes is at a record high. However, the degree to which changes in COVID-19 measures are made by Michigan's governor are difficult to predict on our mortgage banking operations. Michigan's shelter-at-home decorations also had a substantial impact on credit and debit card interchange fees, as card usage dropped. However, activity has recently increased. The degree to which changes and COVID-19 measures are made by Michigan's governor are difficult to predict on these operations. And finally overhead costs, any increase in problem loan relationships could result in an increase in collection costs. In closing, while there are many uncertainties that may impact Mercantile's financial condition, operating performance in future periods, we note that we entered a stressed environment with strong asset quality and solid capital position. We are pleased with our second quarter operating results and financial condition, as of June 30, 2020, and believe we are well-positioned to navigate through the unprecedented environment, created by the coronavirus pandemic and other events. Those are my prepared remarks, I'll now turn the call back over to Bob.

Thank you, Chuck. That now concludes management's prepared comments. We will now open the call for the Q&A.

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Brendan Nosal from Piper Sandler. Go ahead.

Very good morning, guys. How are you?

Good morning, Brendan.

Just want to start off on deferral trends here. So just help me think about how we should kind of interpret the two buckets, the $740 million that's three months or less versus $130 million that's three to six months. Is the expectation here that that $740 million number will decline as we move forward, with some moving into a three to six month bucket, but hopefully, more of that just no longer being on deferral at all?

Well, I guess the biggest perspective around this is that, we were fairly liberal in providing deferrals early out of the crisis, and the guidance was consistent with that from those who regulate us, and the experience around the industry. On the second go around, we were much more concerned with the credit dynamics that surrounded that. We had the opportunity to review more information, financial information from those borrowers, and as a result, we saw that a trend decreased rather significantly. If you look at some of the buckets that were paying particular attention to the number of the deferrals, for instance, automotive dealers went from 17 to 7, restaurants went from 55 to 1, hotels went from 19 to 3. So, in those categories, we’re seeing the ability, at least, through July 17 to function well without further deferrals. Now I would be remiss if I didn't mention that it is July 17, and there are days ahead which could include requests for more referrals, however, the liquidity within the system is such that in total it provides some cause for optimism. But unprecedented is the right term for these times and what the future holds remains to be seen. But as we evaluate deferrals as of this date, they’re down considerably or less than 20% of what they were on the first quarter.

Okay, understood. And then, just one more for me and then I’ll step back. We’d just be curious to hear an update on how some of the larger, let’s call them, at risk portfolios are doing today versus three months ago, in areas like hotels, restaurants, entertainment, just any color on things like occupancy rates or capacity in restaurants today versus two months ago will be quite helpful?

Yes. As it relates to restaurants, they opened under the governor's orders in Michigan, and most of them are active, and operating at a percentage of the normal occupancy. But the take-out business is just absolutely thriving as is the drive through business. So we've seen results that range from better than they were before the crisis to similar and slightly worse. And so, that's an area that I think we will see no more stress [indiscernible] in the future, but it hasn’t happened yet and to be able to quantify that is absolutely impossible. As it relates to hotels, occupancy in many of those has made a turn and started to come up a bit, still well below the levels that you have observed prior to the crisis. And so, the experience there is that the performance is still going to be diminished in the next few months that we'll see and where it goes from there, will hinge on the pace of the recovery.

All right, great. Thank you for taking my questions.

Thank you.

Our next question is from Damon DelMonte from KBW. Go ahead.

Great. Okay. So, first question kind of on the margin here, probably for Chuck. So your reported margin was 3.17% this quarter, and you noted that there was a 10 basis point benefit from the salaries accretion from the called agency securities. So then that would put the core margin kind of like around call it 3.0%, 3.07% or so and you're kind of guiding down to 2.85% to 2.90% is that right?

Yes. I think part of that is the impact of the excess liquidity that we have on our books, which is going to be higher. And the excess liquidity as we have today, and that we've had over the last few weeks is quite a bit higher than the average excess that we had during the second quarter. So what you're seeing there is the impact of the ongoing and increased excess level of balance sheet liquidity.

Got you. Okay. And you expect that to kind of stay on through the end of 2020, and then eventually move off once the PPP proceeds are deployed? Is that correct?

Yes. I mean, yes, that's been the difficulty of -- the impossibility of trying to predict. I think all of us bankers thought that, hey, once PPP money hits within eight weeks, 10 weeks, a lot of that money would be out of the bank. And what we've seen and I know talking to other bankers, they've seen the same thing is that a large portion has remained in the bank. So when we made the loans, we went ahead and credited deposit accounts like we typically would. And we certainly have seen some money leave the bank. But if you just very simply look at the going ons of your balance sheet changes, we can definitely see that some of those proceeds remain with the bank, and it's impossible for us to predict when those monies would go out for operational use. We have over 2,100 loans that we did. As you know, money is very fungible, so trying to trace proceeds for one credit would be very difficult, 2,100 would be simply impossible. So, my assumption is that a lot of that money is going to be staying at least for some time. I think, when we can get past the COVID-19 environment, I think we'll see businesses start to expand, obviously bring all their employees back. So I think, I would expect more movement. But I would say that over the last few weeks, the movement of our deposit balances has been pretty steady.

