Cadence Bank
NYSE:CADE
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Cadence Bank
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Welcome to the Cadence Bancorporation Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. The comments are subject to the forward-looking statements disclaimer which can be found in the press release and on page 2 of the financial results presentation. Both of those documents can be located in the Investor Relations section at cadencebancorporation.com. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.
I would now like to turn the conference over to Paul Murphy, Chairman and CEO. Please go ahead.
Well, good morning, and thank you, all for joining us for our second quarter 2020 earnings conference call. Joining me today on the call as usual are Valerie, Sam, Hank, and David. I am going to kick this off with an overview of our operating results. Of course we're going to talk at length about credit, some of our latest observations from the ongoing COVID-19 stress. David Black is going to go into some detail with you on work that's been done during the quarter around assessing risk and the conclusions from those efforts. Valerie is going to cover the financials in more detail and then we'll have some concluding remarks.
Let's start with our pretax, pre-provision net revenues for the quarter totaled $95 million, which is up modestly from $93 million last quarter. The key drivers of these solid operating results were mainly NIM performance and really continued cost discipline. Our pre-provision, pretax ROA ended the quarter at 2.06 down 5 basis points linked quarter and pretty good on a comparable basis.
We ended the quarter with the NIM at 351. It is down 29 basis points, but when you consider the PPP impact, the lower rate environment all banks are dealing with, the decline was largely offset by our continued repositioning of our deposit base and hedging. As we previously reported we terminated our highly effective net interest rate collar in the first quarter and locked down a $261 million gain we will realize over the next several years.
So all things considered, I feel like we're managing NIM relatively well. Valerie is going to speak in more detail about loan yields and the impact of PPP on NIM in the quarter, but overall we're pleased with our execution here.
Turning to expense management, adjusted expenses were down $5.1 million linked quarter. This allowed our efficiency ratio to improve to 47.9%, nearly 200 basis point improvement over the first quarter. This was aided by reductions in compensation and just good overall expense control. We expect our efficiency ratio to remain attractive as the management team is very focused on expense management and will be so in the coming quarters.
With effect to loan growth, the vast majority of the loan growth of 2% for the quarter was the $1 billion in PPP loans. If you take out the PPP loans, our portfolio would have declined by $725 million linked quarter. This was partially by design as we are reducing energy and restaurant, but we're also seeing borrowers proactively paying down loans. We've seen several borrowers who repaid extensive revolver draws from the first quarter which is a healthy data point.
And the last, just overall, the lower loan demand, the less expansion planning, and there is a lot of COVID caution out there. Another positive for the quarter is our liquidity position. It has strengthened nicely. Our loan to deposit ratio ended the quarter at 85%, down from 92% last quarter. The deposit growth and deposit mix was really incredible and a very strong point for the quarter. Portfolio grew 11% in the second quarter. Non-interest bearing increased $1.3 billion, now 32% of the mix, a 500 basis points linked quarter, just I wouldn’t have thought that achievable and not all of that will stay clearly, but we know some of that is PPP, but we have seen a lot of new accounts.
So deposit costs declined 50 basis points linked quarter and total funding cost declined 46 basis points. So these things really helped us offset the lower loan yields and supported our attractive NIM.
So next, let's turn to capital and capital remained strong at Cadence and despite a challenging credit environment, I'll talk about more in a moment, but the bank has really I think well positioned to manage the pandemic. Our tangible capital equity ratio remains over 10% and despite the material increase in our provisions this quarter 3 of our 4 primary capital ratios increased from last quarter. So as a result of our solid capital base, the Board approved a nickel dividend payable August 7 to the holders July 31.
Let's talk more about credit. So as was mentioned at the outset, we took a powerful and clearheaded view and really diligent approach to credit this quarter. As a reminder, we've got a very seasoned team of bankers. We've been through stress like this before or maybe not like this, but have certainly been through many cycles before, and so we're reviewing our credits with a critical eye. And then we've deployed extensive internal and external resources to just really dig deep and be sure we understand where we are situated. So a result of all these efforts led us to a provision of $159 million for the quarter and I think is a reflection of the reality of the environment and some exhaustive credit work.
