Independent Bank Corp (Massachusetts)
NASDAQ:INDB
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Independent Bank Corp (Massachusetts)
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Good day, and welcome to the Independent Bank Corp's Second Quarter 2020 Earnings Conference Call. Before proceeding, let me mention that this call may continue forward-looking statements with respect to the financial condition, 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 unduly relying upon any forward-looking statements and disclaims any intent to update publicly any forward-looking statements, whether in response to new information, future events or otherwise. Please note that during this call, we will also discuss certain non-GAAP financial measures as we review Independent Bank Corp's performance. These non-GAAP financial measures should not be considered replacements for and should not be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information regarding our non-GAAP measures. Also, please note that this event is being recorded.
I would now like to turn the conference over to Chris Oddleifson, President and Chief Executive Officer. Please go ahead.
Thank you, Sean, and good morning, and thank you for joining us today everyone. With me as usual, are Rob Cozzone, our Chief Operating Officer; Mark Ruggiero, our Chief Financial Officer. And we will again be joined by Gerry Nadeau, President of Rockland Trust, and our Chief Commercial Banking Officer.
To our listening audience, we continue to extend our best wishes to you and your families for good health during these very extraordinary times. And it certainly has been very interesting three months since we last spoke. In many ways, the degree of uncertainty posed by this pandemic crisis remains as great as ever.
On the other hand, we have learned a lot as a company about how to cope, adapt and persevere in ways that are reassuring. On the elevated provision levels an intense pressure on a net interest margin continue to weigh on our financial performance, strong fee income and expense restraint helped to serve as counterweights to produce pretty decent results, and income in the second quarter came in at $24.9 million or $0.76 per share. Mark will be covering the quarter in more detail shortly.
The important takeaway here is that our core profitability gives us a lot of strength to get through this period and ultimately emerge with their fundamentals very much intact. We've been maintaining a laser-like focus on our commercial and consumer customers throughout, serving their needs and providing forbearance where warranted and enable them to manage through this crisis.
We have been active participants in the PPP program, originating about 5,600 loans, totaling nearly $800 million. This has involved about 250 of our colleagues throughout the bank working virtually around the clock. More recently, we have been working very closely with the PPP recipients and helping them navigate the loan forgiveness process with the SBA.
As you can imagine, we are intensely focused on the credit environment with extensive reporting and monitoring of borrower conditions. We monitor daily the loan balances and exposures for commercial customers. Within the industries we consider to be most at risk. In the appendices at the end of the earnings release, we've expanded our reporting of these exposures, along with updates on other pertinent COVID-related information. And in a few minutes, Gerry and Rob will provide added color as well.
Luckily, one of the really encouraging developments that has been the astute manner in which the State of Massachusetts has been managing the COVID pandemic. Our governor has instituted a gradual reopening of economic activity over a four phase process, spaced a number of weeks apart, depending on progress across a series of health metrics. We are currently in Phase III of the reopenings since peaking in April, the number of COVID-related cases has slowed considerably.
Hopefully this measured approach and broad adherence to the recommended guidelines will prevent a spike that is unfortunately being experienced in other parts of the country.
We've also been taking good notes on our experiences and observations over these past few months with an eye towards anticipating the operational implications for what many refer to as the new normal. One obvious takeaway is that that customer preference for digital access and service will certainly accelerate, particularly as many clients have grown more comfortable with this medium during the crisis.
Our prior efforts to steadily expand our capabilities and offerings in the digital spaces, positions us well. We will continue to invest intelligently in robust technology to keep pace with this trend. Likewise, our ongoing review of our branch network may include more drive-ups and outside walk-ups as well as the expansion of our video teller service. Also, our future infrastructure needs will be reassessed as many of our employees have been able to successfully work-from-home since March.
The net result of all these combined efforts should result in further improvement in operating efficiency over time. Times like these, banks like ours serve as critical providers of relief to the enormous financial and emotional stress induced by this crisis on so many constituents. As such, we are fully engaged in providing much needed support and guidance across the full range of employees, customers, and communities.
Our reputation here is intrinsically connected to our brand image, which has never been stronger. This is borne out by the continued high ratings we received from reputable third parties in areas such as customer service, employee satisfaction, diversity, CRA and charitable giving.
Our focus and commitment to build a healthy culture that engenders high quality relationships and a lot of discretionary effort has also paid another huge dividend, meeting the challenges and demands of the COVID crisis.
As I've said before, our crystal ball is no better than any of yours as to the economic path from here. Our best guess is that economic activity will be muted, AKA it will be a slog until a vaccine or protocol to mitigate the symptoms is developed.
What we do know is that we have the capital, liquidity and core profitability to persevere through this crisis. We will adhere to our playbook of focus and discipline that has proven very successful on prior crises and fully expect to resume our growth path as before whenever this crisis abates.
And finally, I always like to end with a salute to my Rockland Trust colleagues, they proved themselves to be resourceful, resilient, and tireless in their passion to serve our customers and journey through this crisis. I am very proud of each and every one of them.
And with that, I'll turn it over to Mark. Mark?
Thank you, Chris. I will now cover the second quarter results in more detail. GAAP net income of $24.9 million and diluted EPS of $0.76 in the second quarter of 2020 reflect decreases of 6.9% and 2.6%, respectively from the prior quarter’s results.
