WesBanco Inc
NASDAQ:WSBC
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Good day and welcome to the WesBanco’s Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to John Iannone, Senior Vice President, Investor Relations. Please go ahead.
Thank you, Sean. Good morning and welcome to WesBanco Inc.’s second quarter 2020 earnings conference call. Leading the call today are Todd Clossin, President and Chief Executive Officer and Bob Young, Senior Executive Vice President and Chief Financial Officer.
Today’s call, an archive of which will be available on our website for one year, contains forward-looking information. Cautionary statements about this information and reconciliations of non-GAAP measures are included in our earnings related materials issued yesterday afternoon, as well as our other SEC filings and investor materials. These materials are available on the Investor Relations section of our website, wesbanco.com. All statements speak only as of July 23, 2020 and WesBanco undertakes no obligation to update them.
I would now like to turn the call over to Todd. Todd?
Thanks, John and good morning, everyone. Appreciate you joining us on today’s call. We’re going to briefly review the results of our second quarter of 2020 and provide an update on our ongoing efforts during the COVID-19 pandemic. Key takeaways from the call today are: we remain a well-capitalized financial institution with solid liquidity and a strong balance sheet. We continue to focus on the health and safety of our customers and our employees. The integration of Old Line Bank continues to go well and we have achieved the post-conversion expense saves as planned and we believe we are well positioned for the current operating environment with sound credit quality, diligent expense management efforts, and a comprehensive range of digital offerings.
Our underlying performance during the second quarter was evidenced by strong year-over-year growth of 15.7% to $66.8 million in pretax pre-provision income, excluding merger-related expenses. This strong performance was highlighted by tightly controlled discretionary costs, record originations and fee income in our residential mortgage program, and year-over-year organic growth of a 0.5% when excluding the loans funded through the small business administration’s payroll protection program.
Our credit quality trends remain strong due to our legacy of prudent lending standards. This inherent strength of our company is evident when compared to all U.S. banks with total assets between $10 billion and $25 billion, as we have better credit ratios across a number of key measurements, which can be seen on Slide 13 of our earnings presentation. Furthermore, we continue to maintain strong regulatory capital ratios, which remain well above the well-capitalized standards.
As I mentioned during last quarter’s call, we successfully converted Old Line Bank into our new Mid-Atlantic market on February 21 of this year and achieved the anticipated cost savings related to that integration by early April. Encouragingly, the integration has gone very well as we continue to experience good customer and employee retention and remain positive about the long-term opportunities in our newest market. We are monitoring the virus trends across our footprint and remain focused on the health and safety of the entire WesBanco family, our customers and employees. We routinely review our policies and procedures to ensure they meet the highest level of safety standards. As we have since March, we continue to stay safe, serve our customers through both our drive-up facilities and via appointment in our branch lobbies.
I’m proud of the entire organization as it has worked tirelessly to help our customers and communities, and our efforts have not gone on appreciated by our customers, as we have received quite a few positive comments across our organization. I’m also pleased to mention that WesBanco Bank was recently named, for the second year in a row, a World’s Best Bank by Forbes magazine. The second annual ranking is based upon customer satisfaction and consumer feedback, and we received very high scores for customer service, financial advice, general satisfaction, and digital services. I’d like to personally thank our employees for their hard work and dedication, and congratulate them on the job well done.
In mid-March, WesBanco was one of the first banks to launch a number of initiatives to help mitigate the impact of the unprecedented COVID-19 virus outbreak, including offering, mainly 90-day payment relief options to affected borrowers and participating in the SBAs payroll protection program. We have received hundreds of letters and messages from grateful customers and community-based organizations. Since most of these deferrals were made from mid-March through early May, we are beginning to enter a timeline when customers are coming off of deferral status. In fact, we have seen a reduction in the amount of loans receiving payment deferral, as a significant majority of those customers are not requesting a second deferral.
As of July 20, loans receiving relief represents 15.9% of loans, where 17.2% of loans when excluding PPP loan balances. We have long had a robust platform of digital banking service, including digital bill pay P2P payments, mobile deposit and online residential mortgage applications. Deposit account opening, small business loan application capabilities, again, just to name a few of our capabilities on the digital side. Reflecting the realities of the current environment, we have seen increased utilization of our digital channel products by our customers. This combined with the unmitigated success of our employees working remotely; we anticipate accelerating our branch optimization strategy during the second half of this year. I look forward to provide you more details on that on next quarter’s call.
Before I turn the call over to Bob, I’d like to make a few comments in our diversity and inclusion efforts. For many years, WesBanco has been a leader in its communities, and we want to continue to take a leadership role by noting our stance on equality. As CEO, I’m looking internally and constantly reaching out to my team members in hopes of having constructive dialogue within our own company on the subject of inclusion. In addition to our existing women’s symposium events, we are adding a Diversity and Inclusion Council as an added resource and a positive catalyst for how we conduct business. This program focuses on employee development, education and community outreach.
Our hope is that it not only helps us evolve and grow as a company, but it also spreads to all of our other community-based efforts. In fact, during the past year alone, WesBanco has made approximately $1 million of philanthropic donations in support of our communities, and this is in addition to the approximately 600,000 of pandemic-related grants we distributed to organizations across our footprint.
To affect change, we must all lead by example. as a company, we are focused on being leaders in our markets. Personally, I am reaching out to all the mayors’ cities across our footprint and asking them to include WesBanco in community-wide discussions on how Corporate America can help move the country forward. We’ll strive to be transparent in our efforts, in our activities around Diversity and Inclusion and that includes being the example first.