So reserves have now increased over 50% in the past quarter, while net charge-offs have been in the mid $30 million range for the last three quarters, roughly 94 basis points annualized for the second quarter. So nonperformers were up $65 million or 35 basis points, somewhere to what we saw in the first quarter, but over the last two quarters, we've expanded our reserves by over $250 million and that brings our ending reserves to 2.71%.
So let's talk now about some of the portfolios which have most impacted restaurant and energy. First restaurant, now stands at right at a $1 billion excluding $141 million of PPP loans the portfolio would have declined $78 million linked quarter. As many of you will recall from having studied us, 68% of this portfolio is to quick service restaurants. The vast majority of those were backed by the top-5 strong brands we call, Taco Bell, Pizza Hut, KFC, Burger King and Wendy's.
QSR comp sales for the second quarter across these franchises were down in April, but showed nice improvement in May and June and in many cases have recovered to prior year comps. So the overall QSR space has remained relatively healthy and Pizza has been – you know Pizza is by the way 11% of our portfolio, has been positively impacted and we're seeing some sales there quarter-over-quarter that are about low teens year-over-year basis. So yes, I'm sorry, year-over-year.
Full service concepts, casual and family dining trends continue to be challenged and were facing some really tough year-over-year comp sales figure. This portfolio now stands at $191 million, down from $214 million linked quarter and it is still roughly 20% of our portfolio, down just a touch as a percentage. So while we do see some improvements later in the quarter, we're just very clear and very real about the caution on this part of the portfolio with quarantine restrictions being mixed in different parts of the country. This would be the highest growth portion of the business I think.
Turning to energy, recall that we improved the mix of the portfolio over the last several years. We peaked at about 18% of loans 5 years ago. We're now just under 11. We now have a bigger increase of midstream and a lower allocation to E&P. The portfolio commitments declined to $188 million or little over 8% during the quarter. The reduction driven by a combination of things, but it is really requiring amortizations and deleveraging or is just an – and consolidation that is happening in the industry. So while we see in the business a number of bankruptcies really throughout the industry, we have not had any Cadence clients declare bankruptcy in the first six months of the year.
It is our plan and our expectation that this portfolio will decline by 15% to 20% between now and the end of 2021. This again will be from scheduled amortization, consolidation, some refinancing that we think will likely happen. So overall, we have relative confidence in the health of this portfolio for a number of reasons and first our portfolio, our energy portfolio is far different than any other bank which is 62% midstream.
I am not aware of anyone that is anywhere close to that allocation and we're pleased with this by the way. So midstream companies as we talked about in the past were typically contracted cash flow businesses. They are not directly tied to the commodity prices. They are impacted, there is no denial there. But a key point we've made before is the low leverage. So debt to cap of the portfolio at the end of the second quarter is 37% down from 39% at the first quarter. So these midstream companies have gone from very well capitalized, very low leverage, nicely profitable to some interruptions which have some shutting production early in the quarter and stress.
You know, we're not suggesting there is no stress, but what we see now as the quarter rolls forward is that almost all of the production that were shut down has either come back on or scheduled to do so quickly, and really the stress and the borrower covenants has been normal. So, we're pleased with the progress there.
Let's talk about E&P, we just finished the spring borrowing base redetermination process as they went relatively well from our perspective. We saw borrowing bases decline between 10% and 40%. We have of course seen some improvement in commodity prices, but commitments are down $58 million, 13.5% linked quarter. So many of our borrowers are actively hedging and overall we feel okay about these results. I'd say in general E&P feels a good bit better than it did even just a quarter ago. So, continued high degree of scrutiny and high degree of focus on that portfolio.
And last energy services would have decreased about $39 million were it not for the PPP loans and I would summarize saying that the trends are somewhat similar to E&P. We're seeing stress, but manageable, and we think this portfolio is one that would take a bit longer to recover.
So let me now turn the call over to David to give some context on credit migration. David?
