Cadence Bank
NYSE:CADE
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Cadence Bank
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Good day, and welcome to the BancorpSouth First Quarter 2020 Earnings Conference Call and Webcast.
[Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Will Fisackerly, EVP and Director of Corporate Finance. Please go ahead.
Good morning, and thank you for being with us. I will begin by introducing the members of the senior management team participating today. We have Chairman and Chief Executive Officer, Dan Rollins; President and Chief Operating Officer, Chris Bagley; and Senior Executive Vice President and Chief Financial Officer, John Copeland.
Before the discussion begins, I'll remind you of certain forward-looking statements that may be made regarding the company's future results or future financial performance. Actual results could differ materially from those indicated in these forward-looking statements due to a variety of factors and/or risks. Information concerning certain of these factors can be found in BancorpSouth's 2019 annual report on Form 10-K. Also during the call, certain non-GAAP financial measures may be discussed regarding the company's performance. If so, you can find the reconciliation of these measures in the company's first quarter 2020 earnings release.
Our speakers will be referring to prepared slides during the discussion. You can find the slides by going to bancorpsouth.com and clicking on our Investor Relations page, where you'll find them on the link to the webcast or you can view them at the exhibit to the 8-K that we filed yesterday afternoon.
And now I'll turn to Dan Rollins for his comments on our results.
Thank you, Will. Good morning. Thank you for joining us today to discuss BancorpSouth's first quarter 2020 financial performance. I will begin by making a few brief comments regarding our pandemic response as well as our first quarter financial highlights. John will discuss the financial results in more detail, and Chris will provide more color on our customer and business development efforts. After we conclude our prepared comments, our executive management team will be happy to answer questions.
Let's turn to the slide presentation. Slide 2 contains the legal reminders Will has already discussed. I'd like to spend just a few minutes talking about the current pandemic and our response as a company, a few highlights of which are included on Slide 3.
These are certainly challenging times in which we live. Our thoughts and prayers go out to this morning to those impacted by this horrible virus, both from a health standpoint and financially. We've had several teammates across our footprint who have contracted the virus and, obviously, many others who have been impacted, whether it be through the health of friends or family or through financial hardships. As we look at the impact to our company operationally, we've taken many of the same steps as our peers. Our priority from day 1 has been to protect the health and well-being of our teammates while also continuing to meet the needs of our customers and communities we serve.
I would categorize our response into 3 broad categories: operations, front line and our teammates. Our business continuity team under the leadership of Jeff Jaggers has done yeoman's effort implementing and adapting our pandemic planning to this particular situation. Over 40% of our teammates have the ability to work remotely, at least in some capacity. This has allowed us to create more space in our facilities to spread out our teammates whose job functions require them to be on site. Beyond that, we have physically separated teammates in highly critical areas, both in terms of space and work schedule such that personal interaction is very limited. In an effort to adhere to the government guidelines and to protect both our customers and teammates, we did convert our branches to drive-through only with appointment availability as necessary. I believe these actions are consistent with most of the banks across our industry. These are just a few of the many steps our business continuity team has helped us implement.
As to our teammates more specifically, our first priority has been to protect their health, particularly those who are high-risk according to CDC guidelines. We have provided our teammates the opportunity to take care of themselves and their families during this time in a way that's not damaging to them financially. Additionally, we've provided our teammates with an additional 3 weeks of paid time off that can be used specifically for family and dependent support.
Finally, I'd like to briefly address the customer impact. I think it's important to emphasize that our team is available to put -- to meet any and all needs of our customers. Chris will talk more about the government stimulus and the SBA program in a moment, but the SBA programs are a great example. While the Paycheck Protection Program was designed and implementing -- implemented at lightning speed, it has certainly been well received by our business customers, our bankers have been working around the clock since the CARES Act passed in Congress to ensure we could support our customers. I'm extremely proud of our team's effort. Our technology team, our marketing team, our SBA team, our loan operations team and almost all of our frontline bankers have invested countless hours into this program. In total, well over 2,000 of our teammates have been actively involved in supporting the Paycheck Protection Program effort.
In addition, while working 18-hour days to handle this loan demand, the team has been working diligently with our current customers to provide loan modifications for qualifying customers who needed assistance. These are just a few very high level highlights of our efforts. I can't begin to cover all the steps that have been taken or give proper recognition to all of our deserving leaders and teammates during the time we have allotted this morning.
Let's now discuss the results for the quarter. Slide 4 contains our financial highlights for the first quarter. Given the volatility in earnings associated with the provision, which we will discuss more in a moment, we've heard a number of our analysts and investors the desire to monitor pretax pre-provision revenue, or PPNR, as we work through this cycle. Accordingly, we've added this non-GAAP metric to our disclosures this quarter. Outside of the impact of the provision, our company continues to perform very well. We generated PPNR for the quarter totaling $91.7 million or 1.74% of average assets on an annualized basis. This represents an increase from 1.3 -- 1.63% for the first quarter of last year and 1.68% for the fourth quarter. I would point out that we adjust for nonoperating items in our calculation of this metric, which is defined and reconciled in our earnings release.
We reported GAAP net income available to common shareholders for the first quarter of $21.9 million or $0.21 per diluted common share. We had a negative MSR valuation adjustment of $11.1 million while merger-related expenses totaled $4.5 million for the first quarter. Accordingly, our net interest -- our net operating income, excluding MSR, was $34.4 million or $0.33 per diluted common share. Earnings for the quarter were certainly impacted by both the rate environment as well as additional provisioning associated with the economic impact of this pandemic.
