Independent Bank Corp (Massachusetts)
NASDAQ:INDB
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Independent Bank Corp (Massachusetts)
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Good and welcome to the INDB’s First Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions]
Before proceeding, let me mention that this call may contain forward-looking statements with respect to financial conditions, results of operations and business of Independent Bank Corp. Actual results may be different. Factors that may cause actual results to differ include those identified in our annual report on Form 10-K and our earnings press release.
Independent Bank Corp. cautions you against any unduly relying any forward-looking statements and disclaims any intent to update publicly and forward-looking statements whether in response to new information, future events or otherwise.
Please note that during the call, we will also discuss certain non-GAAP financial measures as we view Independent Bank Corp's performance. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results.
Please refer to the Investor Relations section of our website to obtain a copy of our press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information regarding non-GAAP measures. Also please note that this event is being recorded.
I'd now like to turn the conference over to Mr. Chris Oddleifson, President and CEO. Please go ahead.
Good morning and thank you for joining us today. With me as usual, are Rob Cozzone, our Chief Operating Officer; Mark Ruggiero, our Chief Financial We're also joined by Gerry Nadeau, President of Rockland Trust, and our Chief Commercial Banking Officer.
As with you, I imagine, we are each participating from separate locations today in keeping with physical distancing guidelines. And before we begin, I'd like to extend – we'd like to extend to our listening audience our very best wishes to you and your families during this pandemic crisis. These are extraordinary times. Our first quarter results are reflective of that challenging environment, with net income of $26.8 million or $0.78 per share, which included a sizable $25 million loan loss provision arising out of revised assumptions related to COVID. Our early adoption of the CECL accounting standard at January 1 had minimal impact. This outsized provision stood in contrast to the net credit losses in the quarter of less than $0.5 million.
Mark will be covering Q2 – Q1 shortly, but the bulk of my and other comments will address COVID-19 related matters in our action. But first, these are the basic messages I will really like to leave with you today. We are totally engaged in working with our customers and are striving to support them as they deal with the enormous burdens imposed on their day-to-day operations and households. Our business continuity planning has enabled us to successfully maintain high levels of service and operational continuance.
From the outset, we focused intensely on the well-being of our colleagues to ensure their physical, financial and emotional well-being. And they have proved themselves to be resilient, engaged, resourceful and relentless in their pursuit of providing what our customers need right now. And lastly, INDB is a resilient company. We are confident in our ability to meet the profound challenges of these stressful times. As we have proven – it has proven to be the case in the past.
While this crisis is unique from prior ones in many ways, we feel we have the people, business model and balance sheet to persevere and over time as the crisis ebates, subsequently regain our momentum.
There are appendices at the end of our earnings release the many ways in which we can support our operation consistency, which I'd like to just briefly touch on. It also contains details on various loan exposures and forbearances along with the background on CECL, which I will speak to in a moment.
Here are some of the ways we've been supporting our personal customers. We have increased the daily debit card spending and ATM withdrawal limits. We've increased mobile deposit limits. We've waived penalties for early CD withdrawals. We have waived late charges for consumer loan payments. We've provided an option for payment deferrals on mortgage and home equity loans. We've instituted 90-day foreclosure moratorium on residential loans. And provided for drive up window service at the vast majority of our branches, along with accommodating requests for on-site appointments. And we've added additional call center resources to answer questions and reassure customers.
For our business and commercial customers, we've extended several of the same retail style concessions to small businesses. We participated in the government-sponsored PPP loan program for small businesses we have received thousands of applications thus far and secured guarantees for approximately $700 million in loans. And we have accommodated request for forbearance, including payment deferrals and modifications.
For our Rockland Trust colleagues, we continue to take many steps to keep them safe so they continue to deliver exceptional service to our customers. This includes leadership communicating frequently with robust real time information, offering support, compassion, and understanding for colleagues on personal circumstances as they manage family, work life balances. We've increased employee education over proper health practices in accordance with the CDC guidelines. We're supporting and enable significant work-from-home capability with about 86% of our non-retail workforce operating on remotely.
Of course, we're practicing physical distancing and safety measures in the workplace, increasing cleaning frequency across our branches and offices. And we're maintaining full time compensation for employees despite any reduced work schedules. And I should know we have had no layoffs to date as a result of the COVID pandemic.
Likewise, we promptly stepped up our outreach to local communities where we have a long history of active involvement and support. This includes donating an additional $500,000 on top of already planned support of key nonprofits, meeting urgent needs, increasing donations to local food banks, expanding our online free access to our popular financial literacy program aimed at school-aged children. All of these efforts have been accompanied by extensive communications to all our constituents in addition to our colleagues across all channels, with video, social media, our website include helpful hints, insight and access to informative third-party websites.
An important distinction between this crisis and the great financial crisis of 2008 is the banks are considered the conduits for providing relief. The federal, state and local governments are all relying on us to expedite programs, designated to help individuals and businesses through this very trying period. And we embrace that role. We take our obligation to aid our customers and our community during this unprecedented time to heart. And we are working tirelessly through all channels.
Our long-standing commitment to customer focus applies in both good times and bad. And our customers have come to value our reliability, especially in difficult times, which is reflected on our consistently high loyalty and service rankings. And of course our brand is as strong as ever.
There is no question that near-term earnings for our industry will suffer during this crisis from a combination of higher credit costs, low interest rates, the cost related to forbearance, and dramatically lower economic activity, we are certainly not immune for this. Yet as I said before, we are confident in our ability to get through this and resume our track record of solid performance when conditions improve.
We have a strong capital base and significantly enhanced our – we have significantly enhanced our liquidity position during the first quarter. And I think it is worth noting that similar to the period leading up to the financial crisis in 2008, we have maintained our underwriting pricing and concentration disciplines rather than reaching for volume. Our crystal ball is the timing or shape of the economic recovery is really no better than any of our listeners. We obviously can't tell you when the turn comes or whether it's V-shaped, or more gradual, or some other shape. We will just continue supporting all our constituents these in the ways I just described. And are confident our efforts and actions will position us well when that time comes.