I think what it does point to also Damon, is it points to the strength of much of our customer base. And as they were really good positioned as we headed into the pandemic, they took advantage of the various offerings and the government programs through SBA to help fund their payroll costs. And as their businesses have contracted, due to some of the stay-at-home orders and business shutdowns, they're sitting in a pretty hefty cash position right now. But as we talked about in our comments, as the economies continue to open back up around the country, and hopefully, continue with the phased reopening they'll go back to more of a normal operating environment as much as we can at this point in time. But I think the factor of the strength of our customer base is also one that I don't want to escape mention in the conversation as well.

Got you. Okay. It's helpful. And then with respect to this quarter's provision and kind of how you're looking at the reserve going forward, you noted, if you exclude the impact on the PPP loans the reserve is actually 1.16%. So, pretty sizable build this quarter. You feel like you're at an adequate level, or do you think that additional reserve building is likely as we progress through 2020?

I think that's the question that we're all hinging on right now, David, is that we feel really good about our reserve at June 30. We did the provision building through the qualitative factors that Chuck had outlined and Ray outlined in their comments, and it was a prudent thing to do. That aligns us up very nicely with the CECL model will continue to show throughout the rest of the year. But really going forward, we'll continue to monitor that and make adjustments to qualitative where we find it necessary. And also with specific quantitative adjustments that we need to make based on deterioration of the specific loans in the portfolio. We haven't seen that as of yet, and we're very pleased with that. But we know that where the pandemic continue on the shutdowns lasts a lot longer and deeper into 2020, there is going to be some detrimental effect to our client base. And so the qualitative factors help with that at the moment. But then if we get some specific deterioration with specific credits, we'll address that appropriately too. But right now, we feel really good about the reserve. With a prudent provision build at the end of the -- throughout the second quarter and where we stood at June 30 was where we felt we needed to be at. And we will react appropriately as this quarter continues on and surely in the fourth quarter. But we feel good about it.

Okay, great. And then just one final question. I want to make sure I'm reading this properly. So, the initial 90 day deferrals on the commercial portfolio is the total of $790 million. Then you have another $130 million that's from four to six months. So in total that's around call it $850 million, so basically 30% of the commercial portfolio is deferred right now?

Yes. I would say, when you look at three months or less, a lot of those have runoff now, Damon. And so what we see is the four to six, those are mostly what we would call second round, so a vast, vast majority if not all of the original payment relief for three months. And then those customers that seek additional payment relief were generally giving them another three months. And so that other three months is really what you’re seeing on Page 7. So, I don’t think you really want to add those two slides together, because there’s going to be a lot of -- anybody that's on Page 7 was also included on Page 6. That’s a better way of seeing it.

And all the ones on Page 6 that there were three months or less both payments have resumed.

Okay. So, is there a way based on this information I can look at your portfolio and say x% of the commercial portfolio is deferred right now? Or no, because they overlap?

What I would say, if you wanted to simply do that Damon, look at Page 7. I think as Ray indicated, we’re definitely having ongoing conversations with certain borrowers to talk about potential additional needs. So, as we sit here today, Page 7 would be the number you want to use.

Okay. So, Page 6, gives you a snapshot of what your initial round of deferment request were, and then subsequent to that some of that has gone back to performance and then others have migrated into the four to six months?

Right. The vast majority have gone back to making payments and then what you see on Page 7, at this point in time, these are the ones that have said, I need additional help.

Got you. Okay, that’s all I had for now. Thank you very much, guys.

Thanks, Damon.

[Operator Instructions]. Our next question is from John Rodis, from Janney. Go ahead.

Good morning, everybody. So, just back to the previous question. So Page 7. So if you include retail that’s $132 million. So that's roughly 5% of core loans excluding PPP, correct?

That’s correct, John.

Okay. So, that’s what's on deferral right now?

As we speak today, yes. As of Friday, I need to mention.

The 17.

Yes, 17.

Chuck, your margin guidance 2.85% to 2.90% for the second-half, does that include your "normal amortization" I guess of the PPP loans that you outlined?

That’s correct. Yes, that includes that schedule that I provided.

Okay. And then, I guess what is your assumption as far as forgiveness? What percent? I know it’s a guess, but what percent do you think is ultimately forgiven? And as far as timing, is it a third quarter, fourth quarter or mostly fourth quarter, first quarter? What are you sort of thinking today?