We closed the acquisition of Texas First effective January 1. We completed the operational integration of this transaction late in the first quarter as well. Our new teammates from Texas First under Rodney Kroll's leadership have done a great job working through this conversion and getting up to speed quickly, particularly in light of the current operating circumstances.
As to the provision specifically, while it is too early to estimate the ultimate impact of this crisis to our borrowers, we recorded a provision for credit losses of $46 million for the quarter. Most of that is reflective of the new CECL adoption-related outlook for COVID-19 effect on the economy and our loan portfolio. It should be noted that we came into this cycle with robust capital, low NPLs and strong liquidity. The quarterly provision was determined primarily by the adjustment of certain economic factors that are considered in our reserve methodology. Given the level of uncertainty associated with regulatory guidance, we elected to go ahead and adopt CECL as of January 1, 2020. As previously disclosed, our total day 1 allowance increase was approximately $63 million, $23 million of which was a gross up of previously purchased credit impaired loans, while the remaining $40 million was recorded straight to the beginning retained earnings net of tax impact.
Mortgage had an excellent quarter in light of the rate environment and refinance activity, producing total volume of $477 million for the quarter, which contributed to production and servicing revenue of $20.6 million. Chris will discuss our mortgage activity in more detail in a moment, but our experience has been that mortgage has been somewhat of a natural hedge for us in a declining rate environment.
Coming into the quarter, we were in a unique position relative to many of our peers and that we raised over $470 million in capital during the fourth quarter of 2019. We began the quarter looking to execute on our share repurchase plan to deploy a portion of this new capital. Accordingly, we repurchased 3.3 million shares in the first quarter for approximately $87 million. We temporarily suspended our buyback program in March due to the changing economic environment and intend to wait until we have further visibility into the impact of this crisis before we repurchase additional shares. John will discuss capital more in a moment.
Needless to say, raising low-cost capital late last year has turned out to be a very good decision for us. We are obviously pleased with our capital levels and confident in our ability to weather this economic downturn. As of March 31, each of our regulatory capital metrics have buffers in excess of 300 basis points above the regulatory well-capitalized thresholds.
I'll now turn to John and allow him to discuss our financial results in more detail. John?
Thanks, Dan. Good morning, all. If you'll turn to Slide 5, you'll see our summary income statement. In reviewing the summary income statement, net income available to common shareholders was $21.9 million or $0.21 per diluted common share for the quarter. As Dan mentioned earlier, we did have 2 significant nonoperating items in our first quarter results. We had a negative pretax MSR valuation adjustment of $11.1 million and pretax merger-related expense of $4.5 million. Accordingly, we reported net operating income, excluding MSR, available to common shareholders of $34.4 million for the quarter or $0.33 per diluted common share compared to $67.8 million or $0.65 per diluted common share for the fourth quarter of '19 and $55.9 million or $0.56 per diluted common share for the first quarter of 2019.
I would like to remind you about the merger with Texas First that Dan mentioned earlier does impact the comparability of the financial information shown on this slide as well as the subsequent slides that we will discuss. In addition, the Summit and Texas Star mergers, which closed late in the third quarter of '19, impact comparisons of the first quarters of 2019 and 2020.
This slide also shows the pretax pre-provision and net revenue metrics that Dan mentioned earlier, both in terms of dollars and as a percentage of assets. You can see from the comparisons provided that we fared well relative to both the first and fourth quarters of 2019. Our net interest revenue declined 1.9% compared to the fourth quarter of 2019 and increased 9.8% compared to the first quarter of 2019. I believe it goes without saying that the net interest margin has been and should continue to be under pressure as a result of the ongoing pandemic and related Fed rate actions. Our reported net interest margin for the first quarter was 3.54%, while our net interest margin, excluding accretable yield, was 3.48%. Comparable metrics for the first -- fourth quarter of 2019 were 3.76% and 3.61%, respectively. We reported a net interest margin of 3.86% for the first quarter of 2019, while our core margin was 3.74%. The accretion component of our GAAP margin was adversely impacted by the changes in the rules associated with the accounting for PCD loans under CECL.
As we look at the quarter-over-quarter change in our core margin, the shift in earning asset mix is responsible for approximately 10 basis points of the 13 basis point total decline. As we mentioned in our fourth quarter call, given the mid-November capital raise, only about half of the margin impact was realized in the fourth quarter results. Also, we had a shift in asset mix attributable to the deposit growth in the quarter. Finally, the Fed actions contributed 2 or 3 basis points of that compression, while closing of the first Texas First transaction had a very nominal impact.
I'll take just a minute to talk about our liquidity position. Whether in the form of the SBA Paycheck Protection Program loans, request for loan deferrals or mortgage forbearances, the bank has more than sufficient resources of liquidity to address our customers' needs during this pandemic event. In addition to $1.7 billion in unpledged securities, as well as on balance sheet cash and cash equivalents exceeding $250 million at March 31, we do have substantial off-balance sheet liquidity, including secured funding lines of $6.7 billion with the Federal Home Loan Bank and $950 million with the Federal Reserve. The bank also maintains unsecured Fed fund lines with other banks totaling about $1 billion. These off-balance sheet liquidity sources together with unpledged securities provide approximately $10 billion in additional funding sources should we need it. In addition, both the FHLB and the Fed have provided additional funding opportunities to assist with the stimulus programs. Suffice it to say, liquidity is not a concern for us at this point in the cycle.