While pretax income was actually up by 13% this quarter, the return to a more normalized tax rate accounted for the decline in the bottom line. Pretax pre-provision, return on average assets was 1.66% for the second quarter compared to 1.89% last quarter with the decrease being driven primarily by the temporary balance sheet increase associated with the PPP program.
Our typical approach is to provide details over quarterly results and trends, which we will certainly be covering, but we will first focus on the unique dynamics of our operating environment, which is of intense interest to you all as the COVID-19 pandemic-related loss provisioning and PPP activity all contributed heavily towards Q2 results.
Focusing first on the COVID-19 pandemic, similar to most other financial institutions, we are seeing direct impact on a number of areas within our financial results. From a credit perspective, the environment is challenging and still playing out.
As referenced in Appendix F of our earnings release, as of June 30, 2020, total loans subject to future deferrals was $1.17 billion or 12.5% of our loan portfolio. This balance reflects a reduction from an actual June deferral amount of over $1.4 billion, as certain 90-day loan deferrals have reached their maturity end date prior to June 30.
With another $490 million of loans set to reach deferral end dates through July, we are actively in the middle of understanding and assessing the current and projected future situation for a lot of these borrowers upon maturity, a portion of which we would certainly be expected to request another round of deferral.
Along those lines, I'd like to turn it over to Gerry and Rob to provide a brief update on the respective commercial and consumer portfolios. Gerry?
Thank you, Mark. Good morning. We are facing now what we call second request for COVID deferrals. They are either – for some cases, for the first time, but in any of those for the second time, it's a second 90 days, which the majority of our first round of deferrals were, and that might be for interest-only or for a complete deferral.
And while it's probably too early in the quarter to be completely certain, it appears that the volume of these requests will be much less than in round one, when there was so much more uncertainty for our clients. The early round two requests have not surprisingly been primarily from hotel, retail, real estate owners, which have a large number of restaurants and service type businesses, we've only been recently been allowed to reopen, and in many cases with reduced capacity.
Some Massachusetts business will close for all of Q2 due to the governance phase reopening plans. And small number, where actually have to remain closed until Phase IV, which may not be till much later this fall or early in 2021. Our requirements for round two deferrals are much more demanding than for round one.
We are requiring the receipt review of 2019 fiscal year-end financials, 2020 projections. We are looking for detailed summaries of current circumstances and justifications for the request, including rent rolls with tenant payment updates on hotels, looking for current occupancy and ADI reports. And then for other businesses like restaurants or gyms, we are looking for sales trends. We are also asking for sources of liquidity. They have status of government loans, whether they be PPP, EDIL or the Standard 7A.
We are looking for our loan offices to assess collateral strength and the sustainability of the current risk rating. And from an approval process, all of these require a one up from our normal credit approvals, so many of these are going to our highest level of loan committee approval.
Other findings for the quarter have been somewhat mixed. Some very positive and others less so. For example, the apartment owners have been largely experiencing minimal negative impacts except for a few that are very dependent on students in either the city of Boston or in providence.
Retail property owners with small retail and personal service tenants are experiencing challenges, as many of those tenants have been asking for deferrals of their own rent. Hotels is very interesting for us. Approximately half of our portfolio hotels are in vacation like areas, whether that be Cape Cod, Martha's Vineyard, Nantucket, New Hampshire and Plymouth. Those with those tourist aspects to them have actually been experiencing some fairly strong demand as people want to get out. And so they have seen occupancy rates in some cases up almost up to 75 or more on an average weekly basis percent.
Unfortunately those that are more business travel oriented are experiencing occupancy rates more akin to 25% to 50%. And again, we're about equally split between those two groups. Retail, automobile, boat, RV, and motorcycle dealers are reporting strong sales, but are facing inventory shortages, but also they are facing solid demand for service work. So overall, they have been fairly optimistic.
Suburban home and condo developers are reporting strong demand for the newly built homes and condominiums, but are facing some construction material shortages and price increases, particularly lumber, which has risen almost 20% in the last month or so due to unprecedented demand, not only by home builders and contractors, but also by homeowners going to the local Home Depot and Lowe's.
And those contractors that focus on renovations to homes are booked out for months. People have been home more, discovering things they want to change in their home, adding homeowner offices, et cetera. So that's also helping our contract supply houses who service those contractors.
And then last, not surprisingly, our portfolio of liquor stores are all reporting robust sales. I guess that's not very surprising. We realize that some of our borrowers are likely going to need their loans to be restructured to accommodate extended repayment terms in the future and that we will be seeking to require them to pledge additional collateral and other guarantees to help them fall through those periods of time.
We also have certain borrowers who are going to require additional working capital as they have depleted it, surviving the last two months. For this purpose, we have added additional resources to our SBA Group to help with the processing of Standard SBA 7A guaranteed loans.
As Mark commented early on, utilization rates have made a big impact on our commercial loan outstandings during the quarter. They have dropped from 48% average in Q1 to 38% in Q2, representing nearly $200 million decline in average balances.
So the customers have not left the bank, they are just borrowing less on their working capital lines of credit. Now some of this is certainly attributable to the receipt of PPP money. Approximately $600 million has been received by our commercial C&I borrowers, and that money is really become at least a temporary increase in working capital. For many of them though it will be permanent if those loans are forgiven.
So that excess liquidity has improved their financial position such that they don't need to borrow as much from the bank on their working capital lines of credit. As the PPP forgiveness process weighs out that may change as some of those may need to be repaid, if not forgiven.