I would now like to turn the call over to Bob Young, our CFO for an update on the second quarter’s financial results. Bob?
Thanks, Todd, and good morning, everyone. During the second quarter of 2020, we experienced a continued declining rate environment due to the 150 basis points of cuts in the Federal Reserve short-term interest rates during March. The continuation of the limitation on interchange fees for large banks above $10 billion in total assets and the deterioration in the macroeconomic forecast, which has required by the new current expected credit losses accounting standard, otherwise known as CECL, negatively impacted the provision for credit losses.
Primarily reflecting CECL’s impact on the provision for credit losses, in the current pandemic driven environment, we reported GAAP net income of $4.5 million and earnings per diluted share of $0.07 for the three months ended June 30, 2020. And GAAP net income of $27.9 million and earnings per diluted share of $0.41 for the six-month period. In order to provide better comparability to prior-year periods and to demonstrate the strength of our underlying second quarter results, it is important to evaluate pretax pre-provision income, excluding merger-related costs.
For the second quarter of 2020, we reported $66.8 million in pretax pre-provision income, excluding merger-related costs, which increased 15.7% and 7.8% compared to the second quarter of 2019 and first quarter of 2020 respectively. In addition, we reported strong second quarter pretax pre-provision returns on average assets and average tangible equity of 1.61% and 19.47% respectively.
We believe our strong balance sheet is well-positioned for the near-term operating environment, as we proactively addressed our various lending portfolios in order to more properly balanced risks and rewards during the last few years. When excluding the Old Line Bank acquisition, which primarily drove the year-over-year increase in total assets and total loans, total organic loan growth for the second quarter was 11.3%. Reflecting both loans funded through the SBA’s payroll protection program, and organic growth in commercial and residential real estate loans of 3.9% and 1.6% respectively.
As of June 30, we have added thousands of current and new business customers by funding more than 6,800 PPP loans totaling $837 million. Furthermore, reflecting strong demand deposit growth, we continued to strengthen our balance sheet by reducing higher cost certificates of deposit and Federal Home Loan bank borrowings, which declined 6.7% and 28.8% quarter-over-quarter respectively. Total organic deposit growth excluding certificates of deposit was a strong 20.3% year-over-year, reflecting the CARES Act and PPP loan deposits, delayed tax payments and stronger personal savings rates.
As Todd mentioned, we were one of the first banks to proactively assist our customers with various loan deferral initiatives, the majority of which were for 90 days during the early stages of the pandemic. Over the past 30 days, as we have moved past that initial deferral period for many of our customers, we have seen the overall level of deferrals decreased by more than $300 million and we are not yet seeing a significant number of requests for a second round of deferrals. Our long-term lending strategy is built upon balanced and diversified loan growth across both our six state footprint and various loan categories while adhering to our prudent credit standards.
on slide 5 of the supplemental presentation, we filed last evening, we provided an update on certain commercial loan categories disrupted by the pandemic, including hotels, restaurants, retail, and energy, which combined represent 16.7% of total period end loans, including PPP loans. As you can see across each of the categories, which were detailed on Slides 6 and 7, there is good diversification and granularity. The loans in our hotel portfolio are two well-known seasoned hotel flags and operators across our footprint with an average loan to value of 56% and debt service coverage of 1.6 times. There are no outsized loans in these portfolios. In fact, the vast majority of loans across retail, restaurants and direct energy, average less than one million. Furthermore, within our retail portfolio, the largest subcategories as a percentage of total loans are commercial real estate loans for strip shopping centers with anchor tenants like grocery or other essential stores or standalone buildings like pharmacies.
turning now to our credit quality measures, which were highlighted on slide 13, key metrics such as non-performing assets, past due loans, criticized and classified loans, and net loan charge-offs as percentages of total portfolio loans remained at low levels and favorable to peer bank averages. In this case, peer banks are those with total assets between $10 billion and $25 billion for the prior four quarters and consistent with prior years.
reflecting the adoption of the CECL accounting standard earlier this year, the allowance for credit losses specific to total portfolio loans at June 30, was $168.5 million or 1.52% of total loans, or when excluding the SBA PPP loans, 1.65% of total portfolio loans. The increase in the allowance and related $62 million provision for credit losses was related to the continued deterioration in the macroeconomic forecast during the second quarter of 2020, primarily driven by the negative forecasted economic impacts of COVID-19.
This forecast based upon a blend of two nationally recognized economic forecast published in June is primarily driven by national unemployment and interest rate spreads as well as other various qualitative factors. Key information and measures affecting this quarter’s provision can be viewed on slide 14 of the earnings presentation. I would also like to mention that there’s an additional $11 million accounted for in the unfunded commitments liability.
moving now to interest income in the margin. as we’re seeing across our industry, net interest margins are being negatively impacted by the cumulative 225 basis points of cuts to the Federal Reserve Board’s target federal funds rates since July 2019, as well as the relatively flat yield curve. Reflecting the significantly lower interest rate environment, we have aggressively reduced our deposit rates in particular higher priced CDs and shortened the maturities, and lowered rates in our borrowings, partially offsetting lower earning asset yields, which reflect materially lower yields on new or re-priced commercial loans, as well as the negative two basis points impact from PPP loans this quarter.
excluding the purchase accounting accretion benefit of 19 basis points, our net interest margin declined 36 basis points from last year and 22 basis points from last quarter to 3.13%, which was consistent with last quarter’s outlook statement.