Before we move to noninterest revenue and expense, we -- you can clearly see the impact of the provision that Dan mentioned earlier on earnings. We had a provision of $46 million for the quarter, compared to no recorded provision for the fourth quarter of 2019 and a provision of $500,000 for the first quarter of '19. Dan has already mentioned the impact of the pandemic on our provision, and Chris will touch on credit quality in more detail in a moment.
If you turn to Slide 6, you'll see a detail of our noninterest revenue streams. Total noninterest revenue was $76.5 million for the quarter compared to $74.7 million for the fourth quarter of 2019 and $64.2 million for the first quarter of 2019. Mortgage revenue is the largest driver of volatility in these totals across quarters. As Dan mentioned, the rate environment resulted in elevated refi activity, providing a significant increase in our mortgage production and servicing revenue in the quarter. Total production and servicing revenue of $20.5 million was somewhat offset by the noncash MSR valuation charge of $11.1 million. Chris will discuss mortgage as well as insurance and wealth management in more detail in a moment.
The final item I would like to mention briefly is other noninterest revenue. During the first quarter, we sold a book of business within our insurance agency to one of our producers, which generated a book gain of just over $4 million. This gain was recognized in other noninterest revenue during the first quarter. Chris will also touch on this further in a moment, but it will have an impact on future commission revenue of about $2.5 million annually.
Slide 7 presents a detail of noninterest expense. Total noninterest expense for the first quarter was $168 million compared with $162.4 million for the fourth quarter of '19 and $150 million for the first quarter of '19. Total operating expense, which excludes merger-related expense and other onetime items was $163.5 million for the quarter compared to $156.6 million for the fourth quarter and $149.1 million for the first quarter of 2019. Salaries and employee benefits expense is the only item that really warrants additional color. The remainder of the expense categories were very stable quarter-over-quarter.
From a sequential quarter comparability standpoint, I would remind you that in our fourth quarter call, we discussed year-end accrual true-ups totaling approximately $4 million that provided a onetime benefit. Beyond that, the quarter-over-quarter increase is driven by several seasonal factors in addition to the Texas First merger. First of all, the seasonality in the renewal cycle in our insurance book of business drives higher producer commission payouts in the first quarter. Second, the FICA limit resets adversely impact our first quarter expense as well. Beyond that, I don't believe there are any other large variances or other onetime items that warrant further color.
Slide 8 provides a graphical presentation of our total capital position. As Dan mentioned, and as you can see here, our fourth quarter capital raise really bolstered our total capital ratio and provided some needed diversity to our capital stack. As of March 31, each of our capital metrics is over 300 basis points above the regulatory prescribed well-capitalized minimums. We've stressed our capital using prior cycle loss experience as well as current economic forecasts. We do feel good about our capital levels at this point in the cycle.
That concludes our review of the financials. Chris will now provide some color on our business development activities. Chris?
Thank you, John. Good morning, everyone. Slide 9 reflects our funding mix as of March 31 compared to both the first and fourth quarters of 2019. Of the total growth for the quarter, $370 million was attributable to the Texas First acquisition, while $130 million was achieved organically. The organic growth was a little bit lighter than our normal seasonal experience with first quarter growth. We had some public fund balances that were moved out a little earlier than expected and our historical experience. While it's not shown on this slide, you can see that trend in the average balances, which were up $700 million in total quarter-over-quarter.
We mentioned in our fourth quarter call that we believe we had reached the inflection point on deposit costs. We saw 1 basis point decline in the average cost of deposits compared to the fourth quarter. However, this elevated seasonal public fund balances provide a headwind of approximately 3 basis points on our total cost of deposits. While the magnitude remains to be seen, we expect deposit cost to continue to trend down in light of the current rate environment.
As we look at geographical performance relating to deposits, we had several divisions across our footprint stand out this quarter. The East Central Mississippi, Memphis Metro, Northeast Mississippi, West Tennessee, Missouri, North Central Alabama and Pine Belt divisions all reported strong deposit growth for the quarter.
Moving to Slide 10. You'll see our loan portfolio as of March 31 compared to the fourth quarter of 2019 and the first quarter of 2019. As Dan mentioned, we closed and integrated the Texas First transaction, which added $185 million to our portfolio. Otherwise, our loan portfolio declined nominally on an organic basis. The mix of our loan portfolio is consistent quarter-over-quarter. Beyond that, I would like to just make a few comments around our efforts to work with our customers.
We've not seen the increases in line utilization that many banks in our industry have experienced. I believe this is largely attributable to the makeup of our loan portfolio. As we've discussed in the past, we're not a large ticket C&I lender, and our average loan size is less than $150,000. In an effort to work with our customers through this pandemic, we are offering 90-day payment deferrals on loans that are less than 30 days past due and in compliance with all borrowing covenants. As of the end of last week, we had received deferral requests on approximately 3,700 loans and total payment deferral of approximately $28 million. These customers are taking prudent steps to preserve cash during this time of uncertainty.
Additionally, our lenders, SBA specialists and credit administrators have been working around the clock helping our customers take advantage of the SBA opportunities provided under the CARES Act and specifically, the PPP or P3, as we've started calling it, program. Our relationship managers received approvals for approximately 8,500 loans totaling approximately $1 billion, which we are currently in the process of funding. Of these applications, approximately 40% of the loans were for less than $25,000. We are pleased and proud that we're able to serve such a broad coalition of diverse businesses across our footprint, and we are ready to support existing requests, new request if additional funds are granted.