I would like to end by once again extending a salute to all my Rockland Trust colleagues. You've heard me described by colleagues as the greatest resource. This is being totally borne out throughout this crisis as the responsiveness to customer needs and keeping our operations going, despite all the logistical challenges is truly remarkable and all inspiring. And it's a hearty thank you to each and every one of them.
With that I will turn it over to Mark Ruggiero, our CFO.
Thank you, Chris. I will now cover the first quarter results in more detail.
GAAP net income of $26.8 million and diluted EPS of $0.78 in the first quarter of 2020, reflect decreases of 43.7% and 43.5% respectively from the prior quarter’s results driven primarily by elevated provision in expense in response to the COVID-19 pandemic. Regarding provision expense, the company adopted and implemented CECL effective January 1, 2020, resulting in minimal changes to the allowance upon adoption. However, the $25 million provision expense for the first quarter reflects the estimated impact of the deterioration in general economic conditions the bulk of which is obviously being driven by the COVID-19 pandemic
Appendix C to the earnings release lays out the underlying assumptions to our first quarter CECL model, but in summary, the provision level leveraged at Moody’s S4 economic forecast, which includes the following assumptions: that the COVID-19 crisis will persist and continue to meaningfully impact the economy. Unemployment rate peaks at 16.9% in Q2 2020 and remains elevated throughout the remainder of the year. 50% of industries will be on lockdown throughout Q2 2020, creating additional downward pressure on spending. No sustained economic recovery expected until Q4 2021 and federal funds rates will remain at or near 0% for the foreseeable future.
In addition to these macro economic assumptions, Appendix E provided with the earnings release shows the loan amounts within industries that are heavily impacted by the stay in place orders, government, shutdowns, et cetera. As such, we also laid in a review of these higher risk industries, as well as the review of our largest customer relationship balances to assess potential future exposure given the current environment. These analysis help to determine a qualitative overlay of additional estimated loss that was not deemed to be captured in the initial quantitative results of the model.
From a capital perspective, the company elected not to take advantage of the regulatory capital deferral relief associated with CECL impact, as we felt it prudent to align regulatory capital ratios in a manner consistent with how we would manage our capital and run the business.
I will now turn it over to Gerry at this point to provide some additional color over the commercial loan portfolio and he will be followed by Rob to cover the consumer side. Gerry?
Thanks, Mark. Good morning. As you know, we provide additional detailed information in our commercial and business banking portfolios today. So I'm just going to limit my comments first to a brief summary of how we've managed our business for the last 25 years, which gives us some comfort in this challenging environment. And I’ll maybe just give you a few observations on the current situation as well.
For those of you less familiar with our approach to the commercial credit business, it is based on a foundation of constructive contention to credit approvals. With the balancing of credit versus line viewpoints or needs with the heaviest thumb on the credit scale. We also continue to prove all new business relationship exposure greater than $4 million at weekly loan committee meetings, which we feel provides us greater insight into a portfolio, as well as the ability to pivot quickly both to threats and opportunities.
We practice our growth on a model that’s 2% to 4% annualized organic growth rates are acceptable when the economy is growing at a similar pace. They are trying to achieve outsized growth rates is simply us taking more risk, whether it be credit or pricing than we're comfortable with.
Loan sizes, our average loan size in our commercial real estate portfolio is approximately $1 million. In our C&I portfolio, $141,000. We have a high level of loan diversification across over 500 industries at the six-digit MACE level. We benefit from a very seasoned, long tenured team of commercial bankers and risk professionals whose incentive compensation includes measures from portfolio quality and compliance in addition to the usual growth goals.
Despite occasional protests for Mark and his predecessors, we have maintained a fully staffed workout team that is led by a career long workout officer whose first experience with total credit dates back to the late 1980s when I also was first exposed to loan workouts.
In addition to our internal loan review process, we have also maintained a 30-year practice of engaging an outside loan review firm to examine our commercial loan portfolio, achieving annual 50 plus percent penetration rates.
These practices have benefited the bank in the downturn since the late 1980s with better than peer charge-offs, non-accruals and delinquency rates. All that being said though, we are not immune to this pandemic and we will surely suffer losses and quite possibly in credits, we had not identified to be at risk.
Not surprisingly, we view our hotel, restaurant, personal services, healthcare, amusement and entertainment segments to be most at risk with a prolonged shutdown. Hotel operators for the most part, have placed their hotel properties into what I call government induced comas, cutting staff to be at bone levels preserving cash and have sought payment deferrals from their lenders.
Restaurants, which include full service restaurants, bars, small takeout, Dunkin Donut franchise, ice cream shops, et cetera have also, except for those with take out have done the same thing, put them to comas and wait for when they can open up again.
Another group worthy of commentary is our automobile and RV and boat dealer customers with floorplans. We have followed industry practice to defer curtailments of inventory, which is a practice that essentially as you start to pay down inventory that sits on floorplans, because in Massachusetts almost all dealers of those products have been closed.
With respect to deferrals on payments, we have approximately $1 billion principal balance loans where clients have sought deferrals. Not surprisingly, the largest number comes from hotel, food service and entertainment districts types. With the balance coming from clients that have more specific issues, whether they might be a supplier to businesses on the islands, which have largely shut down all construction activity or we have companies that service the restaurant industry like commercial linen companies that provide table cloths, aprons, et cetera.
And some retail landlords who have everything from barber shops, beauty shops, day care centers to medical professionals that have been forced. A customer sentiment based on my conversations with across wide swath of them have reflect a largely optimistic viewpoint. That's probably why they own businesses, but nonetheless hotel operators, with their properties in vacation areas and that represents just a bit more than half of our portfolio of them, for the most part, they're in either Massachusetts or New Hampshire and Cape Cod. And they really feel that local travel will restart before longer distant options as consumers will be reluctant to fly or travel too far from home, but nonetheless they're anxious for change of scenery.
