WesBanco Inc
NASDAQ:WSBC
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Good afternoon and welcome to the WesBanco Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded.
I would now like to turn the conference over to John Iannone, Senior Vice President of Investor Relations. Please go ahead.
Thank you, Carrie. Good afternoon and welcome to WesBanco Inc.'s third 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 reconciliation 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 October 22, 2020 and WesBanco undertakes no obligation to update them.
I would now like to turn the call over to Todd. Todd?
Thank you, John, and good afternoon, everyone. On today's call, we're going to review our results for the third quarter of 2020 and provide an update on our operations. Key takeaways from the call today are that we remain a well-capitalized financial institution with solid liquidity, strong balance sheet, solid credit quality. We delivered strong pre-tax, pre-provision earnings driven by our diversified growth engines and company-wide commitment to expense management, and we remain focused on the continued successful execution of our long-term strategies, which have positioned us well for both the current operating environment, as well as future opportunities.
We are pleased with our performance during the third quarter as we reported net income of $44.2 million and pre-tax, pre-provision income of $68.9 million when excluding merger and restructuring charges. PTPP income grew 33.8% year-over-year and 3% quarter-over-quarter driven by strong fee income growth and disciplined cost control. On the same basis, we reported pre-tax, pre-provision returns on average assets, and average tangible equity of 1.64% and 19%, respectively. Reflecting our strong legacy of credit and risk management, our key credit quality ratios remained at low levels, and our regulatory capital ratios remained well above the applicable well-capitalized standards. Furthermore, as can be seen on slides 11 and 13 of our earnings presentation, our key ratios also remain favorable to peer bank averages.
During the third quarter, we announced a couple of significant events that we believe were very well received by the investment community. On August 4th, we raised $150 million of non-cumulative preferred -- perpetual preferred stock. The capital raise essentially replaces the movement of our trust preferred securities from Tier 1 to Tier 2 risk-based capital late last year, as required for banks with total assets greater than 15 billion. Further, it provides us very strong and peer leading capital ratios. We initially viewed this as a more defensive measure due to the economic uncertainty earlier in the year. However, while we have no immediate plans, the improved environment provides us more flexibility on the potential uses of this capital to maximize the benefit of our shareholders.
Then on August 27th, we announced the acceleration of our financial center optimization plan in order to better align our operations with the needs and preferences of our customers. As we indicated last quarter, reflecting the current operating environment, increased utilization of digital services by our customers, and transitions with our communities, we're planning to consolidate a total of 25 locations and convert two others to drive up only across the states of Indiana, Kentucky, Ohio, Pennsylvania, and West Virginia. The significant majority of these consolidations will occur during January, with the anticipated gross cost savings of $6 million to $6.5 million phased in during the first half of 2021. Importantly, staff at the locations being consolidated will be given the opportunity to fill certain open positions and other nearby financial centers.
I continue to be extremely proud of our employees as they have gone above and beyond to serve our customers and communities during the last six months. In addition to our company donating more than $0.5 million for pandemic-related efforts, our employees continue to provide their time and effort supporting local charitable organizations. They've assisted more than 7,200 appreciative businesses secure Payroll Protection Program loans from the Small Business Administration, as well as helped another 3,600 grateful customers worry about one less thing during the pandemic by ensuring they had appropriate cash reserves through our loan payment deferral program.
As you know 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. Through our efforts, we helped nearly 2,300 small businesses, 550 residential mortgage, 490 consumer loan and 230 home equity loan customers during the early stages of the pandemic. Since most of these deferrals were made from mid-March through early May, our loan deferrals peaked to 21% of total loans.
Since that time, we've seen a continued decline in these balances as approximately 95% of those initial deferrals are not requesting a second. In fact, total loan deferral balances are down 75% since the May peak, and are now just 4.9% of total loans. These customer and community-centric actions speak loudly to our community bank roots. Our long-term success remains dependent upon continued execution of our well-defined operational and growth plans.
As a reminder, our long-term growth strategy is focused on several key pillars; building a diversified home portfolio with an emphasis on commercial and industrial and home equity lending; increasing fee income as a percentage of total net revenues over time; maintaining a high-quality retail banking franchise; and franchise enhancing acquisitions. And these pillars would not be possible if they were not built upon our two strong legacies of our franchise, the unwavering focus on delivering positive operating leverage, while making the necessary growth-oriented and risk prevention investments, and maintaining our strong credit quality, risk management and compliance principles on which our company was founded 150 years ago.
Furthermore, the inherent strength of our diversification and growth strategy is how the components complement each other to support each other and ensure success and profitability regardless of the operating environment. Our strategies are enhanced by unique key differentiators, including our core deposit funding advantage, majority of our organization residing in major metropolitan markets with positive demographics, a century old trust and wealth management business, and back office functions that are consolidated in lower cost markets.
Last year, we continued our methodical growth and diversification plan, as we expanded into the Mid-Atlantic region, through our merger with Old Line Bank, which we closed and converted just prior to the early stages of the pandemic. This merger allowed us to attain our internal goal of reaching $16 billion in total assets, which we believe was the appropriate size to leverage the infrastructure build associated with crossing the $10 billion asset threshold.