It was really a tale of 2 quarters. And then we woke up one morning with 3% unemployment and a good loan pipeline, and things came to an abrupt stop as businesses and projects were put in a conservative hold pattern. Despite the overall organic loan growth pressure during this time, it's still worth mentioning several divisions producing meaningful loan growth at the beginning of the quarter. Our Dallas, Texas, Missouri, South Arkansas and Northwest Florida divisions all had great quarters from a loan growth perspective.
Starting on Slide 11. The next set of slides provide some additional disclosure on those portfolios we consider to be higher risk as a result of the pandemic. I'd like to reiterate Dan's comment that it's simply too early to estimate the ultimate impact on the economy or our loan portfolio. Said differently, our risk is not limited to just these particular portfolios, but they are deemed to be the highest risk at this point in the cycle.
Slides 12 through 14 provide additional detail on the granularity and diversity within each of these portfolios and across our geography. As we've mentioned several times, our average loan size is less than $150,000, which is further evidenced by the SBA statistics I provided a moment ago from the PPP program as the average loan size under that program has been approximately $120,000.
Slide 15 contains credit quality highlights for the quarter. The first bullet contains information regarding our adoption of CECL, some of which Dan covered earlier. Our day 1 increase to the allowance was $63 million, $40 million of which was recorded to retained earnings net of the tax impact, and $23 million was the result of recharacterizing PCI loans into the new PCD treatment and grossing up the credit mark. We recorded a provision of $46 million for the quarter. Finally, we had net charge-offs for $13.7 million for the quarter primarily from charging down previously marks from those former PCI loans. On March 31, 2020, allowance for credit losses totaled $218.2 million or 1.53% of net loans and leases. We are pleased with the level of coverage at this point in the cycle.
As you can see in the second bullet point, our net charge-offs for the quarter were driven exclusively by acquired loans. As we have discussed with many of you, when we've been out and on the road, the accounting under CECL will have a significant impact on charge-off metrics given the accounting under the PCD rules as compared to the old PCI methodology. The fact that the credit discount has grossed up in our allowance results in higher levels of charge-offs when fundamentally there were -- there have been no economic change. We've attempted to provide good disclosures in our press release around all our credit quality metrics from an acquired versus legacy perspective.
Finally, aside from the impact of the acquired loans, our other credit quality metrics are stable quarter-over-quarter. We've tried to be as transparent as possible with additional disclosure around current activity and portfolios that could be impacted by the pandemic, and we will continue to apply our allowance methodology and credit monitoring functions as the economic impacts become more visible and measurable.
Slide 16 provides a graphical waterfall presentation of the changes in our allowance, which I discussed on the previous slide. You can see the impact of CECL adoption, the Texas First merger, the net charge-offs and the first quarter provision in the roll forward of our allowance for credit losses. Again, though the adoption of CECL, combined with our first quarter provisioning, our allowance coverage increased from 0.85% of net loans and leases at year-end to 1.53% at March 31, 2020.
Moving on to mortgage and insurance. The table on Slide 17 provide a 5-quarter look at our results for each product offer. Our mortgage banking operation produced origination volume for the quarter totaling $477 million. Our mortgage team has worked long and hard hours to help our customers take advantage at a historically low rate environment, particularly the dip that occurred in mid-March. Home purchase money volume was $285 million or 60% of the total volume for the quarter. Given the timing of the rate declines, we expect refinances to be larger percentage of volume in the second quarter. Deliveries in the quarter were $409 million compared to $419 million in the fourth quarter of 2019 and $239 million in the first quarter of 2019. Production and servicing revenue, which excludes the MSR adjustment, totaled $20.6 million for the quarter compared to $6.9 million for both the first and fourth quarters of 2019.
Our margin was 4.37% for the quarter, representing an increase from 1.03% for the fourth quarter of 2019. The velocity of the pipeline increase near the end of the quarter created an anomaly in the mechanics of the margin calculating for the quarter. The pipeline increased from $290 million at the end of the year to $570 million at March 31, 2020. The $570 million pipeline on March 31 consisted of approximately 70% refi and 30% purchase money.
With that said, spreads widened in the quarter as a result of capacity limits from a processing standpoint. Finally, as Dan mentioned earlier, the MSR valuation adjustment during the quarter was a negative $11.1 million.
Moving to insurance. Total commission revenue for the quarter was $29.6 million compared to $27.6 million for the fourth quarter of 2019 and $30.2 million for the first quarter of 2019. As we mentioned each quarter, we typically benchmark to the same quarter in the prior year given the seasonality of our renewal cycles. First quarter is always 1 of the better 2 quarters for insurance as a result of the percentage of our renewals that occur at the beginning of the year. The slight decline compared to our first quarter of last year was a result of a couple of factors. Our contingency commission estimates for the quarter were about $1 million less than the first quarter last year. And additionally, as John mentioned, we sold a book of business to one of our producers which generated approximately $2.5 million annually in revenue. We are pleased with our ability to hold revenue in a tight range early on in this cycle. While our renewal rates are extremely high compared to industry averages, it is difficult to generate new business in this environment, and insurance commission revenue could certainly be under pressure if this pandemic lingers.
Finally, I'd like to briefly mention wealth management. Wealth management revenue held up well during the first quarter at $6.6 million, which was flat compared to the fourth quarter of 2019 and up from $5.6 million for the first quarter of last year. With that said, our revenue is directly correlated to assets under management in those valuations. Therefore, this is another area where we would -- could see some downward pressure on revenue going forward if asset values remain low. Even with this volatility, we believe these noninterest-bearing business lines continue to be a core strength for our company as they give us a diverse revenue stream, not totally tied to the lending and credit space.