We are also hearing from them that they believe that many former Airbnb customers who were been upset by their cancellation policies and also fears over how well clean the properties are. They drive more business back into traditional hotels.
Contractors are seeing job sites be reopened and are calling back laid off staff, which we're going to need to follow new safe social distancing rules. Another interesting area has been our new home builders. Interestingly they still see strong demand. In fact, this week, I was talking to some builders they have open houses going on, have never missed and with office being presented, as there's still pent-up demand for new housing projects.
One interesting observation though from across the board and this is fear, is that it will be hard for many industries to bring back furloughed workers as long as long as the federal government is subsidizing unemployment payments, to whereas many furloughed employees are now making more money collecting unemployment than they did in their previous position.
In summary, thinking ahead through the somewhat hazy windshield that I see, we see potential for some benefits coming from this crisis, which those which have followed every downturn in my 35 years. I believe that pricing terms and structure will improve on new credit. As other banks step back from the market, there will be an increased demand for working capital from businesses, who have depleted their resources and need to re-ramp up their business.
And lastly they'll be opportunistic investors out seeking to buy businesses and real estate from those either unable to open or to continue to sustain their operations. But for the near term, we will continue to be vigilant in monitoring risk, listening and questioning our customers with new issues and developing workout strategies for those borrowers who become troubled credits.
Now Rob Cozzone.
Thank you Gerry. Good morning. As mentioned like many banks, we are doing our part to provide much needed relief to all of our customers. In regards, to our consumer lending customer base, we have halted foreclosure proceedings. We are waiving late fees on delinquent loans and we have introduced a streamlined 90-day payment deferral process.
Not surprisingly, there was little noticeable deterioration in either our mortgage or home equity portfolios through March 31, of course with mass closures of businesses during late March and then the need for relief programs like these became readily apparent. As of April 17, 8.8% or 390 of our mortgage customers had requested loan payment relief.
In addition, 1.7% or 284 of our home equity customers had requested the same. With 650,000 jobless claims in Massachusetts since mid-March, these numbers are neither surprising nor unmanageable. Many of our payment deferral requests are coming from self-employed individuals who may also seek relief under the paycheck protection program. A program Mark will discuss in more detail in a moment. If warranted, these relief programs may be extended should the pandemic endure.
The underlying quality of our consumer real estate portfolios as of March 31, was quite healthy with an average FICO and average LTV of 749 and 58.1% for mortgage and an average FICO and LTV of 768 and 46.9% for home equity. Only 4.6% of our accounts or 9.2% of consumer real estate portfolio balances at a current LTV of greater than 80% as of March 31.
Mark back to you.
Thanks Rob and continuing on with credit. Asset quality metrics remains strong at quarter-end as non-performing assets remain consistent with the prior quarter at approximately $48 million or 0.4% of total assets. And as Chris and Gerry alluded to and comments regarding the anticipated payment deferral requests, Lowe's loans that were performing prior to modification will not be reported as TDRs delinquent or non-accrual and accordingly they will continue to accrue interest during the deferral periods.
As Chris noted, we participated in the paycheck protection program under the Cares Act stimulus program. To-date, we successfully approved and obtained SBA guarantees for over 2,900 loans totaling approximately $700 million in balances. The loans are anticipated to generate approximately $20 million in processing income, net of agent fees, which will be recognized as an interest income over the life of the loan.
I'll now provide a bit more color over the first quarter results specifically. During, the first quarter, the company experienced loan growth in several categories as strong pipelines at year-end resulted in another solid quarter for loan closings, with C&I and commercial real estate loan growth offsetting declines in construction balances. And although the full impact of COVID-19 is yet to be determined, the company ended the first quarter with an approved commercial pipeline of $250 million and we continue to see opportunities to close deals despite the current economic conditions.
On the consumer real estate side, the overall reduction in balances continues to primarily reflect the fact that the majority of the company's mortgage production is being sold to the secondary market. While home equity line usage and new deal flow drove an annualized increase of 4.4% in outstanding balances for this portfolio.
In terms of mortgage origination activity after a significant rate driven refinance wave mortgage application activity has moderated significantly. Fortunately, this allows much needed time to work the existing pipeline given necessary procedural changes related to such things as appraisal and employment verification. And although the home equity pipeline is also elevated, recent home equity application activity has begun to slow.
On the deposit side, the company experienced strong growth of 2.9% or 11.8% on an annualized basis during the first quarter. Core deposit growth was exceptional across all categories, with this deposits leading the charge with 8.5% growth for the quarter, consumer deposits up 1.5% and municipal also up over 15% for the first quarter.
Offsetting the core deposit growth, time deposits decreased by 9% driven primarily by the maturity of brokered CDs. Cost of deposits stayed flat at 48 basis points for the quarter as March deposit rate cut decisions were offset by purchase accounting adjustments in the quarter.
Further rate adjustments already made should drive Q2 period and cost of deposits down into the high 20 basis point range by the end of the quarter, with the average for the quarter being slightly higher.
From a funding perspective, in response to the significant decline in overall economic conditions, the company secured additional federal home loan bank borrowings of $300 million during the first quarter to proactively enhance on balance sheet liquidity. With a historical track record of minimal wholesale funding, as of March 31, the company has immediate access to $2.7 billion of liquidity through various channels should additional funding be needed.
These off-balance avenues as detailed in Appendix-G provide more than enough liquidity to cover funding for the aforementioned TPP loan demand as well as to absorb the temporary cash flow reductions associated with customer requested COVID-19 payment release.
Lastly in conjunction with the additional borrowings, the company also entered into a $1 million hedge in an effort to pre-fund the future maturities of higher cost time deposits at a much lower fixed rate.