As we said previously, our plan after closing of the merger was to focus internally for the next couple of years to ensure the successful integration of Old Line Bank, introduce our suite of products and services into the Mid-Atlantic region, focus on our organic growth opportunities, continue to manage expenses and prepare for our own core systems conversion. And the pandemic has not changed these plans at all.
Our organization has adapted well to the pandemic to ensure our long-term success. We’re focused on our core strengths; assisted our customers and communities, while maintaining our strong credit standards; we've strengthened our reserves to levels that protect on the downside and provide upside in a better operating environment; significantly enhanced our capital structure that allows long-term flexibility to drive shareholder value; maintained a diligent focus on operating expenses to sustain our mid-50s efficiency ratio despite the very low interest rate environment that's offsetting that revenues; and delivering strong core profitability as demonstrated by a pre-tax, pre-provision return on average assets of 1.64%, excluding restructuring and merger-related charges.
Lastly, I'm also pleased to mention that WesBanco Bank continues to receive national accolades. In addition to being recognized as a top workplace in a couple of large markets and being named both a Best Bank in America and a World's Best Bank by Forbes Magazine earlier this year, we were just named as America's Best Bank by Newsweek in their inaugural ranking. I'd like to personally thank our employees for their hard work, dedication and congratulate them for a job well done.
I'd now like to turn the call over to Bob Young, our Chief Financial Officer, for an update on our third quarter results. Bob?
Thanks, Todd. And good afternoon, everyone. During the third quarter, we experienced the continuation of the low interest rate environment and concerns about the pace of rebounding economic growth across the country, as COVID-19 case counts first decreased and then increased. In our case, these issues were mitigated somewhat by record residential mortgage origination volumes, strong expense control, and an improvement in the macroeconomic forecast utilized under the current expected credit losses, otherwise known as CECL accounting standard.
Primarily reflecting CECL's impact on the provision for credit losses as compared to the prior year, we reported GAAP net income of $41.3 million and earnings per diluted share of $0.61 for the three months ended September 30, 2020, and GAAP net income of $69.2 million and earnings per diluted share of $1.03 for the nine months period. Results excluding restructuring and merger related charges were $0.66 per share for the quarter as compared to $0.71 last year, and $1.14 per share year-to-date versus $2.31 for the first nine months of last year. As a result, returns on average assets and tangible common equity on a similar basis for the quarter improved to 1.05% and 13%, respectively.
In order to provide better comparability to prior your periods and to demonstrate the strength of our underlying financial results, we believe it is important to also evaluate pre-tax, pre-provision income, excluding restructuring and merge related costs. For the third quarter of 2020, we reported $68.9 million in pre-tax, pre-provision income, excluding restructuring and merge related costs, which increased 33.8% and 3%, compared to the third quarter of 2019, and the second quarter of 2020, respectively.
In addition, on a similar basis, we reported strong pre-tax, pre-provision returns on average assets and average tangible equity of 1.64% and 19% for the third quarter, and 1.61% and 18.74% on a year-to-date basis, respectively. We do believe our strong balance sheet is well-positioned for the near-term operating environment as we continue to address our various lending portfolios in order to more properly balance risks and rewards.
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 year-over-year was 10%, reflecting both loans funded through the SBA's Payroll Protection Program as well as organic growth in our commercial real estate book of 4.9%. Furthermore, reflecting strong demand deposit growth and resulting excess liquidity, we continue to strengthen our balance sheet by reducing higher cost certificates of deposit and Federal Home Loan Bank borrowings, which declined 5.6% and 29.7% quarter-over-quarter, respectively.
Total organic deposit growth, excluding certificates of deposit, was 20.9% year-over-year, reflecting the CARES Act and PPP loan proceed deposits as well as stronger personal savings rates, with nearly 80% of the deposit increase in demand deposit accounts.
Turning now to our credit quality measures on Slide 13. Key metrics such as non-performing assets, past due loans and net loan charge-offs as percentages of total portfolio loans remained at low levels and favorable to peer bank averages for those with total assets between $10 billion and $25 billion for the prior 4 quarters and consistent with prior years. In addition, reflecting our strong loan underwriting and credit process, annualized net loan charge-offs to average loans remained very low for both the quarter and year-to-date periods at zero in the third quarter and 8 basis points for the year-to-date period.
We believe criticized and classified loans as a percent of total loans remained favorable as compared to peer bank averages. Although they did increase to 3.25% during the third quarter due primarily to the downgrade of $72 million of hotel loans resulting from reduced occupancy due to the pandemic.
Regarding the downgraded hotel loans, they have an average loan-to-value of 60% and strong guarantor support as well as satisfying the CARES Act loan deferral guidelines, excluding them from TDR classification. Further, we remain in constant contact with our hospitality industry customers to receive monthly updates and ensure they have the appropriate cash reserves to sustain themselves until next spring. Additional deferrals may be offered through year-end in select situations and with appropriate credit review and approval in order to assist in their recovery until travel increases in various markets, next spring.
The provision for credit losses of $16.3 million for the quarter decreased significantly from the second quarter due to improved macroeconomic forecasts. At September 30, 2020, the allowance for credit losses specific to total portfolio loans was $185.1 million or 1.68% of total loans; or when excluding SBA PPP loans, 1.83% of total portfolio loans. These metrics are up from the second quarter's 1.52% and 1.65%, respectively. Excluded from the allowance for credit losses and related coverage ratio are fair market value adjustments on previously acquired loans representing 43 basis points of total loans. Key information and measures affecting this quarter's provision can be viewed in a waterfall slide on Slide 12 of the earnings presentation.