Thanks Paul. Good morning everyone. I'm going to walk through credit migration for the quarter and discuss the drivers of our 2Q provision, give an update on loan modifications and highlight some of the tangible actions we've taken related to credit over the past year.
As Paul previewed, we did see significant migration in the second quarter, but as we get into the details, you'll see that it was in sectors where stress as anticipated, those aspects of the economy most acutely impacted by COVID-19. Over the course of the quarter, given the rapidly evolving environment, we conducted some very intense and critical credit work both through our known processes and through in-depth incremental reviews. Therefore, we believe this migration is a realistic reflection of the elevated risk in a very challenging macro environment.
Criticized loans increased from the prior quarter about $334 million to just over $1 billion or 7.4% of the loans. Approximately two thirds of this increase was driven by restaurant and two thirds of the restaurant migration was in the non-QSR space as owned premise dependent family and causal sectors have been much more severely impacted by the economic shutdown. 34% of the restaurant portfolio, excluding PPP is now criticized, which is consistent with prior expectations of stress in this line of business.
The majority of the remainder of the increase in criticized loans was driven by energy and more specifically E&P. CRE also contributed $48 million to this increase in criticized which is almost exclusively hospitality. General C&I actually offset some of this negative migration reducing by $78 million due to several upgrades to pass in the quarter. Classified loans reflected similar trends increasing $178 million from the prior quarter ending at $557 million or 4.1% of total loans. This migration was again primarily related to Restaurant & Energy sectors.
Nonaccrual increased $65 million from the first quarter to $224 million. The linked quarter increase was primarily due to Energy, Restaurant and Healthcare. The majority of our nonaccruals are comprised of seven relationships was greater than $10 million of exposure representing 60% of total NPLs, while significant linked quarter movement at 1.6% of total loans still a very manageable number given our capital and reserve levels.
Net charge-offs were $33 million or 94 basis points annualized and all material charge-offs in the quarter were all nonaccrual and rated substandard or doubtful going into the quarter. While still elevated relative to our long term expectations, the amount of charge-offs was in line with the prior three quarters.
Provision in the second quarter was $159 million, producing an ending reserve of total loans of 2.71% from 1.83% in the first quarter. The provision in the quarter was significantly impacted by Moody's baseline economic forecast, including assumptions for depressed oil prices, and a meaningful negative shift in the outlook for commercial real estate.
Additionally, management used qualitative and environmental factors to overlay portfolio specific assumptions, most notably for restaurant, energy, and commercial real estate. Collectively the forecast model and these assumptions drove approximately 60% of the provision for the quarter. Other factors, included charge-offs, specific reserves on paid credits and general negative grade migration impacting the quantitative output. Also I think it's important to point out the allowance for credit losses as a percent of NPLs improved only on quarter basis from 1.54 times to 1.65 times.
COVID-related loan modifications as of 6/30 totaled $2.4 billion or 18.2% of the portfolio. $1.5 million of these mods were in C&I with the largest dollars at $707 million in general C&I given the size of that segment and the highest percentage in restaurant with 40% or $462 million of that portfolio being modified. On the other end of the spectrum only 4% of our midstream credits have been modified. Commercial real estate had $570 million in modifications, with the highest percentage in hospitality, 61% representing loans or $155 million.
Only 6% or 48 million of our multifamily portfolio, our largest commercial real estate portfolio has been modified. Over 20% of our modifications have made a payment post their modification date. In the quarter we almost also completed our fourth iteration of borrower level COVID survey work with $11.2 billion of total commitments included in our scope, the pull and penetration was high, and we're tracking potential impact in a very granular fashion.
Taking a step back, I wanted to touch on a myriad of recent risk actions taken by our team, most of which were embarked upon well before COVID. We've made enhanced and strong policy, particularly around leveraged lending. We've adjusted hold limits to more conservative levels with an emphasis on higher loss given default [ph] exposures. We've modified concentration limits to drive more asset diversification. We've meaningfully reduced loans segments where higher risks characteristics over the past year. Most notably leveraged loans without a moderator is down $276 million, or 33% decrease year-over-year and we reduced Shared National Credit exposure by about $143 million over the past year.