Turning to net interest income, the net interest margin for the first quarter decreased 16 basis points to 3.74% reflecting the full quarter impact of the 2019 fourth quarter rate cuts. The partial impact of additional cuts made during the first quarter and a 2.6 million or 10 basis point decrease in loan accretion income when compared to the fourth quarter.
Shifting gears to cover some highlights of non-interest items, deposit service charges, ATM and interchange fees were down quarter-over-quarter due to typical seasonality combined with decreased overall customer activity due to the COVID-19 pandemic.
Mortgage banking income declined sharply quarter-over-quarter for two reasons. First, a $900,000 swing in the value of our servicing asset as a result of a rapid change and prepayment speed expectations as well as a reduction in loans sold servicing retained. And secondly significant dislocation in the secondary market for mortgages.
The hedging model that has served us well broke down in the quarter as valuation changes in the TBA market were not offset by actual gains on sales to aggregators whose demand was outstripped by supply.
In addition, pull-through rates became much more difficult to predict, when realizing this disconnect, we began to move to our best efforts delivery method, a move which should improve results in the second quarter.
Investment management income was significantly impacted by the market conditions brought on by the pandemic as assets under administration dropped by 12.5% to just under $4 billion at quarter-end.
However, early rebounds in the market in late-March and subsequent to quarter-end if sustained would further complement the anticipated tax preparation fee increase typically experienced in the second quarter. Loan level derivative income increased to $3.6 million as demand for interest rate swap products remains elevated.
And lastly, a reminder that other income in the prior quarter included the recognition of a $3.1 million insurance recovery contributed to the decline in that category during Q1. Regarding non-interest expense, despite reduced work schedules for much of the retail network, due to reduced branch service levels the company maintained full pay for all workers as reflected in the flat salaries and benefits expenses quarter-over-quarter.
With other relatively small changes in various expenses quarter-over-quarter, overall non-interest expense was inline with expectations and decreased slightly from the prior quarter.
The lower tax rate for the first quarter reflected a $4.7 million discrete tax benefit associated with net operating loss carryback provisions included in the Cares Act. In particular, a net net operating loss available through the Blue Hills acquisition is now eligible to be carried back into previous tax years at higher statutory tax rates, resulting in an additional tax benefit to be recognized. Excluding the impact of this discrete benefit, the tax rate would have been approximately 25%.
Lastly, from a capital standpoint, despite the large provision charge in the first quarter, tangible book value increased by $0.35 in the quarter, bringing the March 31, 2020, tangible book value per share to $34.46, representing a 16% increase over the prior year level. The stock repurchase plan that had been approved by the Board in October of 2019, was finalized in early April with approximately 1.2 million shares purchased during the first quarter and the remaining 300,000 shares purchased by April 7. There are no current plans to seek authorization for any additional repurchases. The company has actively deployed capital stress testing scenarios incorporating adverse assumptions specific to the current environment with each of those scenarios supporting the completion of the previously announced buyback plan. In addition, these analysis will continue to guide our assessment and ongoing management of capital.
In summary, the tangible capital ratio of 10.01% as of March 31, 2020, provides a strong capital base from which to operate within this uncertain environment.
I typically conclude my comments with updated guidance. Given the profound uncertainty as to the economic outlook and customer impacts, we cannot confidently provide comprehensive forward-looking guidance. I can, however, provide some near-term insights into a few key areas.
We estimate the near-term core net interest margin to compress further, assuming the following: full impact of the March Fed Reserve rate cuts to be partially offset by deposit rate adjustments, consistent with previous guidance. No further adjustment to the Federal Reserve target range. Further compression of the one-month LIBOR index throughout the quarter. Loan accretion income to be fairly consistent with Q1 levels, but stay below last quarter's guidance of $2 million to $2.5 million per quarter. And on balance sheet cash position to be consistent with the first quarter end levels.
We also want to note that this margin guidance does not incorporate the impact from the PPP program given the uncertainty over how much of the volume will qualify for debt forgiveness and trigger acceleration of the processing fee income versus how much will be retained on the balance sheet to be repaid over the two-year term. We anticipate overall expenses to remain relatively consistent with Q1 results, the tax rate to normalize back to approximately 25%.
And lastly, we are certainly aware of the intense interest of the investment community and the outlook for loan loss provisions in the banking industry. Our first quarter amount addresses the harsh impact of the COVID pandemic based on the assumptions enumerated earlier. This is obviously a fluid situation. Our provision for loan loss in the coming quarters will be highly correlated with any further deterioration of economic factors in excess of those used in the March 31 assumptions as well as any increased perceived loss exposure inherent in the company's portfolio.
That concludes my comments. We will now open it up to questions.
Before questions, Mark, there might have been a little static on the line when you were talking about the hedge. I heard it as just want to clarify it to $100 million.
$100 million.
Yes $100 million.
$100 million hedge on the bonds.
Great. Thank you. Okay, Jason, we're ready for questions.
Thank you. [Operator Instructions] The first question comes from Mark Fitzgibbon from Piper Sandler. Please go ahead.
Hey guys. Good morning. First question I had was for Mark, and I apologize if I missed this. On the margin I heard the various puts and takes there, but did you give a number in terms of your guidance for the margin and if not, I'd be curious if you could provide a little color? I know it'll likely be lighter, but is it maybe sort of down in that 345 to 350 range in 2Q?
Hi, Mark. I did not give a specific number. But if we – what I alluded to was essentially following guidance we provided typically in the past regarding the 25 basis point cut. And as you know we had much more than that partially through March. So if you apply that to the a 100 basis points that we received towards the end of March that would essentially get you in that range you were talking about.
The one caveat that we're certainly monitoring is the one month LIBOR index. It surprisingly held up well through the first round of cuts and the first quarter. It has started to drop back down to levels that we would expect given where the fed funds target range is. But certainly that could add a component to Q2 margin that creates a little bit of volatility. But should the one month LIBOR index continue to drop to the levels we would expect, I would say that that range you just talked about is a reasonable assumption.