On the subject of fee revenues, non-interest income for the quarter ended June 30, 2020, was $32.9 million, an increase of 5.5% year-over-year and 17.3% quarter-over-quarter. The primary drivers of fee income growth were mortgage banking fees and commercial loan swap income partially offset by lower electronic banking fees due to the Durbin amendment to the Dodd-Frank’s Act, mandatory limitation on interchange fees as well as lower service charges on deposits due to higher consumer deposits from personal savings, as well as overall fewer transactions and limited consumer spending experience during the quarter.
reflecting the current low interest rate environment and organic growth, mortgage banking income was $7.5 million during the second quarter due to record one-to-four family residential mortgage origination volumes of 368 million, half of which were sold into the secondary market and also of which approximately 55% were related to mortgage refinancing.
We continue to balance discipline growth and important technology investments with a fundamental focus on expense management in order to deliver positive operating leverage and enhance shareholder value. total operating expenses, excluding merger-related costs for the second quarter of 2020 of $85 million continued to be well-controlled and lower than expected with a resulting lower efficiency ratio of 55.57%, as well as a decrease in these expenses from 1.3% from the first quarter. this reflects the anticipated cost savings from the Old Line Bank merger and effective discretionary expense controls and acted early in the pandemic.
Salaries and benefits were somewhat reduced this quarter by lower incentive compensation accruals and deferred costs on the PPP loan program originations as well as lower healthcare costs. for 150 years, the bank’s management is focused on being a strong and sound financial institution for our shareholders. while our regulatory capital levels remain strong during the great financial recession a decade plus ago, they are even stronger now as we have regularly reported capital ratios, significantly above both regulatory requirements and well-capitalized levels and we have grown tangible equity to 9.09%. We remain focused on appropriate capital allocation to provide financial flexibility for the foreseeable future.
Well, let me now turn to our current outlook. with an operating environment that continues to be unprecedented, it remains difficult to provide meaningful earnings expectations for the rest of the year. That said, I would now like to provide some limited thoughts on our outlook. as a somewhat asset sensitive bank, we are subject to factors expected to affect industry-wide net interest margins in the near term, including a relatively flat spread between the three months and 10-year treasury yields. The 150 basis points of federal funds rate cuts experienced in March and a continued overall longer-term rate environment for at least the next one to two years.
Our GAAP net interest margin for 2020 may decrease by a few basis points per quarter, due to the lower purchase accounting accretion from the 19 basis points that we recorded during the second quarter. declining asset yields should be partially offset by the aggressive pricing actions we have taken and are continuing to take on our deposit costs along with continued borrowings reductions. We anticipate our second half of 2020 core net interest margin, excluding accretion from both purchase accounting and PPP loans to be down a few additional basis points from 3.13% during the second quarter. However, we also anticipate margin accretion over the next few quarters as PPP loans are forgiven by the SBA and as net deferred fees on such loans are accreted into income.
We will maintain our focus on diligent expense management and delivering positive operating leverage. While second quarter salaries and wages reflect the planned personal cost savings from the Old Line Bank acquisition, typical midyear merit increases are effective late second quarter through mid third quarter of 2020 across an employee base that now includes our mid-Atlantic region.
We have delayed the implementation of up to $2 million in planned 2020 brand awareness and other marketing expenses into 2021 and expect marketing expenses during the second half of 2020 to be similar to the first half of the year. Furthermore FDIC insurance expense will increase from 2019 due to a higher assessment rate associated with our larger asset size as well as last year’s $3.1 million assessment credit from the FDIC, which was realized during the last two quarters of 2019. we are comfortable with the current consensus for expenses in the back half of the year of some $87 million to $88 million for quarter.
as a reminder of the anniversary of the impact of the Durbin Amendment on our electronic banking fees will occur during the third quarter of 2020. Relative to our provision for credit losses under CECL, that provision will depend upon changes to the macroeconomic forecast, as well as various other credit quality metrics, including loan growth, potential charge-offs, delinquencies, criticized and classified loan increases, and other portfolio changes.
Lastly, we currently anticipate our effective full-year tax rate to be approximately 13% to 14% subject to changes in certain taxable income strategies and now inclusive of the State of Maryland and our total state income tax provision.
We’re now ready to take your questions. operator, would you please review the instructions?
Thank you. [Operator Instructions] First question today will come from Casey Whitman with Piper Sandler. please go ahead.
Hey, good morning.
Good morning, Casey.
I’d just maybe, start with the NIM guide you just gave, what does that assume for, I guess, a level of liquidity you guys have, does that assume some of the deposit growth that you had this quarter is going to come off and sort of how quickly just to get to, I think you said a couple of basis points more of compression? Thanks.
Yes. one thing I would note is that with the July 15 tax payment due date and both April 15 and June 15 have been moved forward. I think those banks and we as well are, and would continue to experience some runoff in deposits related to those large tax payments for companies and individuals that are due. And we also expect that while the personal savings rate has been high over the last quarter that some of that, particularly, if another round of stimulus isn’t adopted; some of that personal savings would be used for expenses if unemployment and another round of CARES act like payments aren’t made to individuals. plus the PPP loans and those deposits then put back into the bank should be spent by those businesses. Casey, we did calculate that the higher base of cash and due from banks, basically earning 10 basis points on the portion invested at the federal reserve cost us anywhere between three and five basis points for, call it the extra $500 million or so that we were carrying here in the second quarter on average.
And so I do expect as maturities of federal home loan bank borrowings come up and you can see that we’re down from the first quarter or the second quarter, in terms of the federal home loan bank. We had taken some extra money down at the end of the first quarter just to have a reserve. And so we’ve paid down over $300 million of those in the second quarter, and that pace should continue here in the second half of the year. Is that responsive?
Yes. Yes. Thank you for that, Bob. I guess the other question on margin, can you let us know the actual amount of PPP income you got this quarter both from the interest and the net deferred fees please?