And then maybe just to touch upon our loan pipeline. Our competition continues to be very keen from our smaller competitors, but less so from larger banks, which has really helped us improve terms and pricing on new opportunities. And it's also enabled us to expand the requirement for interest rate floors in minimum all in yields.
Now just to give you a couple facts on our pipeline. At the end of June, our pipeline was up to $1.43 billion, which was up from May and the approved portion of it was a $200 million and again, improved from May. We were able to close a $100 million in new credit in June, which is the best month since February. And we are able to add $259 million of new opportunities during the month of June. And again, that's the best since February.
Our year-to-date closings are just a bit over $600 million, which interestingly enough is only $1 million less than it was for 2019 at this point of the year. And then just to close out on this, the majority of our new loan opportunities are from CRE borrowers, mostly looking at refinances and from existing C&I customers looking to increase their term borrowings.
Now let me turn it over to Rob for some consumer updates.
Thank you, Gerry. In regards to consumer portfolio, federal stimulus programs, fairly generous unemployment benefits, significantly reduced spending due to COVID, delayed tax bills and readily available payment relief have all led to improved consumer balance sheets for the time being.
One need only turned to second quarter deposit growth for widespread evidence of the enhanced consumer liquidity picture. In addition, as suggested by robust mortgage banking activity, residential real estate values have also held up well today. And with limited inventory and historically low rates, there was no sign of short-term weakness.
With the combination of healthy consumer balance sheets and strong residential real estate values, the underlying quality of our consumer portfolios remains quite good. Average credit scores and LTVs have been stable to improving. And as reflected in the schedule to our financial statements, requests for payment relief on our consumer portfolios continues to be manageable.
As of June 30, 8.2% of our mortgage portfolio, and only 2.6% of our home equity portfolio was in forbearance. New requests for deferrals slowed significantly in June. However, about 70% of the balances of expiring consumer deferral arrangements chose to extend during the second quarter.
We had anticipated that the duration of the shutdown would lead to follow-on requests and we are providing the additional 90 days of relief with little incremental scrutiny. However, should relief be needed after a combined 180 days of forbearance, we will follow our more structured legacy modification process. In addition to payment relief, just this week, the governor of Mass extended the state mandated moratorium on foreclosures and evictions to October 17.
Our state's cautious approach to reopening has certainly contributed to the nation's highest unemployment rate. Fortunately, it has also helped to keep COVID rates comparatively lower. Of course, there was much uncertainty in regards to the course of the virus, its impact on the employment picture, should we suffer another local wave and the availability of additional stimulus with an election approaching. In the meantime, most consumers seem to be on solid footing for now. Mark?
Thank you, Gerry. Thank you, Rob. Leveraging the information that Gerry and Rob just shared, economic forecast assumptions based on the Moody's S4 scenario and other qualitative factors of our own consideration, our provision for loan loss was $20 million in the second quarter compared to $25 million in Q1.
With the deferral programs providing temporary relief for the majority of customers directly impacted by the pandemic, actual net charge-offs and asset quality information remained benign through the second quarter with an expectation that the ongoing effects of the pandemic will more directly impact those metrics through the remainder of this year and potentially into 2021.
And similar to last quarter, in addition to the appendix in the earnings release providing details over loan deferral information, Appendix E reflects loan amounts within industries that we view as heavily impacted by the stay-in-place orders and government shutdown. Our level of exposure to these loan segments are contemplating the potential relief from deferral assistance and the PPP program continues to be the primary factor behind the determination of provision levels for the last two quarters.
Regarding the PPP program, the company has closed on over 5,600 loans, totaling 793 million of PPP volume through June 30, 2020. As a reminder, these loans accrue interest at 1% in a subject to origination fees paid by the SBA, which vary in percentage amount depending on the loan size. Approximately $26.2 million of origination fees in total are expected to be earned on the PPP loans closed through June 30, with the amounts to be amortized into interest income over the term of the loan or accelerated into income upon full payment and/or SBA forgiveness.
As such, normal amortization resulted in $2.2 million of the fees being recognized in interest income during the second quarter. Although, we anticipate some level of fee acceleration in the second half of 2020, the amount and timing will be driven primarily by the ability of customers to use their loan proceeds in accordance with the program rules to maximize forgiveness. As such, our best estimate at this point would be to see some level of accelerated amortization in the fourth quarter of 2020.
As part of our PPP program, the loan proceeds were required to be deposited into accounts held at Rockland Trust. With the loan balance is still outstanding and the majority of the proceeds still in the deposit accounts, the impact of the PPP program on balance sheet metrics and the net interest margin is noteworthy.
Although impossible to identify with precision, the amount of loan proceeds still on account, we estimate that at least 80% of PPP funds were still on deposit as of June 30. And we would expect to see some level of that balance a trite as customers utilize the proceeds.
While PPP-driven deposit growth was substantial, additional factors combined with PPP activity led to a $1.3 billion increase in total deposits for the second quarter. The increase in deposit balances as seen widely across the banking industry as a whole is being fueled by a combination of both business and consumer government stimulus programs, loan deferral programs, allowing customers to preserve additional cash and an overall mindset of businesses to prioritize liquidity in the current environment.
With that being said, the level of PPP volume and resulting excess liquidity in the form of cash held at the Federal Reserve has significantly impacted our reported net interest margin for the quarter.