Now I'll turn it back over to Dan for his concluding remarks.
Thank you, Chris. This pandemic and its impact on the economy is certainly not the start for 2020 that we had hoped for or envisioned, but I believe our industry and our company are in a much better position than we were entering the last financial crisis. And looking at us specifically, we have much better risk management processes and functions across the board. In particular, as Chris mentioned, we've made significant strides in our credit underwriting and monitoring processes as well as the diversification of our loan portfolio. As John discussed, we are pleased with our regulatory capital metrics as well as our funding mix and liquidity metrics. Our capital metrics indicate we are positioned to be able to weather all of the stress scenarios that we have analyzed. Whether there is still -- however, there is still obviously a lot of uncertainty around the ultimate impact of this pandemic.
With that, operator, we'd now be happy to answer any questions.
[Operator Instructions] The first question today comes from Kevin Fitzsimmons of D.A. Davidson.
I appreciate all the additional disclosure, very helpful. Specifically on the PPP program or the P3 program, I like that better. Can you walk us through, in general terms, just the -- I would assume that there's going to be a lot of noise in second quarter from that. So from a very top level, I would think there's some dilutive impact to the margin in a vacuum just from loans that are basically earning 1% or carried at 1%. You're going to have the balances carried in average loans, but then basically going away for the most part, third quarter. I'm sure there's expenses associated with this program. And then origination fees, are they -- how should we think of those? Are those going to flow through the margin or flow through the noninterest revenue line? If you could just give us a sense on that.
Yes. Sure, Kevin. I think that's -- those are good questions. And again, we've never made $1 billion in loans in a week before. So it was an interesting time, and it looks like they're going to turn on some more money. So our team is geared up for round 2. So your specific questions had to do with the fees. So there are fees associated with these loans that the SBA pays. We will book those in, and that will come in as interest income amortized over the life of the loan. If the loan pays off early or the loan is forgiven, as you suggested in the third quarter, then we would have a windfall at that point for whatever amount that the loan is forgiven. There's been discussion recently on how much of the loans are going to be forgiven, how much of the loans businesses are going to just carry as low-cost capital and use the proceeds for different reasons. So at this point, I don't know that we have a lot of clarity and if all of it will be forgiven or something less than all of it.
But you're exactly right on your second quarter impact. The 1% carry plus the fee coming into interest income is still going to cause some reduction in our net interest margin. It will be dilutive to margin in the second quarter. And then assuming we have big pay downs or big forgiveness in the third quarter, it would be hugely accretive to margin in the third quarter. There are certainly expenses involved in carrying that. So you'll see some elevated expenses in 2Q. I don't know what those expenses would flow forward into 3Q because at that point, the extra costs should have basically gone away, but we will definitely see some additional cost in 2Q for the processing of all of this. Does that answer your questions?
Yes. That is great. One quick follow-up because you alluded to the potential round 2. Of the requests you initially got, what kind of percent would you say you fulfilled? In other words, is there a pipeline of requests you didn't get fulfilled because the program ran out of money that will start the pipeline going for round 2?
Yes. So we were actually taking applications on Thursday morning and entering them and getting approvals up until the time that the money ran out. So from a success rate on the first round, we were in the high 90s, 97% plus that came through in the first round. Since then, our team has already seen a little over 1,000 applications that are sitting ready to go in round 2. We're taking -- we took 300 applications plus yesterday. So the applications are still flowing through and I would suspect will continue to grow until the money becomes available whenever they decide what they want to do and do see.
Most of the stuff -- remember, sole proprietorships were not allowed to apply until the second Friday or a week after it started. Those are going to be the smaller dollars. Chris commented, we saw 40% of the dollars that we -- the loans that we produced come in at under $25,000. Our average loan size at $120,000 is half or less of the national average. To me, that continues to show the granularity of our overall customer base, which I continue to believe is a big positive for our company as a whole to have that granularity in our loan portfolio, our existing loan portfolio, plus the size of these Paycheck Protection Program loans that we've put out.
The next question today comes from Jennifer Demba of SunTrust.
Can you talk about what kind of deferral rates you've seen on maybe the more vulnerable loan buckets in your portfolio, whether it be health care, restaurant or whatever it is, hotel?
I think we're seeing deferral request across the portfolio in total. It's interesting, many of the folks that were the first ones calling needing deferrals would -- may be in the groups that we would wonder -- we don't think they're going to need a deferral, but I think people were just afraid. I think there's still fear out there. Chris gave the numbers. We've got about $28 million in payment deferrals sitting out there right now, which represents somewhere less than 9% of the number of loans that are in our portfolio. I don't think we break it down at all by loan type, do we, Chris?
No, we don't have that granular look at it. Just to add some color to it, I think Dan's right. Some of the first requests that came through were from the medical community. They felt it pretty quick, especially in elective surgery, the orthopedic, that type of space. What we've seen them do is they're weathering the storm by protecting cash with the loan payments. We've seen them reducing salaries, making furloughs, taking advantage of the PPP program and other things to get through this. The visibility we see on those folks now is they're positioned well to get through the 90 days or 120 days, whatever that looks like. And then clearly, the hospitality industry, that was, I would say, the high percentage of those requested deferrals. Once again, what we're seeing them take action is they're consolidating down to lower staffs, operating on 1 floor. Some of our operators that might have multiple hotels in 1 area are consolidating into 1 hotel and kind of a pod approach like we've done with branches to some extent.