I believe it was 3.7%. The – if you look at the average and I think that would be a question you’ve got $840 million and we figured the average, it was kind of front-loaded. So, the average of the quarter about $680 million, we think the monthly run rate when there’s no forgiveness is about 2.5%, but we do expect margin accretion. If you’ve heard that one sentence I had on PPP loan income, being accretive to the margin in the back half of the year that is a quarterly comment. So, as forgiveness occurs, we would expect to see against our other comments on the margin, three basis points to five basis points per quarter of specific that quarter margin pickup as forgiveness occurs. But we really don’t know yet the pace at which forgiveness occurs. there aren’t instructions yet posted by the SBA.
So, no one has submitted their first forgiveness application. We do have a queue of them from some customers that we’re anticipating forgiveness to occur after that initial eight-week period, but with the change in the program and now allowing up to 24 weeks for people to spend the money and then the 60% versus 75% against the portion related to salaries. We think it’s just going to be longer before we see the – call it the tsunami of forgiveness applications to submit and you don’t get that the additional fee income that’s deferred until that forgiveness occurs. But it was not dilutive, significant late to the second quarter, even without the forgiveness. And even though I just quoted an overall yield including regular accretion of deferred fees – net deferred fees and a 1%. So yes, again, I hope that’s helpful.
definitely, I think we’re all expecting just the noisy margins in the back half of the year. So, thank you for that. I guess I’ll just ask one other – just as I think about capital here, just broader thoughts in terms of what would have to happen for you guys to need to rethink the current dividend that you guys are paying.
Yes. I’d be glad to jump in and answer that. I think when you look at what we anticipate at this point, looking at it at our own forecast and kind of what we see the economy doing and everything else, we don’t see any reason to have any kind of impact on our dividends. So, we didn’t have to forecast any kind of changes in that. We think we’ve got a good capital position. I think our pretax pre-provision earnings are very strong. We think we took a really significant step with reserve built this quarter. That puts us right in line with peers, if not a little bit of a little bit ahead of peers. And we still look at this as the earnings event, not a capital event with regard to this pandemic. I think like a lot of other banks do. So, we really don’t have any anticipation of that. You’d have to get into a really dire scenario, where banks are posting consecutive quarter losses and things like that and we don’t anticipate that.
Understood. Thanks for taking my question.
Sure. Thanks and welcome back by the way.
Thank you.
And the next question will from William Wallace with Raymond James. please go ahead.
Thanks. Good morning, guys. Real quick follow-up on the PPP numbers that you gave, Bob. I heard two different numbers. What was the yield on the loans net – with the net deferred fees is 3.7% or 3.5% exclusive of forgiveness.
I think I said 3.7%; if I didn’t, I meant to say $3.7 million was earned in the second quarter related program. By the time we got them on the system, out of the in-process count, it was about 2.5% in the month of June on a run rate basis. But again, that will increase in the back half year – and more in the fourth quarter and the first quarter of next year, when any particular quarter could see as much as high single digits, low double digits of margin accretion to that quarter, right. We don’t currently anticipate any significant margin accretion for the year of 2020, taken on a full-year basis, but a particular quarter, yes, because of those higher fee deferrals. we have about; I think on a net basis, net of costs, we have right around $25 million to accrete into income over the next couple of years.
Yes. Based on the way the rules are now, understanding that there’s a proposal to forgive maybe, some of the small salons without, just forgive them automatically. But exclusively, just the way the rules are now, what percentage of the loans that you’ve originated. What you think would qualify for forgiveness?
Well, we’ve redone our forecast and we’re figuring – we originally assumed that there’d be 30% to 35% left by the end of this year and 85% would be forgiven. We’ve now increased those assumptions to round 90% – a little bit higher than 90% would be assumed to be forgiven. But the pace in terms of what happens this year versus early next year has been moved more into that first and second quarter timeframes next year if you just think about all the times you have, or the number of months you have within the new process.
understood. Switching gears to the deferrals, I believe you have a slide that says the bulk of your deferrals were 90 day. If you look at the loans that have come off their 90 days and have hit a payment due date, what percentage of those have actually paid or said another way, what percentage have had needed a second deferral of the one thing that has had a payment due?
Yes. Given the timing again, we’re just coming off of that first referral, what I can say, because I just taught this question with our Credit Executive yesterday. What we’re seeing with regard to request for another deferral period is it’s very low. It’s like 3% of those that are coming due or asking for a second referral. And we’re putting them through credit underwriting and everything else. We’re being a little more generous obviously with the hotel portfolio. Because we would just expect that to be needing a second 90-day time period. But it’s very, very little, I mean, just a few a week at this point, but we’re still early in that process.
And we haven’t gotten the point yet where those coming off of deferral, would be coming up on a payment or anything like that at this point. But it’s been relatively quiet, which has been good – good to hear the pace of deferrals is down 95% from its peak. If I look at the last two weeks and compare that to maybe end of the highest two weeks, a couple months ago, it’s down 95%. And then with only 3% asking for new referrals that’s encouraging at this point. but I’ll have more color on that maybe, in a month again, when the next payment comes up for those companies and individuals that did not request the second deferral to see what they’re looking like. But again, if we see stress and if they’re asking us, we’re providing that deferral.
Understood. Thank you. So, I have two big picture questions for you. Todd, one, I mean, you built your reserves, not even including the marks that are off the balance sheets of 1.65% over 2% if you include the marks, do you scratch your head at all when you look at the economic forecasts in your reserve models of high single-digit unemployment and pretty significant GDP contraction? Do you scratch your head a little bit when you see the 3% of your loans on deferral or asking for re-deferrals about 97% are coming off? I mean, does that flip with you or does it seem perfectly rational?