Within the earnings release, we have provided a basis point path to the notable decline in the margin this quarter with the pressure on loan yields being the biggest factor. We have also included Appendix C in the earnings release to provide insight on the quarter-over-quarter trend in adjusted and core margins. And we plan to continue to provide this margin view over the course of the PPP program.
As noted in the appendix with PPP and excess cash on hand, diluting the margin by 4 and 19 basis points respectively, we pegged the quarterly adjusted margin inclusive of purchase accounting adjustments to be at 3.48%. As a side note, we assume the two previous quarters average cash balance of approximately $100 million as the baseline in this analysis.
Also, excluding all purchase accounting impact, the adjusted core margin would be 3.41% for the second quarter, representing a 28 basis point drop from the similarly calculated Q1 adjusted core margin. With average one-month LIBOR decreasing 94 basis points from Q1 to Q2, along with the full impact of the drop in prime rate from March, the immediate repricing of loans, specifically tied to those indices and overall repricing of loans into this low rate environment have led to a core loan yield compression of 43 basis points for the quarter. That is offset by 20 basis points of relief on deposit costs as total cost of deposits fell to 28 basis points for the quarter versus 48 basis points in Q1.
To help address the rate environment headwinds, we are looking for more opportunities to place interest rate index floors on new variable rate commercial loan volume and with additional cost of deposit relief anticipated also help offset these asset yield challenges. We expect our core margin to compress only slightly over the second half of the year.
To round up the discussion over COVID-19’s direct impact on our results and financial position, in addition to the color that Rob and Gerry provided regarding customer behavior for loan demand, we continue to see reductions in deposit service fees as government stimulus programs and reduced levels of spending have driven reductions in overdraft fees and ATM fees.
Regarding capital management. During the second quarter, we completed the stock repurchase plan, which had been approved by our Board in October of 2019 with approximately 1.2 million shares purchased during the first quarter and the remaining 300,000 shares purchased in April.
With the stock buyback complete and balance sheet growth driven primarily by PPP activity, tangible capital as a percentage of assets was 9.12% as of June 30, 2020. We believe this level of capital to be appropriate for operating through this environment as we expect future earnings should continue to provide support for sustained dividend and prospective capital growth.
I'll now provide a bit more color over some of the other second quarter results. The second quarter decrease of $330 million in loan balances when excluding PPP activity is driven primarily by reductions in the commercial and industrial and residential portfolios.
And as Gerry alluded to, C&I balances were impacted significantly in the second quarter as line utilization within the portfolio dropped from 48.5% in Q1 to 38.4% in Q2 with decreases across the Board and asset-based lending, floor plan, in general C&I revolver product categories.
In addition, with the challenges associated with the current yield curve and longer-term mortgage pricing, the majority of mortgage production continues to be sold in the secondary market, which reduced the level of new retained portfolio loans available to offset the continued pay down activity within that category.
And although the consumer pipelines at the end of Q2 were strong and the approved commercial pipeline sits out approximately $198 million as of June 30. We anticipate the continued uncertainty over the business activity within this environment is likely to challenge loan growth over the second half of 2020.
As noted earlier, a number of factors contributed to strong core deposit growth during the second quarter with time deposits continuing to runoff as anticipated. Second half of the year deposit balances will certainly be impacted by the timing of PPP funds utilization as well as overall business dynamics as the pandemic outlook progresses.
As such, we expect to see some level of decline from the outsized balances at the end of the second quarter. And with current cost of deposits already down into the low 20 basis point range in June, we should experience continued relief from deposit costs, which should partially mitigate expected further loan yield compression in the second half of the year when compared to Q2 results.
On the borrowing side, with on-balance sheet liquidity at historic highs, the company prepaid $200 million of federal home loan bank borrowings, resulting in a $389,000 prepayment penalty included in other expenses in Q2. In addition, we made a $37.5 million prepayment on our outstanding $75 million term debt that was obtained as part of the 2019 Blue Hills acquisition financing. These June payoffs will further decrease interest expense going forward when compared to Q1 and Q2 levels.
Turning to non-interest items. A few highlights to note in the second quarter. For non-interest income, as noted previously, deposit service charges and ATM fees were negatively impacted by the COVID-19 pandemic, while interchange revenue showed signs of rebounding in June.
As a reminder, the Durbin amendment impact are crossing the $10 billion asset threshold will come into effect in Q3 and is anticipated to decrease interchange revenue by $4.5 million to $5 million over the remaining second half of the year.
With a sharp rebound in the market and the periodic annual bump due to tax return preparation fees, investment management income increased 6.8% quarter-over-quarter as assets under administration increased by 10% to $4.4 billion at quarter end as compared to Q1 quarter end.
Mortgage banking income also rebounded nicely in the second quarter as stabilization of the secondary market combined with a strong demand led to a significant increase in income quarter-over-quarter. And with a June 30 pipeline of $268 million, origination activity is expected to remain strong through at least the third quarter.
Also continuing to serve as a natural hedge against the low rate environment, loan level derivative income remained elevated at $2.9 million for the quarter though down slightly from the prior quarter.
Regarding other non-interest income gains on equity securities were up $1.4 million compared to the prior quarter, offset by $460,000 of flow through losses from small business investment company funds, decreases in cash collateral interest and other miscellaneous items reflecting quarter-over-quarter decreases.