Okay, great. And then a couple of questions for Gerry. Gerry, I think in the press release you disclosed at about 13% of your loan book has or will be modified. What do you think that number looks like maybe at the end of the second quarter? Is it likely to change dramatically? Are you having early in the second quarter lots of requests for forbearance, et cetera?
Well the forbearance requests have slowed. So I think it's – sort of the first round was the obvious industries that have been directly impacted with shutdowns. Like yourself, I am sort of curious to see what happens. I think it will really depend on which other industries is obvious, might need some relief. Whether – there's a large scale tenants not paying their rent, for example. That hasn't been the case, residential tenants, I mean hasn’t been the case, but depending on delays and people getting unemployment, et cetera. So at the moment, knock on wood they have slowed, so we'll see where it heads.
Okay. And then line utilization rates surprised me they hadn't ticked up more. Do you think that's because borrowers are digging into their own pockets or they're finding funding through the PPP program, or something else?
Well it's interesting. We actually – so initially when the crisis first hit, they peaked up, they spiked up a little bit and then quickly came back down and we saw a lot of cash build on our clients deposit accounts. And what, I think happened is very interesting, the timing of this was somewhat ideal because most of our clients make large distributions for tax and personal distributions in April. And because of the crisis hitting when it did in March, many of them pulled back.
So I think they ended up having more liquidity than they might otherwise had just like the grace of God, that the timing was before that important date. Now the federal government is not getting those tax payments, but right now they are using that for working capital.
Okay. And then lastly, Mark I'm curious, when do you test for goodwill impairment? Do you do that in the third quarter?
We typically do on a formal perspective Mark. We have done an analysis over that given the current environment. So we did take a look at that in the first quarter and continue to feel comfortable about our goodwill levels. So we think it's prudent in this environment to continue to analyze that on a quarterly basis.
Great, thank you.
You're welcome.
The next question comes from Dave Bishop from D.A. Davidson. Please go ahead.
Yes, good morning gentlemen.
Good morning.
I'm curious, in terms of the PPP program, what are you all assuming, I guess, in terms of maybe a weighted average servicing fee origination fee and in terms of duration of these of these loans on balance sheet?
Yes, I think the interesting dynamic there David will be obviously opening up of the second round. And we, like many other banks, have a backlog of applications that we were not able to get completed through the first round. But through the first round and the amounts we know we have already successfully guaranteed, the number that I mentioned in my call approximates a little under a 3% yield essentially for the processing component. As you know the rate on loans at 1%, and that will be over the two-year term, should the debt not be forgiven or paid back.
But the fee income on the first round was a little under 3% on average. Depending on the pipeline we have now those average loan sizes are much lower. So should we be successful and how much we are able to get guarantee when the second round opens up that that rate could go up a bit, but it's on a much lower for on as the pipeline sits today.
But the interesting part would really be the timing of it all. David, as we still await for further clarification over exactly how debt forgiveness will be determined and how from an operational perspective that will flow through the system, it will be interesting to see how many of these loans actually achieve forgiveness and are off the books by the end of the second quarter, whether that will trail into the third quarter and how much of that fee income will accelerate as a result of that.
So that is why we say the margin guidance for Q2 is really a bit of a wild card because this PPP program could have a significant impact on the margin in the second quarter.
Got it. And then just remind me Mark in terms of the impact for every 25 basis points, what the previous guidance was for…
Yes, we’ve been guiding about a six basis point drag on the margin for each 25 point cut.
Got it. And in terms of some of the deposit cost dynamics, you mentioned some hedging activity and the like. I noticed if I'm reading it right a little bit in uptick in time deposit cost there maybe just talk about some deposit cost dynamics inter-quarter.
Yes, the time deposit uptick is primarily a function of some purchase accounting noise. To be honest, we – if you recall, when we closed on the Blue Hills acquisition, there was a fairly sizable, fair value mark on their CD book that essentially adjust the rate on that to a lower yield than what the coupon is. The matching of that timing of that timing of the fair value mark to the actual maturities of those deposits was not aligned perfectly. So the benefit of the purchase accounting had run off at the end of the year. We still have some of those higher costs time deposits on the books.
So that was essentially a timing difference that caused about a four or five basis point disconnect in the cost of deposits in this first quarter. So if you strip that out, the rate cut decisions that we did make during the first quarter would have broughten the cost of deposits down by about four or five basis points and we'll continue to make more decisions as I mentioned, targeting our cost of deposits in the high 20 basis point range by the end of the quarter.
Got it. Final question, you gave good color in terms of your assumptions and the Moody's S4 scenario. Just curious, is that the worst scenario outlook there in terms of the economic forecast you're using or is there…
Yes, Moody's has been – sorry I didn't mean to interrupt you, David – was there more to the question?
Yes, I didn't know if that was like the most severe forecast in terms of their package there? Or is there even more like an S5 that's even more draconian in terms of the economic impact?
Yes, at the time, right up until pretty much March 28 when we were continuing to monitor the Moody's forecast that was the most conservative forecast. So we will continue to monitor that going into Q2. But that was the most conservative at the time.
Got it, thanks.
You are welcome.
And Mark you might sort of highlight again that the additional sort of qualitative overlay on top of the conservative Moody's forecast.
Yes, I think, it's important to note in terms of how the model is working. Those forecast assumptions, specific data points over economic factors, we have correlated many of those factors to loss assumptions at a portfolio level. And just to give some color as to the Q1 number, by implementing that Moody's S4 forecast that essentially drove the quantitative number of the model up by about $8 million or $9 million. So the $25 million provision in level that we did recognize in the first quarter, a lot of that was rarely driven off of qualitative factors.