Yes. the 3% asking for re-deferral, I think, is pretty low again; we’re early in that process. So, I want to see how that flows out over the next the next couple of weeks or a month or so, but that is a very low re-deferral rate, which would indicate that there’s a lot of companies’ businesses aren’t feeling a tremendous degree of stress. I think you’ve got some really unique things going on here, right? I mean, last quarter, we had the biggest drop in GDP. I think the country had seen since the great depression, but at the same time, household income was up over 10%, which I think was like a record and those are both occurring at the same time. So, it makes it very, very challenging to try to predict out a year or two years, things like that for the reserve and what’s the appropriate level.
So, we follow the rules. we got very specific rules around CECL and we take that process very seriously and we found it very closely, spending a lot of time on that to make sure that we’re reserving based upon what expectations are on unemployment forecast and things like that. And based upon kind of what we see today, we’re comfortable with the reserve steps that we’ve taken. But it may turn out that there will be reserve releases with the industry in a year, or if the industry takes another step downward and unemployment goes up and then there could be reserve increases. But right now, we’ve gone out and said, we’d take a big bite at the Apple here and put us in a position, where we’re – we think appropriately reserved, you look at our criticized, classified numbers, our charge-off numbers, our history of performance and everything else, and then look at our reserve level relative to peers as well.
I think we’re right in there with everybody else, if not; maybe a little, a little farther ahead, but we’re a conservative company. And I think that’s a good place to be. That’s why we carry a little higher capital level, kind of going into the end of the pandemic, even though we didn’t know it was going to be a pandemic. We’re just a little more conservative oriented company. And I think that flows through everything that we do. So, it’s hard to know whether there’s a disconnect, between the reserves that are being built and future stimulus and with the timing of vaccines and all that kind of stuff, it’s just – it’s so uncertain. But you got to quantify the best you can and put in place to move forward with it. But it’ll get evaluated each quarter. And I’m hoping if the vaccines continue to get some traction here. And the country gets spikes under control a little bit better, and businesses start to respond strongly that it may turn out that maybe the downturn won’t be as severe as expected, but we don’t know that and it could be just the opposite.
Okay. Thank you for that. And then the other question is just around the branch network, you may have addressed this in your prepared remarks. I apologize that I have not call run late. but one, Bob, you said you’re comfortable with the $87 million to $88 million run rate in the back half of the year per quarter. Does that include the anticipated saves around the consolidation that you referenced in the release? If not, could you quantify that and then Todd, what is your expectation of how the branch network might change, given how this pandemic has changed the behavior around the acceptance of the digital channel for delivery? How step out and listen to the response? Thanks.
Yes. I’ll start off with it, then Bob can jump in. We’ve been evaluating the bottom 20% performers of our branches historically even, well, before I arrived on the scene seven years ago. So, it’s something we’ve always done and we’ve closed 15 branches since 2017 out of 230 branch networks.
So, it’s nothing new to us, but we do and have been looking at the use of digital services, which has been significantly on the rise. And we’re also looking to see that, how well business has been able to be conducted in appointment typesetting and drive up typesetting and more customers using digital. So, we had plans to continue to optimize our branch network. We’re really looking seriously at accelerating that that’s something that we’re going to be discussing very seriously here in the second quarter as a company.
And I think you can look at probably what would have been done over the next three, four or five years, and probably accelerating that into the near-term next several quarters is kind of our outlook and our plan on that. So, it could be a combination of things. It would be in some cases, closures; in some cases, consolidations; in some cases, closing two and building a new one in the better location. it could be restricting some to ATM type services, things like that, and all of the above.
So, we’re really taking a very strong look at all of that and a lot of our peers have already done that and announced that, and I recognize that. So, our thoughts are very much in line, I think, with what others have done and we’d recognize that if something that we need to do as well too. it’s not reflected in any – I’ll let Bob speak to this, but it’s not reflected in any of the expense numbers or run rate numbers or anything like that, that we just mentioned to you. We would have to evaluate that and if we decided to do something on that, then that would change run rates and things like that. Bob?
Yes. I think you said it well, Todd, I think any discussions, decisions, announcements would, at this stage of the year, primarily just given the timeframe, it takes to get regulatory approval and to close offices, would be more of a 2021 savings event. Just a little bit of additional color, I just want to mention that we go market-by-market with our nine or 10 markets, and we have each one of the market heads evaluate with their teams the re-sightings that Todd mentioned, and those offices that don’t or aren’t getting enough traffic and enough transaction counts. And they make their own recommendations that we evaluate at the top of the house from a committee perspective before we make recommendations to the board, but each one of our regional presidents comes in and makes those presentations and it is led by our Head of Commercial and Retail, Jay Zatta. So more to come, but at this stage of the game or this part of the year, anything that we would do other than the ordinary course of events a couple here and a couple there would be a 2021 savings events.
Thank you.
And the next question will come from Catherine Mealor with KBW. please go ahead.
Thanks. Good morning.
Good morning.
I wanted to just ask about the increase in the reserve this quarter. You touched on this a little bit in your remarks, but can you just kind of talk about some of the qualitative assumptions that you made this quarter versus last quarter that may have driven the higher build? And just to clarify that there wasn’t anything kind of specifically within your portfolio or within your markets that you’re seeing that makes you more nervous that had you pushed the reserve hires more, just kind of big picture macro qualitative reasoning behind that. Thanks.