Regarding non-interest expense, while there were some minor quarter-over-quarter variations in certain expense items, overall non-interest expense was essentially flat with the prior quarter. And as we looked out into the future, as Chris mentioned, we certainly will look to leverage learnings from this pandemic to identify potential opportunities to drive operational efficiency while not losing sight of the importance of continuing to invest in initiatives to promote long-term sustainability.
Lastly, the tax rate of 23.8% for the second quarter returned to a more normal level and was slightly lower than anticipated primarily as a result of updated assumptions over the timing of PPP fee amortization.
That concludes my comments and we will now open it up to questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today will come from Mark Fitzgibbon with Piper Sandler. Please go ahead.
Hey, guys. Good morning.
Hi, Mark.
Good morning.
A couple of questions. In the press release and the table that you have there, Appendix F, I saw that it references $68 million of other deferral types, not principal or interest. What kinds of deferral types would those be?
I believe, Mark, those are primarily just some term adjustments and not necessarily payment deferrals.
Okay. And then I was curious, Gerry, in your estimation, which industry segments do you think have the potential to have the most lost content for banks in general, not specifically you guys, but which sectors do you sort of envision there being potentially the most lost content?
Probably just to go back to one thing on that other question. Included in there was on some floor plans. So what we did with dealers, mostly used car dealers, we basically allow them to curtail their normal curtailment payments on aged inventory, and that deferment has now passed.
So going to your question, which is difficult to answer. I would say, in no particular order. Obviously, the restaurant space is under a lot of pressure. There's different stories in the country they are taking as many – the third of the restaurants in the country could close.
I think hotels will be, especially those based on business travel, which there isn't much going on and depending when there is a vaccine or a therapy, they will be challenged until that time. And then it's probably into retail where such bankruptcy rate effectively for malls, I would think, will be the most challenged. So I think those probably the three.
Okay. And then I guess I was curious, how are the not-for-profits managing through the crisis? Is their fund raising completely dried up and they're more challenged or curious what you're seeing there?
Well, interestingly enough and I'll speak from my personal experience, I won a number of boards of non-profits, and a couple of them actually have been able to raise more money this year than ever in the history. It seems that a lot of people – those people that tend to be philanthropic realizing the pain that non-profits are facing and are willing to share some of their personal wealth to help them buy it over.
Now many of the non-profits were able to avail themselves with PPP money, which is the first time the SBA has ever been able to provide support to non-profits. So I think it's been a combination of PPP to furloughs and then some increased charitable giving.
Okay. And then lastly, I assume that the quality of the new loans that you're booking today is probably on average, a fair bit better than the existing portfolio. Would you agree with that? Are you being more stringent with your underwriting today than you were, say, in the past?
Right. I think, I probably didn't say enough about it in my comments. But yes, really two ways, we've been able to institute stronger floors on LIBOR or prime. And we've been able to negotiate lower loan to values or fuller guarantees or more covenants, et cetera. So you're absolutely right. That's given us, particularly on the larger side, as I mentioned in my comments, the smaller banks haven't changed their practices as much as the large banks, which has given us that opportunity.
Great. Thank you.
You're welcome.
And the next question will come from David Bishop with D.A. Davidson. Please go ahead.
Yes. Good morning, gentlemen.
Good morning, Dave.
Hey. Mark, just circling back to the initial commentary in terms of the deferrals, I just want to make sure I understood this right. As of June 30, about $1.17 billion, correct? In deferrals. And I think – I thought I heard you mentioned another $400 million potentially behind that. I wasn't clear if it's like $1.5 billion under deferral or of that $1.17 billion, $400 millions in process.
Sure. To provide a little bit of clarity there, so the $1.17 billion referenced in the earnings release, what we coined to be the active deferrals as of June 30. So in essence, that is the volume that will result in a deferred payment in July.
The buildup of deferrals over the course of the second quarter and this references back to our disclosure in the first quarter 10-Q, we actually processed and had approximately at a peak level over $1.4 billion of total deferrals in the month of June and approximately give or take $250 million of that had their last deferral in the month of June, which gets you to the $1.17 billion as of that point in time. June 30, that would be subject to a future deferral. The $480 million number that I referenced in my comments is just insight into all of that $1.17 billion, how much of that book will have its last deferral payment in July.
And I think that is just combined with some of the activity that we've already seen roll off in terms of first deferral requests, a portion of those will certainly come to us looking for a second request. So I just wanted to give some of that color into the more immediate runoff of what will be reaching their first deferral end date and what we'll be looking at over the next month or so in terms of potentially second request. So does that help clarify, Dave? Sorry, Dave, are you still there?
Yes. I'm there. Sorry, I had to mute. As you sort of go through that process and your relationship managers are reaching out to your clients and your barrowers, any sense where you think that that will not seek a second round of deferrals? I know it's tough to hedge, but we're seeing some of your peers in the 60%, 70% range, just curious if you have that guesstimate?
I think Gerry alluded to it a little bit in some of his comments. But as you point to, it is a bit of a challenge at this stage of the process to see if this is truly a trend. But as we sit here today, we're seeing in terms of units a meaningful decrease and how much of that first deferral portfolio is now asking for a second deferral.
So we've actually only seen evidence of somewhere in the 15% to 20% range in terms of number of units. The dollar amount is higher than that. And to your point, we haven't quite reached that level that you referenced, but we are seeing in the 40% to 50% range in terms of the dollar amount.