Switching now to net interest income and the margin. As we are 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 rate since July of 2019 as well as the relatively flat yield curve. Reflecting this significantly lower interest rate environment, we have aggressively reduced our deposit rates and overall funding costs, in particular, higher-priced CDs and short maturities and lowered rates on our borrowings, partially offsetting lower earning asset yields which reflect materially lower yields on new or repriced commercial loans. We have also recently implemented new lender guidance for certain commercial loan originations relative to floor rates.
Our reported net interest margin for the third quarter was 3.31%, a decrease of just 1 basis point sequentially from the second quarter, reflecting our interest rate management efforts as well as a 2 basis point benefit from SBA PPP loans. In addition, when excluding the purchase accounting accretion benefit of 18 basis points experienced this quarter, our core net interest margin was 3.13%, essentially flat to the second quarter.
We'll turn now to fee revenue. Non-interest income for the quarter ended September 30 was $34.6 million, an increase of 28.4% year-over-year and 5.3% quarter-over-quarter. The primary drivers of fee income growth were mortgage banking fees and commercial loan swap income, partially offset by lower service charges on deposits due to higher consumer deposits from higher personal savings and lower general consumer spending. Reflecting the current low interest rate environment and organic growth, mortgage banking income was a record $8.5 million during the third quarter due to a 100% increase year-over-year or 7% quarter-over-quarter increase in 1 to 4-family residential mortgage origination volume, approximately 50% of which were related to either home purchase or construction. Third quarter origination volume was a record $394 million, 75% of which was sold into the secondary market on a dollars basis as compared to a historical range of 40% to 50%.
Briefly on operating expenses. Total operating expenses remained well controlled through company-wide efforts to effectively manage discretionary costs, open positions and marketing expenses, as evidenced by a year-to-date efficiency ratio of just 56.15%, which is up only 6 basis points from the prior year period, while the third quarter was down 234 basis points to 55.23%. While higher year-over-year due to the Old Line Bank merger in the fourth quarter of 2019, total operating expenses, excluding merger-related costs, for the third quarter of $86.3 million increased only 1.5% from the second quarter, reflecting mid-year annual salary increases, partially offset by strong discretionary cost controls in the current operating environment.
Turning to capital. For 150 years, the WesBanco's management has focused on being a strong and sound financial institution for our shareholders. We have regulatory capital ratios that are significantly above well-capitalized standards, which were further enhanced by the issuance of $150 million of preferred stock this quarter in August. As of September 30, 2020, we reported a consolidated Tier 1 risk-based capital ratio of 14.29%, Tier 1 leverage of 10.18% and a total tangible equity to tangible asset ratio of 10.27%.
Due to the higher earnings and smaller balance sheet size, these ratios improved nicely as compared to the pro forma estimates at the time we completed our preferred stock offering in early August, providing a significant capital strength, both during the pandemic and for potential capital maximization opportunities in the future. With an operating environment that continues to be unprecedented, it remains difficult to provide meaningful earnings expectations for the rest of the year.
Having said that, I would now like to provide some limited thoughts on our current outlook for the fourth quarter. 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 3-month and 10-year treasuries, the 150 basis points of federal funds rate cuts experienced in March and a continued overall long-term rate environment for at least the next couple of years. Our GAAP net interest margin may decrease by a couple of basis points per quarter due to lower purchase accounting accretion from the 18 basis points that we recorded during the third quarter.
Declining asset yields should be partially offset by the aggressive pricing actions we have taken on our deposit and borrowing costs as well as the introduction of floors into new commercial loans, as we anticipate our overall fourth quarter net interest margin, excluding accretion from both purchase accounting and PPP loans, to be down a few basis points from 3.13% we experienced during the third quarter on lower total earning assets. We anticipate slight overall margin accretion, however, in the next few quarters, from PPP loan forgiveness as net deferred fees are accreted into income with the majority of the forgiveness now expected to occur during the first half of 2021.
In non-interest revenue, it is anticipated typical seasonal slowdowns in residential mortgage generation may somewhat reduce gain-on-sale income. We will maintain our focus on diligent expense management and delivering positive operating leverage and currently believe that fourth quarter non-interest expenses, excluding any restructuring or merger-related charges, will continue to be in a similar to slightly higher range as compared to the third quarter.
As Todd mentioned, regarding our financial center optimization plan, the anticipated gross cost savings of $6 million to $6.5 million are expected to be phased in during the first half of 2021, which excludes the potential impact of any displaced staff that apply for and fill certain open positions. In addition, we anticipate further restructuring charges of $0.5 million to $1 million associated primarily with the employee component of the optimization plan.
Relative to our provisions for credit losses under CECL, such will depend upon changes to the macroeconomic forecast as well as various credit quality metrics, including potential charge-offs, criticized and classified loan increases and other portfolio changes. In general, however, continued economic recovery should bode well for the direction of future provisioning. We currently anticipate our effective full year tax rate this year to be approximately 14% to 14.5%, subject to changes in certain taxable income strategies.