So really, communication flow back and forth between those folks has been good. I think that to Dan's point, everyone was taking advantage of the deferral process. A lot of that, I think, frankly, the regulators worked with us quickly, too. So the regulators came out early and said that was -- gave us some TDR cover, and I think that gave the customer -- the banks the ability to work with their customers quick and efficiently.
Suggested that we work with customers. Yes, I think -- again, I think our team has been engaged with our customer base quite well. And I think at this point, I think everybody is hoping that we can get some recovery and get back to work and do the things that everybody is talking about, Chris, specifically on the medical. The bigger medical clinics and the bigger hospitals, clearly, are going to get some government relief also not near enough to offset the losses in the revenue to them. But the medical business will allegedly, I believe, come back faster than some of the other things can.
How do you think the reopening trends look in your footprint over the next several weeks, Dan?
That's a great question. We're in 8 states, and we've got 8 governors, and we've got 8 governors that all think differently, and they're all putting out different advice. We're in some markets who have really locked down tight with local mayors that have required more stringent processes than the states are requiring. So it's a hodgepodge for us from market to market. We've been fortunate in that we've only had a couple of locations where we've had some virus impact, our company specifically, where we've been -- where we've had to take some action to protect our folks a little tighter.
But I think when you look at the restart process, the local governor here in Mississippi is saying that he thinks that in the next couple of weeks, they're going to allow some things to begin to restart. I think all of us in the banking industry are concerned, we want to continue to protect our people. So I see us not jumping out front and wanting to bring everybody back into the same building and get close to each other. Again, I think we want to make sure that we step into this in a slow normal way. We've actually found out that we can work quite well remotely, and we can communicate with each other. Many of us, like me, have been in the office most days, and a lot of our folks have to come to the office every day. But by allowing the other 2,000-plus people that can work remotely to do so has significantly lowered the headcount within our facilities, and that's protected us and helped keep us safe and not ill.
[Operator Instructions] The next question today comes from Catherine Mealor of KBW.
Dan, I want to see if you could give us any kind of color on some of the economic assumptions that you used for your $45 million COVID reserve build this quarter.
Well, that's a good question, isn't it? We use some of the same providers that others are using out there. We use a list of economic forecasters. I'm not sure that any one of them is any better or worse than another. We use a group called 4most, which is worldwide economic forecasting team. We use others of capital economics, capital analytics, Wolters Kluwer. So we're watching a multitude of different folks that are out there.
I think when you look at the specifics, we're seeing unemployment climb just like everybody else. We're seeing GDP contracting just like everybody else. So I don't know that our numbers are going to be any different per se than anybody else is coming in to March 31. We're now 20 days past the end of the quarter, and things continue to change and adapt. I think today, most of the forecasters are saying, unemployment is going to be worse than they thought on March 31. So it will be interesting to see what happens between now and June 30 at the end of this quarter. John, do you want to add anything to that?
Just that we used the 4most service, but certainly also guided somewhat by Moody's and some other services that a lot of our peer banks are using. We use the baseline forecast from 4most that has projections on GDP, unemployment rates. Unemployment rate is probably the most influential of those stats...
Within our model.
Within our model. Yes, within our model. So we have unemployment rising, I think, to maybe 10% or 12% in the 4most forecast. I think some services are showing higher.
Certainly after March 31, right?
Well, yes. But you combine adopting CECL and having life of loan estimates for the first time as opposed just to the incurred loss model, and then you combine that with COVID-19, it's a perfect storm of -- it's a guess work. I mean it's an estimate, but we feel pretty good about the process that we went through. We feel pretty good about our model.
Yes. The perfect storm on all the different moving parts here in this quarter. The adoption of CECL, we talked about it late last year and earlier this year. Our net charge-offs went from 0 to almost 40 basis points on an annualized basis, but all of that or the 90% of that is due to the adoption of CECL, where we mark loans up and then immediately charge them off. So that puts a lot of noise in our net charge-off numbers. The loans that we originated, we actually had net recoveries in the quarter.
Got it. All right. I guess I just had to compare -- maybe the unemployment rate, that was helpful, the 10% to 12%. Because we're seeing some companies that are probability weighting kind of a base scenario than an adverse scenario. Is that in your forecast as well? Or do you just have kind of 1 base scenario with that 10% to 12% unemployment?
Well, no, we run multiple scenarios. We run adverse, severely adverse. That's what we were talking about earlier in one of our comments on as we look at the stresses that we put through our system, the fact that we went out and raised $470 million in capital late in the fourth quarter makes us look pretty good at this point, makes us look pretty smart. I don't know that we were at the time, but raising $470 million late in the fourth quarter is a real benefit to us at this point in the cycle.
For sure, for sure. Okay. That's helpful. And then how about on energy exposure? I know you disclosed that you only have 1% of energy loans, which is great compared to some of your other peers in Texas. But how should we think about any kind of indirect businesses or markets that may be impacted still by the drop in oil recently?
Sure. I think that the drop in oil carries like every industry that have tentacles that reach out and touch other things. And our footprint where oil and gas production is a big part of the economy, that's going to be mostly in the rural markets in East Texas or the rural markets in Louisiana, where there's wellheads out there pumping and maybe some drilling rigs. The drilling rigs are gone. Those folks were, and many times, staying in hotels, where the hotels aren't having any business, they already aren't having any business. The local Ford dealer and the local Chevy dealer isn't going to sell trucks because of the slowdown in that business. So certainly, the second and third degree impact into that industry can have a longer damaging impact on the economy in many markets that are like that. I don't know that we have a number for that. I mean, again, I would tell you that in some markets where it's heavily oil and gas weighted, the whole town, everything in the town, the dry cleaners are related to oil and gas.