The team has expanded the scope and frequency of credit reporting to both management and the board, including the implementation of enhanced stress testing. We also hired a new veteran leader for our Special Assets Group and expanded senior resources dedicated to the Special Assets team.
Lastly, we engaged a highly regarded third party with extensive expertise in energy and large C&I lending to perform a detailed bone [ph] level review of portfolios most impacted by COVID, specifically focused on all three segments of energy, restaurant, healthcare and hospitality.
We conducted a buyer sample with an emphasis on larger exposures and adversely graded credits. We believed an external review would be prudent, given the current level of macro uncertainty. The exercise proved to be very constructive, providing credible challenge, and ultimately confirming prior statements we've made regarding our team's experience, prudent risk culture, and how we were appropriately grading our portfolio during this unprecedented time.
In summary, we continue to see uncertainty, but we also see signs of customer resilience. Provision and migration for the quarter were dramatic, but we believe a realistic reflection of elevated risk during this time of deep economic pressure and pandemic. We acknowledge there will undoubtedly be some level of continued stress in the quarters to come, but we will approach this stress with eyes wide open,
And now, I'll turn it over to Valerie.
Thank you, David. As Paul noted, our adjusted pre-tax pre-provision net revenue continues to be strong at $95 million, an increase of $2 million from last quarter, reflecting strength in our net interest income and expense management. Our stable PPNR, our robust capital position, and our allowance for credit losses at 2.71% all combined a solid foundation in this volatile environment.
The second quarter adjusted net loss was $57 million or a negative $0.45 per share. The loss was due to increased loan provisions which were up $75 million or 9% for the prior quarter to $159 million in the second quarter. This provision actually brings our allowance excluding the guaranteed PPP levels to 2.93%.
A few comments on our balance sheet mix. Like a lot of other banks this quarter we saw a massive influx of deposits in the quarter of $1.6 billion with $1.3 of that in noninterest bearing. At the same time, while we did find the $1 billion in PPP loans, our core loans declined $725 million, primarily due to pay downs of potential draws [ph] that were taken late in the first quarter, and other pay downs really in both our stress and non-stress portfolios. And the result of all of this was an excess of liquidity in the quarter. We did put some of it to work in securities up $200 million in the quarter to $2.7 billion or 14% of total assets. Total cash balances still increased by $1.3 billion quarter-over-quarter.
Looking ahead, with loan growth expected to be soft, we will put more of this liquidity to work in securities. But I do anticipate that we will maintain a somewhat elevated level of liquidity really until we get to a more normalized environment.
So this balance sheet mix shift, along with what was really a dramatic decline in LIBOR during the quarter, it negatively impacted our net interest margin. NIM 3.51% for the second quarter down from 3.80% last quarter. The impact of the PPP loans attributed 11 basis points of the reduction and excess liquidity and lower accretion income attributed 4 basis points, and 6 basis points of the decline respectively.
All the other fundamental NIM components netted to an 8 basis points decline, with the highly positive impacts of our lower deposit costs and increased hedge income significantly offsetting the impact of LIBOR and lower rates on our loans and securities.
Importantly, our total funding costs declined by 46 basis points from 97 basis points in the first quarter to 51 basis points this quarter. Our interest bearing deposit costs declined by 63 basis points from 1.28% in the first quarter to 65 basis points this quarter, and our noninterest bearing deposits increased from 27% to 33% of total deposits.
We have really been working pretty aggressively to bring our funding costs down and are very pleased with this progress, really the progress we've made over the last several quarters. Given time deposit maturities that are coming in the latter half of this year, we do expect interest bearing deposit costs to come down further, although, certainly not at the pace they did this quarter just given the new base level.
And while our net interest margin declined, our net interest income increased $1.3 million to $155 million in the second quarter. $1 million of the increase came from those core fundamentals, the combination of our lower funding costs and increased hedge income, partially offset by lower core loan and securities income. The PPP loan income, costs of excess liquidity and lower accretion all combined for a net increase of $300,000 quarter-over-quarter.