And I think that goes back to Gerry’s comments where a lot of the second deferral requests that we've experienced so far, some of the larger relationships in our accommodation and food service industries, which typically have higher balances in terms of that overall portfolio set.
So certainly something we'll be monitoring closely. And as I mentioned, we anticipate meeting the needs of second deferral requests for some of these borrowers. But it's been an interesting dynamic in terms of the unit versus dollar ratio that I just mentioned.
Yes.
Mark, for the consumer portfolio has been so far through the second quarter, 70% of the balances have chosen a second 90-day deferral. That's a combination of mortgage and home equity.
And Rob, you sort of attribute to that? I think you alluded to just the high unemployment rate within the state or just borrower just trying to take advantage of more liquidity as much as possible. Just curious.
Yes. I think it's probably a combination of those two things, Dave, there's a little bit of uncertainty, maybe still unemployment or maybe not feeling completely secure if they've just gone back to work. And also, the fact that on the consumer side, we're putting up very little resistance to a second 90-day modification. We're making it pretty easy on them.
So it will be really the third round that will be most telling where we'll begin to institute our historical modification or restructure framework, which requires additional documentation will be tailored plans to the individual borrower, that sort of thing. So I don't read too much into that 70% number at this point. There's still a lot to learn.
Got it. And as we look at the loan loss provisions, obviously remains elevated with the uncertainty out there. Just curious in terms of the model inputs there. What do we need to see to really start to see material decline in that? Is it a decline in the unemployment rate increase in state GDP? I know there's a ton of inputs there, but I'm just curious what are sort of the – what would be maybe one of the – one or two of the material drivers to really show a material decline in that number?
Yes. I think it's certainly an interesting question in terms of how we've had to approach the buildup to-date. A lot of the models that have been built in ours in particular is heavily driven off of asset quality metrics and given the unique aspect of this environment and in some of the release that we have from a regulatory perspective, a lot of that impact isn't necessarily reflected in the data input.
So you're not seeing meaningful increases in NPAs or even levels of net charge-offs that would really influence the model. So a lot of it has really had to – a lot of what we've had to do is be very much dependent on our insight into the at-risk industries, taking a look at what some of our historical max loss given default rates have been.
We've done some stress testing over probability of default on where we consider there to be more at risk. The industries, Gerry alluded to in the first question raised and where we've seen some of the deferral activities. So that's really been the backdrop of how we've built the model and what I call the qualitative aspect of the provision in that we've put up so far.
So I think we've taken a pretty conservative approach at that and we've anticipated that some level of these high-risk industry exposures and deferral requests will certainly lead to non-performing assets and potential loss. But I think where we stand today, we’ve tried to capture a pretty reasonable outlook on that expected transition to lower quality assets.
And I think we'd have to see really a meaningful deterioration in asset quality or economic activity to suggest provision levels would continue to increase at these levels. So I think all things being equal and knowing the approach we've taken through the second quarter, I would anticipate, we start to trend down on provision, but again, I couch that with the caveat that certainly if we start to see levels of NPAs or movement to enhance criticized and classified levels outside of what we've already expected in the model today that could lead to elevated provisioning.
Okay. Got it. Appreciate the color. And one final for me, Mark, you noted on a core basis, potentially a few basis points here or there in terms of NIM compression. What base are you using that off? Is that the 3.41% or 3.48% sort of core net interest margin on the Appendix C, which is great by the way?
Yes. I'd say both. I think the 3.48% is just really inclusive of purchase accounting, and that has been a bit volatile quarter-over-quarter. So I think if we had consistent levels of purchase accounting, I think you'd still see a few basis point decrease off of that level, certainly off of the core margin that we disclosed in terms of the 3.41%. I'd say that's probably more of a pure outlook that excludes some of the volatility of purchase accounting. And it really just reflects probably stating the obvious, but just the continued reinvestment into this lower rate environment.
We do have relief on the deposit side that we've already made changes there. And I mentioned the cost of deposits that we ended the quarter with being in the low 20 basis point range. So we should see relief on the deposit side into the third quarter to offset the asset yield challenges. But I'd say, all-in-all, we still would expect some level of compression over there in the second half of the year.
Would you see some of that excess cash getting utilized? I think you're at $1.1 billion or so. Is that sort of – I don't know how much is that expected to flow out…
Yes. It's tricky. Certainly, I think in terms of knowing a significant portion of that is associated with PPP. I would expect to see that run out. And to be honest, we were a bit surprised to see how much of that deposit was still on account through the end of June. And I think that may just be a reflection of the changes in the government program and the extension of customers to utilize those funds going from eight weeks to 24 weeks.
But we were honestly expecting to see a bit more of that money outflow shortly after the loan was issued. So I do think all things being equal, we should see a portion of that $650 million or so of deposits associated with PPPs stock to runoff in the third quarter. And then in terms of other excess cash, it's just a challenging environment of where to put that money to work.
We've certainly seen some decreases in our securities portfolio and there's been a hesitation with the rate environment to invest meaningfully there. But I'd say that that's likely an area we'll have to do some level of additional purchasing here in the third quarter.
And I think when you look at the loan book and understanding some of the dynamics that drove the decrease as we saw in the second quarter, such as meaningful drops in line utilization. As we have a cautiously optimistic view over some of that business activity coming back in the third quarter, we hope to see some level of increase maybe in the line utilization and in loan volumes to use up some of that cash as well. But it will certainly be a challenge to deploy that cash in any meaningful way over the second half.