Lastly, beginning in the fourth quarter, we will declare our first preferred stock dividend, which will be a little less than $0.04 dilutive to earnings per share available to common shareholders.
We are now ready to take your questions. Carrie, would you please review the instructions?
[Operator Instructions] The first question will be from Casey Whitman of Piper Sandler.
Just first one housekeeping question on PPP. Can you just remind us like what the total fees you expect to record from participation? And how much you've recorded thus far in the second and third quarters?
Bob, do you want to go ahead and cover that?
Yes. It's -- I was thinking it was in the press release, the fee portion underneath the net interest margin table. It will be in the 10-Q. And it -- the total amount originally, Casey, was some $30 million. And I believe the amount left is some $22 million, $21.5 million to $22 million. We're experiencing about $2 million per month, $2 million to $2.5 million per month of total income, including the 1%. Now that will obviously dribble away, if that's the right term. Before increasing here in the first quarter as forgiveness would result in a higher deferred -- net deferred fee accretion in the month of forgiveness.
Got it. Understood. And then, Bob, you moved kind of quickly through the margin guide, which I know we all appreciate. But I guess parsing in all together, it sounds like you expect some just modest compression from accretion income coming down. But otherwise, your core margin should continue to hold up. Is that kind of what you're saying?
That's right. There's a little bit of an increase, if you assume forgiveness. There's a little bit of a decrease, if you assume no forgiveness. And then as PPP rolls off next year -- we're the beneficiaries maybe as compared to some peers of having a larger portfolio of fixed rate loans as well as adjustable loans that reprice after anywhere between 3 and 5 years. And we inherited a fair amount of that from the Old Line acquisition as well that helped this year. So that's one reason why we didn't see as much further diminution in margin in the third quarter as compared to the second. Those loans that we're going to reprice immediately did sell in the second quarter. But having said that, we'll continue to see those loans reprice as it's time for them to reprice and depending upon what their spread is over LIBOR. And so you'll see a little bit more of that as we proceed through 2021 and get beyond PPP.
Okay. Understood. I guess I'd just ask one more, switching gears. For the bucket of hotel loans that were downgraded during the quarter, maybe was there any geographic concentration within that bucket? And then are you expecting -- I know you mentioned we could see more deferrals as we head into the winter, but do you expect more downgrades through the year-end? Or do you think we've kind of seen the movement?
Yes, we took the really -- have continued to take a real hard look at the portfolio. And we went through and really regraded the entire hotel portfolio, $72 million of which ended up going down into the criticized category. And what we did, Casey, was we did an analysis based one-third on the cash flow and one-third on like location and what's their flag and what's their loan-to-value and then a third based upon what the borrower liquidity is. And that's really kind of how we graded that and continue to do that as we go forward. So we think we've got a pretty good read on it and where we're at.
Our view is that, really when you look at that portfolio, the plan is to get them to next spring to next summer. That's really going to be the key. I mean, the vaccine -- assuming the therapeutics continue to improve and continue to get back to maybe a little closer to normal next summer, what we want to be able to do is get them there. So what we did is we've looked at each one of those and looked at what their current cash position is, and their ability, how many months can they support their fixed payments. And between that, and in a lot of cases, we have 10, 12, 15, 20 months worth of fixed payments that they can cover with regard to cash they've got in our bank. But we also then looked at which ones might need some additional support in terms of additional deferrals that would get them through the spring time period. So that's the process that we're going through right now. I don't know how many of them will need that additional deferral period to get them into the spring months. As long as we do it before the end of the year, which we would, it falls under the CARES Act. So it's non-TDR.
And I think by next summer, what you'll be able to do is really get a better sense of which types of hotels maybe a little more permanently disrupted because maybe there's just a permanent shift in business, and how many of them just kind of bounce back to the way they operated before. We don't have a lot of clarity on that yet. But that's what we're trying to get to is to get to that point. So we'll continue to evaluate the portfolio. We think we did a big step in this. I've seen a few other banks, too, that have hotel portfolio. It looks like we all kind of did about the same thing, about 10% of the portfolio, which, in our case, is around $72 million. And that's now in that criticized bucket. But I feel good about where we're positioned.
We're in a lot of contact with them. We get monthly financials. We get monthly STAR reports. We get monthly occupancy, monthly RevPAR. We get all this information with them. And fortunately, we're dealing with some pretty decent-sized operators that have a lot of resources and a lot abilities to maneuver a little bit and also some very solid loan-to-value. So if we do get to next summer, and we have a few that need to develop a little deeper plan because maybe they’re more longer-term impaired, we'll have the ability to do that with them. But I do think the cash reserves that they've got, takes comfort in that. And then also the potential to do additional deferrals as long as we get them done by the end of the year.
The next question will be from Will Curtiss with Hovde Group.
Todd, I'm curious what you're seeing in your markets from a business activity, loan demand perspective and sort of what your near-term expectations are for loan growth?