The PPP loan interest income was $4 million during the second quarter and total net deferred fees associated with these loans was just over $16 million at the end of June. These net fees are amortized over the remainder of the two-year life, but will be brought forward into earnings when the loans are forgiven. And we currently anticipate the majority of these loans will be forgiven during the fourth quarter.
Non-interest income of $30 million was down $5.1 million for the prior quarter. This included a $2 million write down of alternative investments, and they reflect declines in deposit service charges, card fees and loan fees really resulting from the higher deposit balances from the press, consumer card activity, and lower loan volumes. Offsetting these declines were increases in investment advisory revenue, really largely driven by higher market values at quarter end and increases in our mortgage royalties [ph] just due to the active loan generation in the current rate environment.
Non-interest expenses continue to reflect our long standing expense management culture and resulted in a 200 basis points quarterly decline in our adjusted efficiency ratio to 47.9%. Adjusted expenses declined $5.1 million in the quarter and included lower compensation expenses due to lower headcount declines and payroll taxes, and increased deferred loan origination costs related to the PPP loans. Other smaller declines were across the board really, including things like employee travel and business development expenses.
Turning to capital, as Paul mentioned, during this quarter three of our key, three of the four of our key capital ratios increased over really what were already strong capital levels. Given the balance sheet mix shifts, our risk weighted assets declined in the second quarter, and at June 30 our common equity Tier 1 and Tier 1 ratios were up to 11.7% and total capital was up to 14.3%. The leverage ratio ended the quarter at 9.5% and our tangible common equity the tangible assets remain strong at 10.2%.
These robust capital levels, our higher level of allowance for loan losses, our significant balance sheet liquidity and meaningful pretax pre-provision earnings power, all combined to provide a foundation of resiliency as we continue into this period of economic uncertainty. This resilience also provides a sound backdrop for our employee base to confidently focus on serving our customers with the excellence we're known for, and for us to continue to focus on providing value for our shareholders.
With that, let me turn it back to the operator for your questions.
[Operator Instructions] And our first question today comes from Jon Arfstrom from RBC Capital Markets. Sir, please go ahead.
Good morning.
Good morning, Jon.
Good morning, Jon.
Just, I think sort of to describe this a little bit, but it sounds like you did a lot deeper work on the portfolio this quarter compared to last, and maybe that makes sense, but just talk a little bit about what’s you guys learned about the book? This time around did you have any differences between some of your grading and this third party and just a little bit on your approach between now and when we talk again in mid October, in terms of is it another deep dive or do you feel like you've captured most of the paying or expected paying with what you did this quarter?
Yes, thanks, Jon. I'll comment and also invite David Black to offer his perspective here. So, first, I mean, this is the quarter in which the shutdown happened, and but global pandemic impact was really significant. And so, we did a lot of work to be sure. We understood that as best we could, and we again invited a third party to come check our thinking or bringing intellectual challenge to the equation.
And so, one of your questions is that the third party differences were really none. I mean, I think it's sort of a validation of our approach. And, what we hope is that we're being more cautious than we need to be, but we also are very realistic and practical that in risks have changed significantly and we want to be aware, alert, appropriate in our grading of the reality that we're in. So for me, I feel really pretty good about the energy book overall. And I think the restaurant portfolio, which we said for several years now is the highest risk part of the portfolio and where we will be scrubbing harder and harder going forward.
And then, of course, always anything that's leveraged lending is that it's going to get screwed deep. And so we for some period now have been pulling leverage down across the board. So, maybe in some ways, the fact that we had some challenges last year, and we touched upon our work in this area is a bit of a plus for us. But I don't know, Jon hope I'm going to the heart of your question. I'll let David comment and then will certainly follow up on from there.