I think John, the assumption by our customers and we believe that there are so many that their loans are going to be forgiven. But since the fact that there’s been some guidance but not complete guidance by the SBA and the government odds on how the forgiveness part will work, we're just lick -- we’re trying to make our best guess at this point in time. But the assumption of our customers that their loans were used for a payroll as the program prescribed, their loans will be forgiven. But until you have the actual guidance you can’t make that final determination, so it is a big question mark.

It seem to me, John, if I could add, it doesn’t seem like it's going to be a lot of a third quarter activity. We don’t even the guidance out yet as to how to apply or help our borrowers apply for forgiveness. We have been hearing maybe early August that will be published, but we have heard dates before. And then I see that the treasury has allowed up to 90 days to go ahead and approve the request, or to act on the request. So certainly, Congress and other banking trade groups are trying to, at least, for the smaller loans are trying to get more of an automatic forgiveness or at least a much simpler form. That would obviously speed up the process if there is something like that. But if its loan-by-loan, it's going to take quite a while, and I would think it's going to be more of a fourth quarter or first quarter activity without some way of streamlining the smaller loans forgiveness program.

Chuck what percent of your loans are under a $125,000 balances?

I had that with me. I did bring it with me to the room here. I think what you would find is that if you look at the number of loans, a majority fall under that dollar amount. But if you look at the dollars, a majority of the dollars that we lent out our larger customers or larger borrowers.

Yes. Okay. One other question just obviously mortgage has obviously did very well in the quarter. As we go forward, do you expect to see some normal seasonality? Clearly, I would think in the fourth quarter, maybe. But third quarter, do you think just directionally, do you think mortgage is down from the second quarter? Or just what are you thinking?

Yes, this is Ray. The mortgage backlog has been rather steady for the last six weeks or so. So that would portend similar results into at least the beginning of the third quarter, or at the end of the third quarter in the fourth quarter seasonality will certainly take an effect. But particularly, as it relates to purchases, but if rates continue as they are, refinance activity will be a strong contributor. And so in sum, I think the answer to your question is the seasonal pattern will persist, but it will be at a higher level than it's been in the past.

Okay, fair enough. Okay. Thank you guys.

Our next question is from Kevin Swanson from Hovde Group. Go ahead.

Hi, guys.

Hey, Kevin. Good morning.

Hey, I appreciate the commentary around the NIM and the guidance there. But I'm sorry if I missed this, but was there any guidance around what it actually means for spread income?

I'll let you guys do those calculations. So I feel comfortable with assumptions that I gave to talk about the spread and margin. Under my assumptions, I don't think we're going to see a huge change in average earning assets. So, I think those two combined will probably get you to where you want it to be to go.

Okay, fair enough. Yes, I appreciate that, because as much as the margin contracts, if NII doesn't really change all that much, then I guess there's some moving points there. But just one more question, I appreciate the increase in the balance sheet from the liquid assets and the PPP. But you guys kind of jumped pretty far ahead of the $4 billion number. Given, how do you think that shapes out longer-term? Are you now considered yourself north of $4 billion for the longer-term? Just kind of curious in your thoughts on how that all shakes out.

No, I don't think we'll see that. We certainly expect all or a vast, vast majority of our PPP loans to be forgiven. I think maybe where you're going is that while they're forgiven, so that means our loans now become overnight investments to the Federal Reserve. And we'll have to work those off over time. So, I think it's going to be quite a while for that money to work its way out of our balance sheet. But I don't think a majority of that's permanent. But having said that, and Ray kind of touched on that, we're still talking to current customers about loan needs. We're certainly talking to prospects. Ray touched on the PPP program prospects, some opportunities there. So we certainly would expect over time that our commercial loan portfolio will continue to grow. But when you have $550 million in PPP portfolio, that's a slug of money to have to work through.

Got it. Okay. Thanks, guys.

Thank you.

Our next question is from Brendan Nosal from Piper Sandler. Go ahead

Hey. Just one follow-up for me on the margin. I appreciate that the 2.85% to 2.90% includes both typical PPP fees as well as the excess level of liquidity. And then the 3.10% to 3.15% that you gave does that exclude both excess liquidity as well as any impact of PPP? In other words, does that kind of be the expected underlying run-rate for the NIM going forward?

No. Brendan, the 3.10% - 3.15% still includes the PPP accretion. But it brings us our balance sheet back normal on excess balance sheet liquidity. So just the latter.

Got it. Okay. Thanks.

As there are no more questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Bob Kaminski for closing remarks.

Thank you, Kate. Thank you all very much for your interest in our company. We hope you and your families stay healthy and safe. We look forward to speaking with you next at the conclusion of the third quarter. This call is now concluded. Thank you.

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