Yes. When I look at our pipeline, and I just reviewed this last day or 2, because we had a Board meeting today, and we talked quite a bit about it, is the pipeline is down just a little bit over each of the last 2 months, but it's still up over where we were at this time last year. Now this time last year, we didn't have Old Line, right? So we're 30% bigger bank now than we were this time last year. So you kind of take that into consideration. But our pipeline today is bigger than it was at this time last year. So that tends to bode pretty well. We're seeing opportunities that are out there, but you're kind of in that environment right now where there is still a fair amount of uncertainty; what's the next 6 months, 9 months going to look like? So we're being very, very careful on that, particularly with regard to anything that has any type of -- we're not doing hotel loans. I mean that's a given. But other types of real estate, things like that. We're kind of looking at what could go wrong in the next 6 months with regard to the path of the virus and everything else. And I can't say how many times I've talked to customers and said, why are you doing this now? Why don't you do it in 6 months? And in pretty much every case, they've said, yes, that's a good question. Maybe we will wait until next spring.
So I told them, it makes it a lot easier for us to underwrite, I think, next -- second and third quarter than it does right now. So a number of those types of transactions have moved to later in the year. They haven't gone away, they just moved to later in the year. So I would tend to think that the next couple of quarters, I'd just be my expectation, a lot of puts and takes, but flat. Not a lot of growth. But I do think coming out of this, there's going to be some pent-up demand. And I do think that returning to mid-single-digit loan growth longer term is definitely there. It's definitely in the cards. And we've worked hard over the last 9, 10 years to position our bank so that we've got more of our bank in higher-growth markets, Louisville, Lexington, some of the Mid-Atlantic markets that tended to have upper single-digit, lower double-digit loan growth prior to the pandemic. And I believe when we get back to more normal, those growth rates will tend to bounce back to those levels. And then we'll continue to have the low to mid-single-digit growth rate in our legacy markets. And that should sort itself out to the mid-single-digits. But I don't think you're going to necessarily see that for the next couple of quarters. I think it's more around focusing on taking care of your customers, keeping them safe, keeping your employees safe, protecting your balance sheet, protecting your shareholders, using capital appropriately, driving down expenses, work on your digital acceleration and things like that. All those things that we're doing to really position yourselves to come out of this really strong, and that would be my expectation is the second half of next year and into 2022, I'm expecting us to be a bank with a lot of capital, a lot of liquidity, good PTP, pretax, pre-provision earnings momentum, a good handle on controls in the right markets, and a new core that allows us to have the products and services necessary to compete long-term with some of the bigger banks. That's 12, 15 months away. That's kind of what I see. And that's when I think you'll start to see a little more opportunities on the loan growth side, too, if not before then.
Let's see. I know that I think last quarter, you mentioned delaying some of the marketing expenses until next year. Is that still the case? And then kind of maybe higher level, as you've gone through some of the efficiency initiatives lately, are there other things or opportunities that you've identified that you may be considering as heading into next year?
Yes, it is. On the marketing side, we did. We were going to spend some additional money on branding, not a new logo or colors or anything major like that, but just some additional focus on brand because we're in some newer markets that we weren't in 6, 7, 8 years ago. But we did hold back on that. Right now, that is -- had delayed that into next year. We may delay that into the second half of next year. We're not going to go out and do anything on the discretionary side until we get a lot of clarity with regard to the pandemic and the virus and vaccines and all of that. So you're not going to see us embarking on any major expense initiatives until you get to the other side of this. And I think we'll be there in a year. So the delaying of some of those expenses, I think, would continue.
We're being very selective with new hires. We basically aren't expanding staff. We're replacing where needed. And then also with our own efforts with regard to our core, there's a lot of manual work that is going away, quite frankly, and becoming automated. And that helps us on the cost side as well, too. Plus the branch optimization plan that we announced and we're moving forward with. So there's a lot of things out there, I think, that are going to allow us to kind of keep our belts tight. And we're a pretty frugal company to begin with. But we are spending where we need to on the digital side and continue to support risk management infrastructure, cyber. And there's a lot of cyber activity out there right now with the pandemic and working remote and things like that.
So we're continuing to invest where we need to. Our plan always was going up and over $10 billion, and it still is today to make sure we blend in any expenses so that we maintain a mid-50s efficiency ratio. And I'm proud to say that we've been able to do that. And that would be our plan, would be to try to continue to manage to a mid-50s efficiency ratio by making the necessary investments. But we're going to be very careful. We're a pretty cautious company. And we just don't see much in the way of discretionary spending until you get through -- if there is any type of losses that come out of this pandemic, you want to get to the other side of that. You want to see reserves coming down, all that kind of stuff. And then I think you start to feel like you can spend more on some of those discretionary items.
The next question will be from Russell Gunther of D.A. Davidson.
And just to follow up on the expense conversation. I appreciate the thoughts, Todd. Based on what you just said, it seems like the majority of the cost savings from the branch rationalization would drop to the bottom line. Is that your expectation?
Well, I think some of them will, but -- and mentioned on the technology side as well, too, we're making some spends, nothing huge, but a few hundred thousand here or there to really position us better with particularly some of our fee-based businesses that are going to allow us to generate more revenue. So it's not going to -- come in close to $6 million, $6.5 million. So some of that will fall to the bottom line, but not all of it. And we will have some employees that end up in other positions in the company, although we're watching that very carefully. The plan isn't to go through this exercise and at the end of the day, not end up with expense saves. That's not what we're doing here. But it's hard to put an actual number on it right now. We'll manage it month-by-month or quarter-by-quarter. I was kind of looking at the puts and takes there. But a good portion of that $6 million, $6.5 million should drop to the bottom line. And then we've got other things that we're kicking around internally as most banks are at this point with regard to, how can you do things more efficiently and more effectively, remotely with fewer people and things like that. And that's -- those are still very much in formulative stages.