Got it. Thanks.
You're welcome.
And the next question will come from Laurie Hunsicker with Compass Point. Please go ahead.
Yes. Hi, thanks. Good morning. Just staying with the question of margin here, I just want to make sure that I'm thinking about this the right way. So if you look at your accretion income, in the fourth quarter, it was 19 basis points, and then it was 4 basis points in the first quarter, now 7 basis points. So to your guide, does it include more of 7, 8 basis points or does it include more of a 3, 4 basis points? Or is your guide just solely on the core excluding accretion? And then I guess the following question would be, how do you think about accretion for the back half of this year? Thanks.
Sure. I'd say the guide is based off of the core margin. I guess would be the more simplistic way to view it. Although I don't anticipate any meaningful variations from the loan accretion we saw in Q2. That's certainly been a tough number to predict. And to your point, it was a little under $900,000 in the first quarter up to $1.6 million in the second quarter.
So I'd say in that range, obviously acknowledging that that can be a pretty wide range. But I think if you assume purchase accounting accretion in that $1 million to $1.5 million range, I think that would keep the purchase accounting impact relatively stable quarter-over-quarter. And the few basis points compression would be applicable to both that adjusted margin and core margin level.
Okay, thanks. And then just quickly here on tax rate. Is obviously lower. Should we be using closer to 25% or how should we think about that?
Yes. I'd say given the level of provisioning that we've pushed through the first couple of quarters, I think you can drop that to more on the 24.5% range.
Okay. And then, I guess just last question, Mark or Gerry. Just looking at the hotels, so your deferrals are 62%. How much of those go out a 180 days? If you have it – or how many have already done a second deferral request or how many are you expecting there?
Laurie, this is Gerry. So we only granted P&I deferrals of up to 90 days in the first round.
Okay. Got it.
And so in the second round, it would only be an additional 90 days. Is that answering your question?
Yes, it sure is. And then – I mean, I guess, because – well, maybe most of them are coming in the next few weeks. But I guess of your $256 million of deferrals, how much of that are you expecting to request another 90-day plug?
Well, I would think from the hotel side, probably 80%. Although what's interesting, we've actually had some already tell us, we're set. And as I mentioned earlier, I was little surprised by that, because they're not even in vacation areas. So it's really – my suspicion is most will want it because they want to be cautious, which I understand. But there are some of them telling us that they think – those in vacation areas, they think the year will be okay.
The ones dependent on business travel are going to have a very difficult year, and I'm sure we're going to have to restructure cross-collateralized, get additional guarantees and have to do something to get them through even after the period of deferrals. This business travel is not coming back by September.
Yes. Great. So you had mentioned roughly 50% of your $415 million book was vacation. What percentage would you call pure business travel of the $415 million?
That's the harder number to really try to get out and we've struggled with it. Because what's interesting, the remaining balance are simply not in vacation locations. So they're not in the ones I shared earlier, but some of them are near Boston, for example, and there are still tourist groups coming to Boston. So they do have some of that. But the remaining almost all flagged, Marriotts, Hiltons, Hyatts, Days Inns, that type.
I would say probably all of them, probably business travel is at least half of what their normal revenue would be, but the remainder would be people related to staying in the hospital. And many of them have business sourced from people having extended hospital stays, as I said, tourist, family gatherings.
We've actually interestingly enough had a few leaving on places like Brocton that have told us they’re back up to 70% occupancy rates and they do seek deferrals. These again a family-owned hotels, but that they didn't need any further deferrals. So it's somewhat surprising, the ones that are actually doing maybe great, but doing okay, very interesting period.
Okay. And then just sort of one final question on the hotels. Are you seeing any of that again, don't break into the vacation area, but maybe they're close to universities. Have you seen any universities do any kind of a pickup on the hotel or is it just too early to figure that out?
Yes. I've heard those stories as well. I think it's still too early to determine if that does materialize. It may because they're trying to look to spread people out. So we have yet to see it materialize.
Okay. Thanks for taking my question.
You're welcome.
And the next question will come from Collyn Gilbert with KBW. Please go ahead.
Thanks. Good morning, everyone.
Good morning.
Good morning, Collyn.
Just to stick to the credit conversation, which, again, the detail you guys provide in the press release is great. Super good detail. Thank you for doing that. But Gerry, I know it's a tough question, but just given what you know now the level of sort of granularity and digging that you've done into the portfolio and all the movement that you've seen. Do you have a sense of kind of where do you think near-term net charge-off could peak? And I know it's a hard question, but as more just based on what you know now, just sort of curious. And just a general range of where you think losses could go?
Yes. That is a tough question. I mean my gut instinct tells me that if the peak is probably going to be beginning sometime in the fourth quarter 2020 through Q2 in 2021 is my guess. So over those three quarters somewhere in there is my suspicion is it will be peak. Just a suspicion.
Okay. And so I guess then to follow that up, I mean, given that you're sitting at zero right now, I mean the magnitude of change that is, I don't know. I know it's a tough question. But I just – we're just trying to sort of figure out what ultimately the losses will look like here?
Just to add some color there, Collyn. And sorry, Gerry, I don't mean to interrupt. But I think the challenge for us and not to bring this back to see some modeling, but we've been leveraging history and charge-off activity and loss given default from historical crisis. That's where there's really a challenge because this environment certainly doesn't reflect the experience we had through the 2008 crisis.