Some of the analysis I talked about in terms of looking at the high-risk industries, looking at the largest exposures we felt it prudent to understand inherent loss expectations as best we can gauge them at this point that would not necessarily have been captured in the quantitative piece of the model. So what will be interesting going forward is as losses start to materialize and net charge-offs start to materialize, it could provide a component where the model from a quantitative aspect, we'll capture that. And we would need to gauge how much of that qualitative overlay could be relieved to offset. So I just want to provide that bit of color in terms of how much of impact that Moody's forecast had versus how much of a sort of qualitative analysis drove that provision level.
I appreciate that. That's great color. Thank you.
You're welcome.
The next question comes from Laurie Hunsicker from Compass Point. Please go ahead.
Yes. Hi. Thanks. Good morning. Just wondered if we could go back to the deferral details because I think I missed some of that. I heard 390 on mortgage, 284 in home equity. What was the number for commercial?
Hi, Laurie. So in terms of number of units of deferral, and just a reminder, this is what's been . We're still working through those requests. So this has not all been reflected in the March 31 numbers yet, but these are – the data we provided is what's been requested by our customers. So just referring to appendix F in the earnings release, commercial and industrial requests were at 306; commercial real estate 472; and construction 10; small business 274. So combined of those four categories that – if I'm doing the rough math in my head, it's about 1,000 request through that commercial and small business channel. And then there is about 700-plus or so on the consumer side, made up between residential, home equity and other consumer.
Okay. I'm so sorry. There it is. Appendix F, I thought I missed that okay.
No problem.
Great. Also, and I really, really appreciate all the detail that you provided here on the commercial. Really, really helpful. Just a high level, I want to check a couple of things. Oil and gas. You guys are zero. Was that correct?
That's right.
Okay. And then as I'm looking at your C&I book, roughly $1.4 billion, how much of that is leverage lending?
Gosh. Maybe, I'm going to guess maybe hundred, hundred and half maybe at the most – and most of that is secured by business assets. Because of the purchase rules, even if the collateral, we put it in as leveraged loans.
Okay, that's helpful. And then multifamily, I know that's been running around $500 million, $600 million. Just wondered if you had an absolute balance and then what the LTV was on that?
I think we have to get – I don't think we ran it for today. And I think we probably have to get back to it. It's fairly – I'm going to guess it's probably somewhere in the 60% range.
Okay. Okay. That’s helpful. And then last question, Chris, to you, if you could just talk more generally, we're obviously in very, very tough times, but you're sitting here at 2x book. You have one of the strongest currencies in all of the Northeast in terms of your stock currency. And obviously, M&A has just fallen off a cliff. But probably there might be some banks that want to raise their hand. Can you just talk a little bit more broadly about how you're thinking about M&A as we go through the cycle? How you're thinking about trying to understand the balance sheet of a bank that you don't know through the cycle? Or just how you're looking at it? Thanks.
Laurie, it would not be a complete conference call without you asking a question. So thank you. Quite frankly, I have not really thought a lot about M&A in the last six to eight weeks. We've been so heads down with all the programs we've just talked about, the little bit we have thought about and talked about it. I mean, it is – I think it'd be, first of all, we're always interested in conversations.
What I've said in the past calls that it's very opportunistic when banks are sold, not bought. But I would imagine that if sort of at this period, you need a little bit of time for the balance sheet implications and the credit book implications to sort itself out. I would be reluctant to – somebody sort of were to sort of approach us, I'd be reluctant to engage in the usual robust way that we would have in the past.
I think probably everybody else – anybody who is contemplating could – this thought probably as sort of busy with keeping your customers satisfied with keeping your customers satisfied and doing all the things that we're doing. But I also – my observation would be that after we get through this, I have said it sort of half and just that we needed a bit of a recession to clear out some of the underbrush in some of the – what I thought were aggressive lending practices.
Now that we're having – and we just didn't know what would bring on a recession. Now we know something right out of left field. But I suspect that as we sort of work through this over the next couple of quarters, the integrity of loan books around the region will become more apparent, and that will certainly be useful in thinking about the valuations. So Laurie, that's what a little bit of this is off the top of my head, but that's the best. Rob, Gerry or Mark, do you have anything to add to that?
I don’t Chris, I think that's spot on.
I think you summed it up, Chris.
Great. Thank you.
Thank you, Laurie.
The next question comes from Collyn Gilbert from KBW. Please go ahead.
Good morning, everyone.
Good morning.
This is – I appreciate the color you guys are giving on the loan detail side. Super helpful. Just a couple of questions there first. In the $1.2 billion or so that you're getting in terms of loan modification requests, do you know what percent of those might be also then categorized in your sort of $1.6 billion of exposed industries?
Yes. This is Gerry. So the – just to give you kind of a breakdown on the majority first fall into the hotel. So they sort of hotel. So they sort of fall just as you might think. Food services is being second. And that sort of falls into the mix bag. So it's a combination of health costs, some golf courses that can't open, some like hockey rinks, we have some bowling alleys. So it's a real kind of cats and dogs once you get beyond hotels and restaurants. They have a few with day care. So it's really – almost all those that have been forced to shut their business. But the hotels in the restaurant industry are probably more than – I'm guessing probably 40-odd percent of the percent of the total within the rest of all being no more than 5% to 10%. Does that answer your question?
Okay. Yes, that's great. Thank you. And then just curious, of the hotel exposure and it might align just where your general exposure is, and you sort of touched on this in the initial comments, but how that would – where the exposure lies relative to where you guys sit on markets when you're going to name tuck-its? Are much of those hotels? Or maybe what percent of the hotel modification requests have come off of the island?