I mean is it fair to think about at least 50% of that $6 billion $6.5 million falling to the bottom line? Or could it be north of that?
I think as I kind of look at expenses out there, it's not that I don't want to answer your question. It's just that I don't see anything out there that's going to cost us $5 million, $6 million. But I do think that I'd be disappointed if we don't end up with half of that or so falling to the bottom line. But we do have some additional things, obviously, got merit increases and things like that, that will be coming on board next year. So we have some of those expenses. They're just kind of the normal run rate. We don't give guidance on what we think our quarterly expenses are going to be. But as we look at kind of the guidance that's out there, so to speak, Bob and I have talked about, we don't see any reason to argue against what we see that's out there, but it would be my expectation that, that would be an upper bound.
Okay. No, I appreciate that follow up. And then on the criticized, classified migration and the deep diagnosis done in the hotel portfolio. First part of this is, the majority of the increase in criticized, classified was due to just the hotel movement? Or were there any other discernible trends from other loan exposures that may be at risk there? And if it was just primarily hotel, are there pockets of the portfolio that you remain concerned about whether investment CRE, for example, that have yet to undergo a deep dive that may be forthcoming?
Yes. Yes. And just remind me, I think maybe, Casey, had part of that question, too, I didn't answer. Geographically, there's no one geography that's impacted by the $72 million in the movement down in the hotel portfolio. It's spread throughout the franchise. No, we really don't -- I’m not seeing stresses in other aspects of the portfolio, even on the real estate side, multi-family, office, even assisted-living type things. We don't have a big portfolio there, but all seem to be holding up okay. Watching them close because those are the kind of things that will be -- hotels are front and center for everybody right now because of the pandemic and the virus. But longer term, some of these businesses are going to have to maybe operate a little bit differently, and the whole industry is going to have to deal with that. But I don't see anything that's a real big concern for us. We don't have -- we're not into big office projects in major metropolitan areas, so we don't have to deal with that. We don't have a lot of situations where people got to get on mass transit in order to get to a property that we financed, whether that be a restaurant or whether that be an office building. We just don't have those.
Our markets are -- I hate to call them second-tier market because it's second-tier in terms of size, right? So when you look at our markets that we're in, we just don't have mass transportation issues, people get in their car and they drive 10 minutes and they're in their office. So I think we'll be somewhat protected by that. So I really don't see any of that right now. And on the consumer side, we almost have virtually no second round deferrals on any of those. So I don't see anything popping up there either. But again, I would say, being in some of these industries, it's also how you're positioned in the industries, right? And I think that's what will show up over the next couple of quarters is you can be in an industry and be in there at an 80%, 85% loan-to-value or you can be in there a 55% or 60% loan-to-value with good operators, and then you've got a lot of flexibility. And I think you can say that across our entire portfolio, whether it's office or assisted living or whatever the case is, we didn't stretch on anything.
I mean you can see that, I mean we had low to mid-single-digit loan growth for the last 7 or 8 years, we weren't putting on double-digit loan growth. So I think you guys know we're -- puts in our portfolio ought to be pretty careful with, pretty cautious in terms of how we underwrote it, because we weren't reaching for loan growth when -- we were criticized a little bit because our loan growth was kind of below industry averages. And part of our explanation was we're pruning the portfolio. We're pruning in direct. We're pruning some of the hotels in shale-related areas, we’re pruning some of the multifamily. Boy, that's coming back to give us some big dividends going forward because it positions us really well in this pandemic.
So I'm just not sure how many losses are going to fall out of some of these portfolios, partly because I think some of the portfolios performed really well, but we're also positioned really well even in portfolios that are COVID impacted, we're still positioned really well. And that's kind of my comfortable. Now we're reserving and everything else as if there could be more challenges, but that's just because we're conservative. It's not because we expect it. It’s because we're just more conservative.
I appreciate all of the thoughts on that. And then, Todd, last question for me would be thoughts around resuming the buyback and what you'd look for either from a macro perspective or just general WesBanco guidepost you could point us to when that might be an option for you again?
Yes. And I'll let Bob chime in here a little bit as well, too. We think with the capital position that we've got and the capital position that we would hopefully expect to have coming out of the pandemic, that we're going to have a lot of capital. And we want to manage to the right return on average tangible common equity. So we understand that there are downsides carrying a lot of capital in good economic times. You want to be well-capitalized but well-capitalized doesn't mean overcapitalized. So we do think coming out of this that we'll have opportunities to move back into a buyback mode. We were slow to start doing buybacks during the expansionary time period. We just started maybe 6 months or a year before the pandemic hit. We only bought back about 1%, 1.5% of our stock. Peers were about 6.5%. So peers bought back about 5% more than we did. I would expect us to be more in line with others in terms of buyback activity. But we would get -- I want to get to the other side of this first. And I think you'll see reserves coming down and all those types of things, before we would get really serious about buyback activity.