The next question today comes from John Rodis of Janney.
Actually, I was going to ask on taxes and stuff, but you just answered that. So obviously, negative prices and stuff yesterday, pretty interesting. Just curious back to the PPP loans. What is the average fee roughly on that $1 billion? Is it probably around 3%, give or take?
Yes. I think that's a good number. John, you know how it works. It's 5% on under $350,000 and 3% between $350,000 and $2 million and 1% above $2 million, and we have loans in all of those categories, but we're weighted on the smaller side. So 3%, maybe a little higher than 3% is probably a good number for us.
Okay. And then just one other question on mortgage. Obviously, if you -- like you said, you back out the MSR impairment. You had a strong quarter. You've got a good pipeline. As far as going forward, are you guys seeing any disruptions in the market? I mean, there's been a lot of stories out there about obviously, just given what's going on in the operating environment and stuff. But are you seeing any major disruptions to your mortgage operations?
No. We've not -- are you talking about the ability to sell mortgages? And disruptions, what disruptions are you specifically seeing?
Yes. Yes. I guess, in general, the ability to sell versus...
Yes, we're producing Fannie, Freddie, Ginnie paper, and we're not doing any private label pools. So we've not had any issue at all in selling loans very quickly. And like you said, our pipeline is almost as full today or fuller today than it was coming into the beginning of the second quarter. So that team is continuing to hum and work remotely and move a lot of paper through the system. So we're proud of our mortgage team.
Okay. Okay. So -- okay. And, Dan, maybe just one other question, if I can. Just as far as -- so you stepped back on the buyback plan. What -- just any thoughts on M&A activity over the remainder of the year, just given where we're at right now.
Yes, that's a great question, John. I think when we look at the M&A opportunities, certainly, folks were talking coming into the quarter. When you look back, as Chris said, January and February, things are rocking along fine. We've got 3% unemployment. The world is round. Everybody is talking about what do we do next? How do we keep things moving forward? And all of a sudden, somebody had a wreck and off we go, we're off in the ditch, and all the things that we were working on are no longer getting worked on. I do think there's conversations out there, but I think with where we are today from a credit picture, my guess would be that almost everything is going to be put on the shelf at least for a few months to try and figure out, does the economy bounce as some think they're going to? Or does the economy linger in a bad state for a while? Because that will impact M&A activity. We continue to stay close and talk to many of our friends out there in the industry. But I don't think anybody's going to do anything at this point.
The next question today comes from Jon Arfstrom of RBC Capital Markets.
A couple of follow-ups, just back on mortgage. Chris, can you just go over the nuances that the margin on loans sold? And it seems like you're tempering that a little bit for us in terms of the outlook, but maybe talk a little bit about the nuances and then the outlook on that?
I'd like to have a 4% margin into perpetuity, Chris, can you arrange that for us?
No, that won't happen. It's an accounting treatment when you have an increasing pipeline like that, and the fees that are collected on the pipeline are calculated against the book that closes that month. So that's why the margin can bounce around. So typically, you'll see that in our numbers when you have a really rapid increase in the pipeline, that margin is going to go up. Now there has been some upward pressure on margin because of so much volume in the industry, so much -- the capacity issues, people are able to put a little more price in the margin and just a little bit of that. But on average, I think I'm -- if you look at it over time, like we've always said, our margin is going to average in that where we've been probably in the high 1s, something like that over time. But you'll see it bounce around a little bit. Does that help?
I like 4.25%. But when you look at the pipeline that went -- basically doubled, our pipeline almost doubled from the end of the year to the end of March, and we're hanging in there above $500 million. That's a lot of volume coming through our system.
Yes. Yes. Okay. That makes sense. On the topic of pricing, I know it's maybe not the most robust market for new loans. But can you talk a little bit about what you're seeing and what you're asking for on new loan -- commercial loan pricing?
Yes, we're getting 3 requests today. It's, I want to lower my rate, I want to defer my payment or I would like a PPP loan. I think what you're seeing, you had a huge increase in the prime rate, right? So immediately, everybody...
Decrease.
Decrease. Yes, I'm sorry, decrease in the front. So I'm a little fuzzy-brained after the P3 activities. But -- so the first request that came out was, I need to get all my loans lowered, and I need to -- busting my floors. So I think we've taken a conservative approach there. We're not refinancing a lot of loans or repricing a lot of loans. I think it's our feeling today that a prime loan 6 months ago is a prime plus 1 loan today, and that's kind of where our stance is today. We're not seeing a lot of new requests, frankly, right now. I think most people are in a holding pattern. So it's hard for me to give you any color on what new loan pricing looks like. But I would tell you, if we're pricing it today, it's prime plus 1 plus something. That's -- it's in those mid-4s if we're looking at those.
I was trying to think we've seen very few new loan requests at all in the last several weeks. And the ones we've seen have been kind of a unique situation of some type that we've been able to jump in and help somebody with, but very little, business people who are trying to figure out how to get their teams back working.
That's right. And I just think you're going to see until things stabilize from an economic certainty or some kind of certainty perspective, there's just not going to be a lot of loan activity or price new loans. I think the pressure is going to be on what you do with your existing credits, how do you work with those customers through this.
Okay. That makes sense. And then expense base, it's maybe a sensitive topic, I guess. But do you still see some flexibility in your expense base?