That's a good question. Interestingly enough, probably this – half of them had not made a request for modification on the islands. So I'm not sure what – how to read that, maybe that will follow. Certainly the Cape. We've had those requests. And then in our traditional footprint. So just on the hotel business we have, it's really – about 54% of it, I would say, is in vacation areas, the Cape, Islands, New Hampshire, et cetera. And the balance is in more of the suburban locations around Boston and the gateway cities, one in Providence. And so the request from them, I think at this point, and I'll be off a little bit. I think we've had a request of around 75% of the portfolio so far on hotels. So there is another 25% as of yet haven't asked.
Okay. Okay. That’s great. That's really helpful. And then maybe this is a question for you, Mark. That's Mark. That's so interesting that the detail you offered in terms of the quantitative reserve build relative to the qualitative one. That's interesting. Do you also perhaps have – so the $92 million or so that you guys have now risked on reserves, what percent of that would be if you looked at kind of under DFAST severely stressed loss scenarios, what that relationship would be?
Yes. We haven't matched it up to a specific DFAST scenario, to be honest, Collyn. I think a lot of this was really leveraging just the close relationship and lender expertise that we have throughout the network, trying to get a handle over the current situation, a lot of what Gerry's been talking about, which industries primarily being affected by the shutdown policies and really just trying to apply some level of probably a default loss given the fault assumptions on top of that. So we haven't run it through a formal DFAST scenario, per say.
We've looked at macroeconomic level assumptions and a couple of scenarios using national data. But we really want to complement that as best we could with our strong knowledge of our customer base and the industries that we know are most affected by the impact, and that was really what we thought was prudent to come up with that qualitative overlay.
Okay. Okay. That’s helpful. And then just in terms of the NIM, Mark, while we're here. So I indicated that the accretion would likely be lower in the second quarter or comparable to the first quarter but lower than your prior guide. Is that the slowdown of payoffs, do you think it's more of a COVID issue? Or is there some other dynamic going on with the Blue Hills book?
Yes. No. I'd say it's primarily just – Gerry, I think happily coined at the coma of the economy and just the slowdown in overall activity. In the portfolio that we do know will continue to attrite just because of normal paydown is on the residential side. And if you recall, that is the portfolio in terms of the Blue Hills acquisition, in particular, where we actually had a premium valuation on a lot of that book versus a discount. So as that book pays down, it does potentially create an actual negative impact to the margin.
In previous quarters, we've seen the pace of commercial pay down significantly overtake that residential impact. And that's been really the driving factor of the elevated accretion income. So I think from a conservative perspective, I would expect to see similar payoff activity of what we saw in Q1. And again, it can just be – as we've now removed almost a full year from the acquisition, there are less individual credits with sizable marks that can move the accretion income. So I think we'll start to see somewhat of a more normalized level, May have still a one-off here and there that could create a little bit of volatility from a quarter-over-quarter basis.
But I think the combination of the residential book reduction and likely some slowdown and full payoffs on the commercial side, I think we'll land in somewhere probably in between where we were for Q1 and the previous guidance we have been giving.
Okay. Okay. Great. And then just on the – I just want to clarify. So the deposit cost number that you had referenced, I think you said in like the 20 basis point range or so at the end of the March quarter, does that include that $100 million of hedges?
At the end of the second quarter, we would target a high 20 basis point. So just to clarify, the hedge was actually on the borrowings. So the $1 million hedge and maybe this was where there was static, the $1 million – $100 million hedge is on our FHLB borrowings, where we may be able to effectively lock in pricing there.
The deposit has no hedging associated with it. We primarily target that high 20 basis point range based on leveraging through debt deposit rates in previous years, understanding the mix of deposits we currently have. On the books, we do have a bit more of a time deposit mix than we have in previous years. So based on what we think we can continue to do on rate cuts across the board on deposits. We do feel comfortable we can get down into that range by the end of the quarter. But it will take a little bit of time throughout Q2. So the average will likely land higher than that high 20s.
Okay. Okay, good. And then just lastly on the fee side. You had indicated that applications within the resi mortgage book have slowed, obviously, the movement here – or this quarter on the mortgage servicing side. But just – can you frame that a little bit tighter, I mean, in terms of where you sort of see kind of a normalized level of mortgage revenues shaking out? I mean, that's always kind of – it’s kind of been a key business line for you all. Just sort of how you broadly see that, the activity kind of shaping up through the rest of the year?
Sure. I'll let Rob provide a little bit of guidance there, and I'll add on, if needed, after Rob, if that's okay?
Sure.
Hey, Collyn.
Hey, Rob.
The pipeline is still quite significant, Collyn, as we ended the third quarter. Application volume slowed towards the end of the first quarter and into the second quarter here. And as Mark mentioned in his comments, we did shift or begin to shift the pipeline to a best efforts delivery to help lock in gains and not be subject to the volatility of the secondary market. In the fourth quarter of last year, our average gain on sale, including the hedge, was north of 102. This quarter, we were just slightly under 101.
So a significant difference on a net basis as we move to a best efforts delivery, we'd expect to be somewhere between 101 in three quarters and probably 102. In terms of projecting what that means for mortgage banking income, it's obviously somewhere between this quarter and the fourth quarter. Given the significant pipeline we still have, I don't know that it's in the middle of that range, but it should be nicely improved certainly from this quarter.
Okay. I think just to add to that, Rob, we talked about the large hit we took on a mortgage servicing asset. And with rates that have come back up from that low point during the quarter and ideally stabilized in the second quarter. We would expect to see the mortgage servicing asset value stabilize as well. So that should be, again, if we move towards a more consistent and stable environment, we would not expect to see that same impact on the mortgage servicing asset.
Okay. And you said that was $9 million this quarter. Is that right?
The difference was $900,000 in terms of direct P&L. So we had actually a gain because we were selling more servicing retained in the fourth quarter. And that as well as the actual impairment of the asset charge that we had to take this quarter that created a quarter-over-quarter change of about $900,000.
Okay. Okay. Very good. I’ll leave it there. Thanks everybody.
Thank you.
The next question is a follow-up from David Bishop from D.A. Davidson. Please go ahead.