When you look at the larger banks, the really large banks, obviously, they've got rules around buybacks and things that they can't do right now. We don't have those kind of rules. But I do think that's -- it's prudent. Again, it goes back to our conservative routes to be entering into buyback activity to me any time in the next quarter or two. It's a bit premature, but that's just our view. But we could see ourselves being pretty significant in that area once we get to the other side of this.
The next question is from Catherine Mealor of KBW.
Just one follow up on the margin. Bob, you mentioned that you benefit from a larger percentage of fixed rate loans. Can you remind us what percentage of your portfolio is fixed versus variable?
It's about 60-40 on the commercial side, on the business side. Were you thinking of it in terms of the totality of the [$10 billion, $11 billion]?
Yes. If this is fine. Yes, that helps. So you're saying 60% fixed.
Right.
40% variable. Got it.
Bob. This is John, Catherine. It's about 60% variable and 40% fixed in the commercial portfolio.
I'm sorry. And on that variable piece, some of that reprices over time as opposed to immediately. Thanks, John, for correcting.
Great. And then of the fixed part, can you kind of give us a sense as to the maturity schedule to help kind of the pace at which you see those loans repricing downwards?
Yes. That is a little bit longer portfolio. But generally, you should assume that, that's got about a 3 to 3.5-year duration.
Great. And then another follow up just on credit. I mean you've built your reserve significantly, I would say, given your relative level of kind of lower credit risk, and you've got a really big reserve now. Feels like this quarter, more -- most of the reserve bill came from the change in the classified asset movement. But as we look into next quarter, assuming the economic environment doesn't change, what's your sense as to what kind of level of provisioning we will see? And maybe more directionally a number? And where -- and when do you feel like -- do you feel like we're kind of nearing the peak in reserves?
Bob spends a lot of time working with credit on the CECL thing. So I'll let him answer a big part of it. But we thought this is playing out very much the way I think we had expected at the start of the pandemic, and that was the CECL adoption in the first quarter. First and second quarters were going to be the quarters for a second and some degree, third, kind of the big reserve build quarters. And then you’re kind of in a period of time for maybe a quarter or two, where you're kind of seeing how everything is kind of playing out. And then you're in a situation where you're bringing reserves back down in '21 -- part of '21, maybe mid to later part of '21. That's always kind of been the expectation but CECL is very definitive around what you can do and can't do with regard to based off of macroeconomic factors and unemployment is a big part of that. And then we put the overlays on it, but we document the heck out of the overlays to make sure that even those are quantitative.
So there's a lot that goes to it. So there's a lot we don't know. 90 days from now, that will go into that because it has to transpire yet. So it's hard to really estimate a number. But I think Bob and I think directionally that the expectation would be similar to what we had at the beginning of the pandemic and that is you're building reserves through the first two or three quarters and then you start releasing reserves once you get clarity around what any kind of loss potential that might be in any of the portfolios. I know a lot of other banks are doing different things than that, but that's just kind of our view on it. Bob, what would you add?
I think that's consistent with what we're thinking currently. I think by the back half of 2021, you will see more industry-wide releases, if the pace of the pandemic is the way it seems to be playing out. There certainly have been some reserve releases announced, whether you want to look at negative provisions is one version of that or just less than net charge-offs in the case of some other banks. I would envision that that's where you go first as an industry that you have charge-offs that you're not replacing, but you might still have some provision in that particular quarter for qualitative factors, again, depending upon the macroeconomic forecast before you would see true negative provisions below zero recoveries. So that is a later, I think, path to experience.
Just in terms of the near term, we did add to our reserve this quarter for the hotel book. And for the uncertainty around the pace of the pandemic, those are the two judgmental factors that we added as macroeconomic forecast, primarily the national unemployment rate came down. We also did a study with a third-party that showed us that our region is less sensitive to unemployment and related charge-offs than the national unemployment rate. And so that was an offsetting positive factor. But from here, absent charge-offs until, say, the middle of next year, and the pandemic not taking a turn for the worse, you would think provisions would directionally be lower for the industry in the short run.
The next question is from Joe Plevelich of Bennington & Scattergood.
My question, the game plan was to align and then possibly think about M&A couple of years down the road or whatnot, but valuations are down. You got a lot of excess capital. And I was just trying to gauge your appetite for M&A if something really strategic came along here?
I think in this -- the answer is no. We're not interested in looking at things. Kind of our plan initially going into the pandemic is still the same as it is now. 2020 is the year of integrating Old Line, and that's gone very well Old Line Bank. And 2021 is just the year of our own core conversion. So the pandemic really didn't change our strategy at all from that perspective. I think it's really difficult to get price discovery. I mean we just spent 5 or 10 minutes kind of talking about our own portfolio and getting real granular with it and kind of making sure we understand it. And I don't know how you do that with somebody else's. It's just -- to me, it's kind of a bit of a guess and you just don't like to do that in this business.