Yes. it’s clearly big picture macro things. If you look at the end of the first quarter, when CECL was adopted, they did not take into consideration, the pandemic and things like that, because you had to go back to the day one and all that. So, I think when you look at the second quarter, the unemployment forecasts were worse than they were when calculations were being done for the first quarter reserve, so – and that’s a big, big, very significant driver of it is what’s the unemployment forecast. So, when the unemployment forecast goes up, that drives the great majority of the numbers that that you’ve got. And we saw that, and I think another of other banks saw that as well, too.
So, you’d have to put some really significant overlays on top of things to address what the unemployment numbers are showing in. And some banks did that and we chose not to do a lot of that, because I really wanted the reserve level to be strong. But it’s a very qualitative – a very quantitative process. Even the qualitative process is very quantitative. So, you got to have a lot of support and documentation for what you’re doing.
So, it’s a very, very detailed specific process. But we didn’t see any significant deterioration in any kind of areas, where we thought there was a dramatic change that needs to be looked. We continue to look at individual portfolios, hotel portfolio, as an example, and things like that, and continue to watch those very, very closely. But what really drove the increase was, just the economic factors and the great important impact of that was the unemployment number. I mean, that really drove the great majority of the change. Bob, will you anything else to that?
Well, I could drone on for a long time, Todd, and that would probably not be a good thing. but I absolutely agree with Todd that is primarily a quantitative model that’s driven through a third-party purchase software tool that most banks are using these days. I won’t mention the vendor name, but it is infused with a lot of different factors from our data warehouse, from our portfolio specific to the bank. And then there are qualitative overlay supplied to that. So, things like increases in class of criticized and classified loans, a calculation around risk grade in precision. There’s a qualitative tool that we use that has nine or 10 different factors in it that get evaluated mathematically each period. And then we also added – we did add this particular period on the hotel book a little bit extra as well. So that was part of it.
Finally, individual or PCD loans comprise about $7 million of the total of $168 million. And then as I mentioned, during my prepared remarks, there’s an additional $10 million to $11 million in the allowance for loan commitments, which is reflected in other liabilities.
Great. That’s helpful. That makes sense. And then my second question just on fees. Service charges came down as we’ve seen across the industry and then, mortgage had a really great quarter. So, can you just talk about those kind of two moving pieces meaning first one service charges. When do you think that normalizes? Are you still waving fees and, would you kind of expect for the back half of the year? And then on mortgage maybe how much of this quarter was just from the lot pipeline increasing and how should we think about that normalizing in the back half of the year as well? Thanks.
Yes, I’ll, start off on that. As the mortgage business has been incredibly strong and continues to be, and I think with 30 year drop in below 3% here in the last week or two, that got a lot of people’s attention as well. So, we continue to see a lot of volume being driven there and really haven’t seen any slowdown in that. So that’s good. It’s good to see because that does support reduction in service fees based upon really the large deposit balances that, that people have been keeping as well too. So, I would anticipate Bob’s comment earlier about deposits, from those the CARES Act, coming down over time as people would spend them that you would see service charges go back up a little bit higher as a result of that.
And we’re anticipating the mortgage business to continue that to stay strong. We think, we’re going to be in a low rate environment for quite a while, and that hopefully we’ll be continued support for us. So, I don’t know when the two are going to cross, but I would tend to think that the mortgage business would stay strong. And then some of the service fees would come back as deposits are spent down and people return to work and it’s a more normalized balances that they’re keeping in their accounts.
And, Todd, just to add to that, we saw a little bit of improvement in service charges on deposits during or towards the back part of the quarter Catherine, the low watermark was really in the in the April, May timeframe, so a bit of recovery there. And as you might expect as well, and electronic banking or debit card and ATM transactions as well saw a little bit of improvement actually some nice improvement as we moved towards the end of the quarter. I would also point out that wealth management, which would have been lower as we priced accounts at the end of the first quarter given the market recovery. We saw a nice recovery in that specifically trust fees in the second quarter above our earlier forecast expectations. And depending upon where the market is, the rest of the year that should be helpful to the cause as well.
One final comment, we had pretty significant growth in residential mortgage in the first part of the year as well. Not as much refinance business until the second quarter, for sure. But because the volatility and interest rates in March, most companies experienced a negative mark if they were hedging their book, and we had a negative mark in March on our TBA hedges that that reduced the pull through of the fee income on that line. Did not have that to any substantive amount in the second quarter and so you’re seeing a good run rate estimate, at least for the next couple of months until we get later in the fall and winter.
Great. Very helpful. Thank you.
And the next question will come from Russell Gunther with D.A. Davidson. Please go ahead.
Hey, good morning guys.
Good morning, Russell.
Just a follow-up on the deferral conversation, I appreciate the color on the migration there and understanding that we’re in the earlier innings of second deferral requests. But as those come through just holistically, maybe do you consider these loans to be of higher risk given that they are in a forbearance program? And if that’s the case, is that captured in your current reserve even in a qualitative overlay kind of way?
Yes, I would say, we were very, very aggressive, came out early with deferrals. And I think as a result of that, and we were pretty generous, very generous with them actually. And as a result of that, we came out of the first quarter – with the first quarter earnings call, we were up around 21%, which I think it was higher than – higher than the averages and I think that got people’s attention. And what I mentioned on that call was that, it all has to do with the timing of when you provide those, if you went out early, and you’re using your earnings call days, you’re going to have a bigger number. If you went out late and you use the end of the quarter, your number could drop from 21% to 4%. But it’s all going even out by the time you get to the second quarter. And I think we’re seeing that.