Yes. Thanks for taking the question. Yes, just a quick follow-up. I was curious, I think, Mark, you noted in the preamble that I didn't think this word would probably be coming up this quarter just given the pandemic here. But actually, sounds like you guys had a pretty decent commercial loan pipeline. Just curious in terms of where that's coming from? And is that symptomatic of you gaining some market share for maybe some dislocation from people dissatisfied with some of the bigger guys in the market there? Just curious what's sort of driving that pipeline here.
You want me to answer that, Mark?
Sure, Gerry, I was just going to give a very high level and let you provide some color on the details, but I will let you lead off.
Great. Thanks. So as of the 21st, we had an approved pipeline of about $220 million. And we would back out to check everything over $1.5 million just to see – take the pulse on it. And at that point, $100 million of it was absolutely on track. $50 million or so was still going to happen, but be delayed for various reasons, appraisal problems, getting inspections done, things like that. And then interestingly, only $10 million has been withdrawn, which I was quite surprised at. It's a very small number.
But I think that kind of tells to the people who are viewing this is somewhat of a temporary or maybe they're going to be wrong, but it's so little to be withdrawn. And then going to the other part of your question. We have had new requests even the last few weeks at our loan committee. And what we're finding is, not surprisingly, there's a lot of banks not looking at new business at all. They basically – for whatever – maybe they're focused on PPP or something else, I don't know. So it's given us really some nice opportunities to better price and structure new deals. So although will that last or not? I don't know. But at the moment, it seems that the tides are maybe in our favor just a bit. Does that help?
It does, thank you. Appreciate that. Appreciate that feedback.
You are welcome.
The next question comes from Bernard Horn from Polaris Capital Markets. Please go ahead.
Good morning. I just want to make sure I understand Appendix G correctly on the PPP program. So I see the $20 million of processing fee income. Does that include any potential interest income as well? And are you – apparently, there's a funding mechanism associated with this program, are you also taking advantage of that? And if so, what effect would that have on the estimated income you present in the appendix?
Yes. Good question. The $20 million does not incorporate the actual interest on the loan. That is the ore processing fee depending on the size of the loan. So that does not incorporate additional interest that we would earn, should the loans stay on our books for a certain period of time. And from a funding perspective, we are – we're continuing to evaluate all of our options. We are preparing and going through the paperwork to take – to essentially get qualified for the federal liquidity program directly associated with – however, we do continue to believe there is just as equivalent alternative funding scenarios that we are already utilizing.
We continue to have significant availability just through our typical FHLB borrowing capacity. So we have not essentially committed to using any sort of avenue directly for funding PPP loans. We have very good on balance sheet liquidity at this point that we can absorb a decent amount of this first round. And should we need additional financing, we'll make the decision depending on all of our avenues. So we are doing the paperwork and could access that federal line that's become available, but we'll make that decision depending on what we think will be the best interest for the company.
And just out of curiosity, what are you looking at as far as a rate on that federal funding source? Is it much better than your existing borrowers?
It’s a little bit better, but I think either through our swap market or even just through the FHLB borrowings on a short-term basis, to be honest, the differential is not all that compelling. So that's why we obviously want to have it in the toolkit, should we want to access that. But the cost, I believe, is 35 basis points and is not all that much different than what we think we may be able to get elsewhere.
Okay. And then the – I know it's a bit early days, but to the degree that some clients have not been able to obtain funding from this, and there's another tranche coming through, are you able to – I mean, obviously, the terms of this are quite attractive, but if a client does not participate in it, are you transferring that into other potential business prospects?
In terms of if we're unsuccessful in being able to secure the guarantee?
Yes, I mean...
I mean we...
Yes. I mean, there's an option to actually not even pay the money back. So that's kind of hard to make a loan on those terms. But if you have a client that doesn't qualify or can't get it because the funding ran out, could you help them otherwise? And is that potentially generating more business longer-term for you?
Yes. I think it will still to be determined in terms of that aspect of how much of the customer inquiry that we would not be able to successfully get into the program. I think we would have to just – we do know these relationships. We know these customers, and we would continue to look for as many ways as we can to help that customer. We are working very, very extensively over the last week. We've dedicated additional resources and continue to prioritize the customers that we were not able to get successful guarantees through the first round. And so we feel pretty good about when the round two opens up that we can work the existing pipeline and try – really just get them into the program as fast as we can.
The concern is every other bank that has participated in this program is likely doing the same. And we do know that there is a lot of pipeline that was not able to get successfully guaranteed through the first wave. So it will be very interesting to see how quickly the additional funds get depleted. Because many banks like us have geared up the pipeline and are ready to go for when those doors open. So we'd love to get the remaining existing demand in there. If for some reason, the clock runs out and we're not able to do all of it, we will continue to work with those customers to help them as best as we can. And that may be other SBA programs that we know have become available, continuing to look at where those may be helpful. But these are all existing relationships that we care very much for, and we'll look to help as best as we can.
Okay. Thanks. And then the other – sorry, back to the first part of my question. If the interest income is not included in your $20 million fee income, what would we assume for an interest rate on that $700 million? And if – and the funding cost, so if it’s 35 bps, let’s say, of funding cost, maybe we could try to understand the net interest margin on that?
The rate is a stipulated 1% so that the program rate on these loans is only 1%. So it will be a fairly immaterial impact, I think, in the Q2, which is why we have provided the guidance over the fee piece of it. I think the rate net of the funding cost will likely not make too much of an impact in terms of overall margin. It will dilute the margin to a degree just because of the 1% rate.
Okay. Thanks. That clears me. Thanks very much.
You are welcome.
There are no more questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to Chris Oddleifson for any closing remarks.
Great. Thank you very much, Jason, and thank you, everybody, for joining us this morning, and we wish you the very best over the next three months, and we hope when we talk to you again in July that things will be much improved. Stay safe everybody. Good bye.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.