So I would tend to say that we would need to get to the other side of this for our own timing purposes. But also, even if we were ready to go now, you can't get price discovery to me to the extent that we would want to have it as a company and knowing what type of portfolio you're buying. And a lot of times, it's not just -- you're not just buying the portfolio of the bank you're buying, you're buying the portfolio of every bank that they bought in the last 10 years. So those are also things to really think about as well too. And we're pretty conservative in our underwriting and to go out and expand really rapidly in a time like this through acquisition at any price, how do you know what's the right price. So we're not interested in doing anything right now. But we do think, as you get into -- through 2021 and you get into 2022 and later years, with our capital level that I expect us to have and our earnings strength and earnings potential and the management team that we have and the infrastructure we've built and the new core, I think it could be a pretty exciting time for the bank in that 4, 5-year time period once you get past 2021. But again, we're opportunistic. And if everybody is out there looking to do something, we're not going to overpay. So it's hard to know, but we're not really entertaining anything this year or next year.
The next question will be from Steve Moss of B. Riley FBR.
Just one follow up with regard to just the [asset flow] and reserving for criticized and classified. Just wondering, what's the sensitivity to increases or decreases in criticized and classified? Do we think about it as a percentage of the loans moving one way or the other? Like kind of 15% in terms of just a general reserve? Any color there would be helpful.
Sure. Bob, do you want to go ahead with that?
So generally speaking, Steve, there -- we have tiers that result in additional reserves as C&C loans increase. Currently, as I recall, we have about $27 million associated with C&C of the total $180 million -- or $168 million, sorry. It's $180 million when you add in the commitments. So that -- if you had a $70 million increase in a quarter, that could be a couple of million dollars more, $3 million more for that particular factor. But that's one of a dozen different factors, both quantitative and qualitative. And the main model is determined based upon macroeconomic forecast blended between the Federal Reserve and Moody's, the baseline scenario. And we use a model to integrate all of that on a probability of default and loss driven default basis, granular to our portfolio.
So it's not just criticized and classified. There's a number of other qualitative factors that go into the model as well. But this particular quarter, that's what happened with C&Cs. And then as I said, we used some third-party assistance to try to anticipate what the additional effect would be of the pandemic when you have the modifications that you do that aren't yet criticized and classified, for the most part, aren't non-accruals, aren't delinquent. How does that factor in? We've done that judgmentally in the past. This quarter, we used a third-party to assist us with a mathematical infusion into the model for that. Sorry, that was a lot of words.
The next question will be from Brody Preston of Stephens, Inc.
Just have a couple of quick questions. Just -- sorry if you’ve touched on this. But just with liquidity as strong as it is, is the plan just to let CDS keep running off until you feel like you need them for growth reasons or I guess as other deposits run-off post PPP?
That's correct. In addition, our customers, as occurred 10 years ago, are staying relatively short as CDs mature. Industry-wide CD rates are very low. And so most people don't want to go out the curve and do a 3-year CD at less than 1%. So we're going to continue to see those run-off. About 36% of our CDs are single service customers. We're not trying to be as rate shopper or rate competitive on the CD front. We also have purchase accounting on the CDs from Old Line, which were higher cost. And so that factors in as those run-off. And then the more important factor, I think, is our ability to use the excess liquidity to pay down Federal Home Loan Bank borrowings. And so that cost is coming down very rapidly. We basically paid off about half of what we had here at the end of the first quarter.
Recall, we took down some extra borrowings at that time to provide for additional liquidity for customer needs, including line advances, which except for the large banks, we generally did not experience that. And shortly thereafter, everybody was getting their PPP or CARES Act deposits. So banks were awash in liquidity. And so we began paying down the Federal Home Loan Bank borrowings. We've got another couple of hundred million that mature each quarter over the next 4 or 5 quarters. And while we replace some of those early next year, mid next year, at least for the next 3 to 6 months, we'll be paying them off. And generally, they're coming off of 2% to 2.25%.
Thank you for that additional color, Bob, very helpful. And then just one last one. The hotel deferrals. Are those all second deferrals at this point? And I guess, would you consider maybe extending those further? Or I guess, when do those modification periods end?
Yes. I mean you can extend them further as long as you do it before the end of the year. So if you wanted to provide an interest-only or interest with some principal or whatever run that through the middle of next year for those that need it, that's an option that's available. I mean that's part of the CARES Act and auditors, regulators, everybody are comfortable with that. So if you needed to do that, you can do it. That's why I feel really comfortable about kind of where we're at and watching this over the next 6 months, 9 months or so is because you've got a lot of opportunities to get those customers to next summer and even beyond that, quite frankly, and not have them be treated as TDR. You got to grade them appropriately and all that. But there are options to get them there. So we don't know what that will be at this point. If there will be any, they would need kind of an extension of that second deferral. We'll know that more over the next month or two. But that option is there, if needed.
This concludes our question-and-answer session. I would now like to turn the conference back over to Todd Clossin for any closing remarks.
Thanks. Yes, just real quickly, as we talked about, our long-term strategy is still very much intact despite the pandemic. We are well prepared, I think, to operate in any kind of environment. I think we're well-positioned for that. And we talked about that before the pandemic. And I think that's helping us a lot right now as well too. We continue to be conservative, but we also want to be viewed as a growth organization and one that is a good stock to own in any type of environment, and that's what we work hard towards. So I really look forward to, hopefully, given a chance to see everybody at a future meeting. It sounds like it might be a few more months yet. But hopefully everybody stays safe. And thank you for your time this afternoon.
Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.