So as much as we're trying to leverage that information and understanding of where we saw sort of peak charge-off levels in the past, I think trying to correlate that to this environment and taking into account PPP relief and deferral relief, it adds an element to it that certainly doesn't equate from apples-to-apples comparison. But I think there's some comfort in knowing that we did try to leverage as much of that in the first quarter analysis of providing for loan loss.
And what I mean by that is we've really looked to where we see risk in the portfolio and looked back to our history of where we had max loss given default rates. And we've leveraged that data combined with stressing probability default assumptions sometimes upwards of 50% to 75% of what the model suggests PD is based on economic data. So I think we've taken a pretty conservative view over understanding historical net charge-offs peaks and loss given default rates. And that's really been the backbone to how we've determined our provision into the first couple quarters.
So I think that's as best as we've been able to try and think about where charge-offs could go in the next three or four quarters as Gerry alluded to. But I think the nuance of this environment and some of the other external factors and just really how broad and widespread the risk could go, it makes it a unique in much different environment than what we've gone through in the past.
Okay. One – just last question on credit before I move to the balance sheet. So just curious, it looks like you had about $4.5 million of NPAs return to payments this quarter. Just curious what the dynamic was around those credits? Or what drove that?
Yes. To be honest, Collyn, I'd have to look at the relationships involved there. Of the top of my head, I believe these may have just been pre-relationships where some of that short-term challenge was able to be met and they've got back into good footings, but I don't have the specific relationships in front of me, unfortunately.
Okay. No worries. That's fine. Okay. And then Mark, just shifting to the balance sheet, right? So just curious, two things. One is, where are your new loan origination yields coming?
Yes. Not surprisingly they're down meaningfully through the second quarter. And if I take a look through the different portfolios, I can get a little bit of insight there. But on the C&I space, as you can imagine, we're down in the low 3% on average, similarly with CRE, we have tried to look to implement, as Gerry talked about floors, especially on our fixed rate volume on the CRE side.
We've looked at floors of 3.5 to 3.75 depending on five to 10-year maturity. But with some of the variable, especially our swap book as you know is based off of one-month LIBOR pricing that results in many loans being unexecuted sometimes in a sub 3% capacity. So on average, our new volume on the CRE side, I'd say, was right around the 3% to low 3% in the second quarter.
Construction, we typically get to see better spreads and better pricing there. So we've been able to see new volume come in there in the low 4% range. And then on the consumer side, just a reminder, we talked a lot about on the significant mortgage production. Most of that is being sold and those that we are retaining in portfolio are typically better quality and certainly better priced volume in the mid 3% range in this environment to-date.
Similarly on the home equity side, we've been able to keep rates in the mid 3% there. So I think when you look at the entire portfolio as a whole, we've probably trended down into the 3.25% range kind of on a weighted-average. But again, not surprisingly given where the overall absolute levels of rates have gone.
Okay. And then just lastly, as you indicated, obviously, a lot of liquidity built here actually, I said lastly, now there's two more. One, just liquidity, and I know it's an uncertainty as to how the PPP loans are going to move or the PPP deposits are going to move. But is there more to do on the borrowing side? If you sit in this excess cash position for awhile, is it more to pay down on the borrowing side? I know you referenced the things you did in June, but even beyond that.
Yes. Well, there's not too much left on the wholesale borrowing side. We do have a portion of brokerage CDs that we'll set to runoff over the second half of the year. I believe, that's about $60 million in brokerage CDs. Those were some levels of activity that had come over with the Blue Hills acquisition and have a pretty sizeable rate on them up in the 2% range.
The term debt at the parent company that I talked about, we had paid off half of that, which is $37.5 million. We will continue to look to see if we can payoff more, if not all of that here in the second half. And then in terms of FHLB borrowings, it really doesn't leave a whole lot more, $100 million plus. A reminder that that $100 million of that was swapped out and fixed.
So we could look to exit some of those relationships, but I think with the term debt being paid down potentially, and some of the runoff on the remaining brokered CD that should certainly help the cost of funds picture even more than what we did just on rack rates for deposit levels.
Okay. And then just lastly on the PPP. I know it's hard to determine. But just for us, for modeling purposes, any sense of what we should assume or what you guys are assuming on kind of a forgiveness schedule in the next – over the third and fourth quarter after that?
It’s the magic question that we're trying to get our arms around as well. I'd say, based on what we know now and the level of the split between some of the size relationships that we executed. And if you've been following the program, there's anticipation that loans under $150,000 would be sort of a one page application and hopefully a much more smoother avenue to get forgiveness.
So if we would hope to see that the bulk of those loans of which we did probably 80% of our volume, were much smaller loan sizes. The goal and the hope here is that we see most of them be able to get to a level of forgiveness in the fourth quarter, maybe some of the larger relationships might trail off into 2021.
But we've been talking about just doing some modeling here internally that just guess would assume maybe 75% of the overall PPP production would hopefully get to a forgiveness stage by the end of the year. And I think the bulk of that would be in the fourth quarter.
Okay.
Again, that's really just speculation based on sort of reading what we're hearing from that customer base.
Okay. That's great. I'll leave it there. Thanks.
No problem.
This will conclude today's question-and-answer session. I would like to turn the conference back over to Mr. Oddleifson for any closing remarks.
Thank you, Sean. And thank you everybody for joining us today, and all the best to all, and we look forward to talking to you again in three months. Have a good weekend. Goodbye.
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.