So, you’re seeing some banks like us, that are dropping from 21% down into the 17% range. You’re seeing others that are going up, from the high single digits up into the end of the teens. And I think maybe by the end of the next quarter, it will get even a better indication of deferrals and what does that mean with regard to credit quality. So it was – so I guess what I’d say, so judgmental in terms of how banks approach that. If you took a really strict hand in it, you could have very easily kept it into the single digit numbers and that wouldn’t necessarily be showing up in your delinquency yet because of all the CARES Act and the PPP loans and everything else. But conversely, if you have a really high number that, that doesn’t necessarily mean that you’ve got more risk in your portfolio, that just means a lot of people in businesses kind of took these as insurance policies, because nobody really knew what the future is going to hold, and it’s still somewhat uncertain.
So it’s hard to really factor that into it. I think, with the second quarter and the re-deferral rate that’s going on, it kind of that 3% rate, we’ll see how that how that holds up over the rest of the quarter. But I can’t draw a line from looking at a bank’s deferral rate to saying, what’s the risk of that bank. It’s hard – it’s hard to really be able to tell that. But the answer to your question, based upon what we see right now, we feel that we’ve gone through the right process and setting reserves and adequately reserved. And we’re taking all of these factors into consideration, the ones that Bob mentioned, and there’s quite a few more that we look at it and you add all that together. We feel like we’re in a pretty good position right now.
If you ended up with a much higher deferral rate, let’s see still got a deferral rate that’s significantly high, and you’re starting to see delinquencies at the end of the next quarter. I think then you can start picking between banks, who’s doing what? But if you’ve got a bank at a 9% deferral rate in the bank at 17% deferral rate, I don’t think you can draw a line to future losses from that, even though it might be tempting to do so. Because a lot of it just has to do with how the bank approach, the deferral process and whether they’re letting their customers build up a war chest to get through the fall and the winter or whether, they’re not doing that in which case, then those banks with the lower deferral rates might have the higher delinquency rates come to the end of the year. Hopefully that doesn’t happen, but that could be the case.
I appreciate your thoughts on the subject, Todd, thank you. And then, trying to tie it all together in a CECL methodology world, I mean, barring a significant macro deterioration, do you believe reserves have likely peaked and you commented and perhaps bigger picture you could see reserve release in a year. So, trying to get a sense as to your thought of whether we’re at peak reserves and then from a go-forward perspective, are we really matching charge-offs and providing for any future growth?
Well, that’s a unique aspect of CECL, is predicting the future, right, which is why you try to make it as a process that’s very, very difficult to quantify and, but you’ve got to quantify it. And I think that’s the process, all of the organizations are going through. So based upon that, that process and looking at it, yes, I think that we’re adequately reserved for what we see today in our portfolio and for what the expectations are for the economic outcomes that are coming forward that could change up or down in the next couple of quarters, it’s really hard to tell, but as we sit here today we feel that that’s pretty good number.
And I think the fact that we don’t really spend a lot of time looking at others, because you got to look at your own balance sheet. Having 152 with we’re 165, I guess I should say without the PPP loans, the obvious there’s no risk in those. So 165 and then over two, when you put in the acquired mark that puts us in a really good position and at a much higher number than we were at that at any point during the great recession and it’s up there amongst some of the banks, our size with similar models. So, we feel pretty good about it relative to everybody else, but we also feel pretty good about it just based upon our own analysis and our own looking at it, but it isn’t without an awful lot of work and an awful lot of focus by a lot of really smart people that are trained to predict the future as accurately as we possibly can.
I appreciate your thoughts on that as well, Todd, thank you. And then just last one for me would be any commentary, your expectations around organic growth in the back half of the year?
Yes, it’s a really good question. We are seeing some pipeline activity. There are deals that are coming through and obviously we’re not looking to make loans or be aggressive in some of those COVID related industries like hotels and things like that. We’re not putting more hotel money out the door or anything like that at this point. But I think, when you look at growth overall, some of it’s being supported by the lack of payments, right? So, maybe $10 million, $15 million, in a month or a quarter or whatever, with regard to principle payments that don’t need to be made that that supports well and so, I would call that loan growth for the reasons you want it to be, but it is there.
We’re not seeing a lot of things go to the secondary market, which we were seeing before. I think the secondary market, it seems to be opening up, but it’s been relatively quiet. I still think coming out of this, I really like the way we’re positioned coming out of it means probably more of a 21 type of event in the markets that we’re at and the strength of those markets that low-to-mid single digit loan growth number would be something that longer term we think would be appropriate. But right now, I would say, all things being equal. I think most of the banks are kind of treading water right now. You want to take care of the customer relationships you have, and protect those relationships, but clearly not the time to be aggressive, I don’t think this isn’t the time to be taken big swings at on the risk side, if there is a time to do that. Sure, isn’t now.
But I think, our credit quality, our standards, our underwriting, everything has been pretty consistent throughout, and we’ve always said, we don’t get aggressive during the good times, but we’re also going to make sure we support our customers during the downtimes. Because, I think as a community bank, that’s served us well. So, long answer to your question, but I’d say near term, I don’t see a whole lot of growth, maybe a little bit economy recovers, but longer term, low-to-mid single digits would be the minimum that we would expect.
Okay, great. I appreciate the color. Thanks guys.
And the next question will come from Steve Moss with B. Riley FBR. Please go ahead.
Good morning. Well, let me circle back to CECL here. I don’t – just kind of in terms of looking for more of a raw unemployment number, if you will, kind of, I heard it was a blended use of models and just kind of curious as to what the actual number is just as we see unemployment progress over the next couple months as a proxy for what may happen with the reserve?