Sure, thanks, Paul. Good morning, Jon. We, in addition to bringing in the third party, we expanded the scope of the reviews that we've done internally. I think it's just only appropriate that we would focus on the sectors most impacted by the macro environment and the feedback from the third party was that Paul referenced was one of concurrence. It was an independent validation that we were appropriately grading credit, given all the uncertainty that we face. From an outlook perspective, it's a continuation of the disciplined risk controls that we've had in place and trying to assess and early identify problems. So with that, Paul, what do you have?
I would just point to page 8 in our slide deck Jon, we break out the provision. $93 million of that is largely Moody’s driven from the economic outlook, that's a big number for the quarter. And so, estimating provisions is something that is, not simple, I guess you would say, and not precise. But, again, our hope is that we're being more cautious than we need to be. And I think we're also being very realistic. So did we answer your question, Jon or do you want to follow-up on that?
I guess, what we're trying to get at is, what might the third quarter look like from a provision point of view? And I know that's a challenge, but maybe one way to ask this is, can you talk a little bit about loan modifications and some of the trends there? And then David, you mentioned the survey of your clients, talk a little bit about what you've learned there, because again, I think the key is to get back to profitability for you and I guess we're all trying to figure out how you're thinking about third quarter from a provision and the stress point of view? Thanks.
Yes, I’ll comment, I thought, I think it's reasonable to expect that the second quarter will be the peak for provisions. To put an asterix in that and say, it just depends on reopening. I mean, we had such a dramatic period with the shutdown. And now as we're reopening and activity is improving, there's, again, some reasonable to expect it will be the peak. But, I think provisions will be elevated for a period of time until we work through what does the new economy look like and especially how does it impact restaurant and energy. David?
Sure Jon. On the topic of deferrals are as we've previewed, that number did increase from our previously disclosed number in April of $1.5 billion to $2.4 billion. I would note that these are across the board 90-day, deferrals. And given that timeframe, we've had a small amount of loans that makes that $146 million actually into their second deferral, which is 6% of that total deferral population or 1% of total loans. And so from a process perspective, there are incremental questions and documentation and scrutiny that we place upon that second deferral request.
But in the categories in which they are showing up, consistent with our prior conversations, it's in the commercial real estate world it's really centered in hospitality from a percentage standpoint, 61% of that portfolio, $155 million, and really the number would be higher rate, if and then like, particular asset class, if it weren't for how much of a meaningful piece of that book of businesses is a construction component.
Retail, office, multifamily, all have some elements of deferral to a much lesser extent. In the retail space you're matching 10 concessions and as well in office, but multifamily we'd only had $40 million of concessions there. Again, that's our largest commercial real estate book at 25% of the total commercial real estate exposure. The C&I book is largest dollars or again, in general C&I, with the highest percentage in restaurant and that's consistent with what we saw from a migration in the quarter as well and also influenced our qualitative overlays with the provision.
I'll step out of the queue, but anything on - from your survey work?
Sure, I think that the intent there is largely been trying to get it as forward looking as we can with feedback from our clients or what they anticipate impacts will be for their individual business. And I would say the takeaways really influence what sectors we gave environmental and qualitative overlays to from looking though it and so the survey work has definitely influenced our view of potential impact on the various sectors that we have exposure to.
And gentlemen, our next question comes from Michael Rose from Raymond James. Please go ahead with your question.
Hey, good morning and thanks for taking my questions. Just as you guys have done this deep credit dive again this quarter, have you - the loans that were then moved into criticize, I mean, if they've been downgraded in terms of, have you taken specific marks against those loans proactively for potential loss content even if they're on deferral at this point?
I just want to try to get a sense for how proactive you've actually been and Paul, your comment about this could be the peak for provisions if there is continued migration, it does sound like could be likely. It does sound like there could be continued reserve builds beyond what’s you did the score actually to be, I calculated about 110 basis points is that kind of the way to think about it? I think that's the question everyone's trying to get at, thanks.
Yes, Michael, I would say it again. I think it's reasonable to expect that this will be the peak quarter for provision and things are better in the third quarter than they were in the second. People are going back to work and they're seen to be managing the pandemic better. So will there be some lagging effect for things, information that comes in, in the quarter? Entirely possible. So again, I come back to probably elevated level of provision, but reasonable to expect second quarter is the peak.