Yes. So that's a great question. When you talk about expenses, and we're continuing to look to try and make sure that we're controlling controllable expenses in a tight way. One of the earlier questions was talking about what PPPs or P3 is going to cost us. You're going to see some expense creep in this quarter because we're spending money to produce the 8,500 loans that we've already got on the books, having many thousand more come in, in round 2. So there's going to be some noise on the expense side. When we look at just the core operating company, though, from our biggest expense line, it's going to be over salary cost. And I think in 2Q, salary cost typically always comes down because we've bust through some of the tax pieces of the puzzle there. I think we'll do that again.
So I would expect that we will see some declining expenses on most of our lines. We're still in the process of finalizing and further integrating the acquisitions that we closed late in '19 and early in '20. The guys over in Central Texas that came on board, we closed that on January 1. We converted them on the first part of March or middle of March, right, in the middle of the stand-down pandemic planning. So I think we'll continue to be able to harvest a little expense saves out of those areas. I think that's going to be offset at least in this quarter by the run-up in expenses around P3.
Okay. All right. And then just last one. You got the M&A question, and I understand what you're saying on the capital. But what would you need to see to start the repurchase program again to restart that?
Yes. I think we just need some visibility. I think we need to see what really could be happening. Right now everybody is waiting to see any evidence that the economy is going to bounce. And I think if we can get some clarity around what's going to happen there. I think, again, we -- when you look back, we raised $470 million in capital in the fourth quarter. We spent $80-something million of that in this quarter. We had net income in this quarter. So not $80 million of that actually went away from our capital base. I think we continue to believe that we've got sufficient capital to weather whatever storm comes through at this point, and we would like to be able to take advantage of the pricing where we're sitting today. But I think the conservative stance and our stance is going to be, we've got to get some clarity looking forward before we're ready to depart with the capital that we're holding. I think it puts us in a position of strength to have the high level of capital that we have today.
Our next question today comes from Matt Olney of Stephens.
Just a few follow-ups here. In the loan portfolio, can you just remind us how much of that portfolio is variable and will be repricing lower LIBOR or prime? And I assume the floors come more into play here. So just an update on the overall level of floors that will negate a portion of that variable rate loan portfolio.
Sure. John, you've got some of those numbers?
Yes. Matt, floating rate loans are about 20% of our portfolio. That's about $3 billion. About 1/3 of those at March 31 were at the floor. That's good news. The bad news, the 2/3 were not in the floor. So that hopefully will give you a little guidance.
And from a LIBOR pricing, not a big...
Not -- no, mostly prime.
Okay. That's helpful. And then on the slide deck, you gave us a nice breakdown of the higher risk portfolios, whether it's oil and gas, retail, hotels and others. That's helpful. And you gave us a loan to values by state. Those are all the hotspots that I think most investors have identified as being vulnerable asset classes. I'm curious what your views are. Do you agree that those are the more vulnerable asset classes in the portfolio? Or do you have some other views that maybe differ from that?
Yes. I think -- and Chris I'm going to let you jump in here too, but I think we're probably in the same boat with everybody else. These clearly come to mind quickly. If the economy stays down long, this is going to bleed into the rest of the portfolio. This isn't going to be limited to hospitality. This could go a lot deeper into the portfolio if the economy doesn't recover quickly. The stimulus money that the federal government is spending is going to have an impact. But the question is, is when do we see that impact? And how does that impact flow through to us. On a different industry perspective, Chris, is there some industry that you think we're not talking about here? I'm unaware of any.
No. I think, Matt, when you -- when this exploded, the first calls we got from customers or the first folks that we're reaching out, they synced well up with this list. And I think you see that in what other banks are saying, too. I think the next iteration would be as it flows through the real estate book and the tenants that are -- that support or pay those payments. So I mean, my own personal experience, I've got a real estate investment. My tenants are an orthodontist, a dentist, an eye doctor, a title company and a real estate company. Title company is doing okay. The other guys are struggling a little bit. So I think those are the kind of things you're going to see from the real estate side as they start to deal with how their tenants are able to make payments.
Yes. The hospitality, the restaurant industry, in particular, not only are they stressing to pay us, but they're also stressing to pay the rent and wherever they're occupying the space.
Then you actually get down to the breakdown of your restaurant industry. So we're seeing our franchise groups, they're down about 20%. So they're hanging in there with drive-through only business, the ones that aren't franchises or have a good drive-through type model are feeling it worse. So you start breaking it down from there.
Okay. That's interesting. And then switching back to the rate environment, you mentioned the floors and the variable rate loans. What about on the deposit side? It sounds like you've got some more room to bring down deposit cost. Any more color you can give us, whether that's kind of the current spot rate on deposit cost or expectations for how much deposit costs could move lower?
Yes. When you look at deposit cost, I think Chris talked about it or John, one of them talked about the fact that we've got -- coming into first quarter, we typically are collecting deposits from some of the public entities. So the counties, the cities, the municipalities that we bank. Those deposits are priced higher. So in the first quarter, one of you all said that, that was about 3 basis points on our deposit costs, and we've already seen that go away. We continue to reprice deposits down. So I think we'll see a nice move down in deposit cost in 2Q. I don't have a number for that, but we're able to manage those deposit costs down.
This concludes our question-and-answer session. I would like to turn the conference back over to Dan Rollins for any closing remarks.
All right. Thank you all for joining us today. If you need any additional information or have further questions, don't hesitate to contact us. We look forward to continuing to communicate with you. And as we work our daily process with our customers and their respective communities, we're going to take care of our teammates and take care of our communities. We're going to get through this together. Don't forget to wash your hands.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.