Yes, I’ll let Bob, you jump into this a little bit too. At the end of – our model has been based off of using a Fed number, but at the end of the first quarter, the Fed didn’t produce a number. So, we quickly pivoted to a Moody’s and we used – we used Moody’s at that quarter and decided that to blend the Moody’s and the fed, which I think a lot of others have done as well to kind of get a good look at both. But the latest I’ve seen and again, these changes almost week-to-week in terms of what kind of the expectations are clearly changes month-to-month. But it was the high single-digit numbers through the end of the year and getting pretty close to 10% through the end of the year. So coming down from more right now, but staying in that 9% or 10% range, but Bob’s much closer to the model than I am. Bob, any comments on that?
Yes, there was an assumption made Steve. As Todd indicated, we did pivot this quarter to include the Moody’s baseline and the Fed forecast. The Fed gives you period end data points. So, you have to interpolate, but the next year, year and a half. And so those were combined we take out a little bit of the volatility in the numbers by moving the forecast forward a quarter and then make a slight adjustment for the myths that occurred with the employment number on July 2nd versus what the expectation was from the Fed. And more specifically the Moody’s June, I think it was June 10th expectation for unemployment. So, that was the – how we made the soup, so to speak. That’s what went into to the model and, it does phase down it, it starts, with that in mind, it starts in the 8% to 9% range move forward one quarter and then works its way down towards the end of 2021 to the mid-7s. And then we have a one year reversion period. So it’s one year forecast, one year reversion and back then to historical losses that were accumulated in average from 1991, all the way to the present. So and then, on top of that are the Q factor. So that layers in some additional reserve.
That’s helpful. On the hotel portfolio, just maybe going a little further into that, just kind of curious as to what you guys may be seen for occupancy rate within that portfolio and just like underlying activity?
Yes. We get stars reports on all of our hotels. We get them every month, so it’ll track that pretty closely. And we just recently here in the last couple of days, we started to getting the June numbers, they tend to come out in the third week or so of July. So, we’ve got about a third of the portfolio’s June numbers coming in, in each month as has shown improvement. May was up over April, June was up over May and we’ve got some customers we tell customers that are over 80% occupancy. We’ve got quite a few of them that are, I think, in that, that 40% to 50% range and have shown improvement in June over the month before.
So, I’m real curious to see, the July numbers when the July numbers come out, because was the first couple of weeks of July, you had some increase in virus spread, things like that. Not necessarily in our footprint all that much, but I think it shook some people. So, I don’t know whether or not that is going to translate into maybe more of a flatter July on hotel, vacancy rate, maybe not because it didn’t – Memorial Day didn’t slow it down. So maybe July 4th, won’t slow it down either. But we’re seeing continued upward trend in that, which is really encouraging to see. And I think as you get toward the end of the August into September time period, I think that’s another kind of inflection point to look at as well too, because you’ve got people that are traveling doing kind of stay vacations and things like that. But when kids go back to school in the fall, assuming they do go back to school, then the hotels have really relied on business travel and things like that.
So, I don’t know what that’s really going to look like and what people, how are they going to feel about that? I mean, I’m staying in a hotel tonight, because I’m traveling to one of our markets be there tomorrow. So, I think there will be some business activity there, but you know, it may shift from stay vacations to more of a more business travel. I would expect over the next a couple of months to be very telling for that portfolio and hotels in general, but I’m encouraged by what I’ve seen. And we’ve had a number, quite a few of our customers that have hotel customers that have said they do not need a second deferral period. And they’re okay. And a lot of them are sitting on, millions and millions of cash. Because we tend to deal with some of the bigger operators, even though the average loan size, isn’t that big, because we’re careful with our exposures are per loan per customer that there are some individuals and businesses with pretty deep pockets that really could run a year, year and a half if they needed to before they really got into some difficulty. So that’s improving, improving one month over the next.
That’s really helpful. And then I guess just one last question for me, I know there was an uptick in the 90 days still accruing category, just kind of curious what was driving these numbers?
Yes, that’s a good question. What we saw was about $20 million or so of that increase came related to just administrative related aspects we were focused on the PPP loans and focused on loan mods and things like that. And we didn’t get to some of the administrative things that that we wanted to, particularly in relation to quite a portfolio, at Old Line, we didn’t we just – things got backlogged. So, checked into that pretty deeply, because I expected we get some questions on it and a great majority of that is not credit quality related. You may affect a lot of it’s off already. So, we’ve got some processes and procedures in place we’re going to have some additional support there through our credit risk management process to get these things through. So they’re not backlog.
So that some of them were even PPP or – I’m sorry, some of them were even loan modifications that had been approved, two months earlier, they just didn’t get done, administrative things. So you shouldn’t see that next quarter. I wouldn’t expect related to administration. I would expect over time, I mean that, we’re going through the pandemic and everybody’s reserving money. So, I would expect, that criticized some classified would rise overtime. I would imagine over 90 days is going to rise over time. I would expect that in future quarters, but this quarter, no, I mean, there was a little bit so pay in there, but the great majority of that was really just administrative related and shouldn’t have happened.
Great. Thank you very much for all the color.
This concludes today’s question-and-answer session. I would now like to turn the conference back to Todd Clossin, for any closing remarks.
Thank you again for everyone’s time today. We believe, we’re well positioned in the current operating environment. I think we’ve got very good strategies in place. You all know about our strong legacy of credit and risk management. We’re very conservative on liquidity and capital position as well. So, I think, we’ll see that should stand up well through the pandemic. I look forward to speaking with you soon at an upcoming virtual investor events and thank you all again for you time. Have a good day.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.