Go, ahead Paul.
I'm sorry, Valerie. Yes, just so with respect to specific credits, yes, I mean the process just got through and we look at specific credits and what's going on and the COVID impact and there are - in many cases are specific provisions allocated to those credits. But there's also, just a portfolio view element that goes to this and so I'll pass it to Valerie.
Yes, that's part of what I was going to add, but then also just, kind of referring back to that slide 8, where we break out the portfolio changes, and then the economic forecasts, the whole point on the provisioning, I mean, I think we feel very comfortable that we've captured everything that we know today. We're hopeful that the decline in the economic forecasts, the magnitude of that was the greatest in the second quarter, but the folks at Moody's and their PhDs know that better than we do and as the quarter rolls on, we'll see how that goes.
So that's always, which also has an asterisk in that. And then like you said, on the portfolio changes, yes, there will be, there will undoubtedly be some movement in that. Some negative, some positives as we go through, just seeing the full impact of the pandemic on some of these borrowers. That's a lot of non-answer to your question, but those are really the moving parts that we have right now [ph]. Thanks.
Understood and maybe, Paul, if we could talk about the midstream portfolio a little bit, we saw the portfolio sale last week at another bank that primarily is in the Gulf of Mexico. I think the majority of your assets would be in Texas, so there is a difference, but how can you give us confidence that you think that your midstream portfolio would hold up if stress continues? Obviously, breakouts down as well, lower drilling activities, et cetera. But can you help us feel a little bit more comfortable about your midstream books at this point, just given the severity that we saw taken on that other sale? Thanks.
Yes, sure. Thanks, Michael. So as I mentioned in my prepared remarks, the midstream business our portfolio overall is really far different than most other banks because of the midstream components which contracted cash flow, its low leverage, its good operators with a good track record of charge-off lifetime to date have been less than $3 million bucks. It's a very experienced team. We lead a number of major relationships to top midstream operators in the industry. We're pleased with the portfolio.
We did have linked quarter two non-performers, totaling $37 million, both of those are paying in accordance with their terms. So they are stressing the portfolio, there is no denial of that, but it's a good portfolio. It's going to perform well over time and yes, I'm aware that some other banks have sold their portfolios far different mix than ours. And as you point out, our Texas portfolio is way different than the Gulf of Mexico with only one E&P borrower in the Gulf of Mexico and that was a credit that we took a charge on in the quarter, so final resolution of that credit.
So overall, there is – the energy business is going to be around for a long period of time. We're managing our portfolio tightly and managing it down a bit. Again, as I mentioned, we expect to see it through amortization and refinancing and industry consolidation we expect to see some reductions in that portfolio over the next 18 months. But all in the covenant violations to the quarter that relates to midstream were manageable, so we're going forward.
Paul on the second, I'll just add to that. They were also seeing the shut-ins come back online. We had two good months, during two months there where we saw pretty significant shut-ins, but we're seeing those come back online and that's kind of a green shoot that we're seeing for the midstream portfolio.
Okay, maybe one final quick one for Valerie. Any sort of outlook that you might have for the core margins as we move into the third quarter? Thanks.
Yes - yes, thanks, Michael. Yes, we feel pretty good about where our margin is today. When you had a shake up and noise that the PPP and the lower accretion and some of the excess liquidity et cetera, really the core fundamental piece of it really just declined 8 basis points, and that's what the significance that the LIBOR dropped in the quarter.
So when we kind of look at where we are at June 30, we still have some room at our deposit costs. We've got about $1.3 billion of time deposits that mature over the latter half of the year. Those are coming off probably on an average of about 1.6% coming back on at 60 basis points. So there is opportunity and we will see some of those deposit costs continue to come down in the quarter.
Likewise, some of the excess liquidity that we have we're going to be putting to work in securities. So those are both positive factors kind of put the core margin outlook. I guess the only caveat I would give that is, if we continue to see meaningful loan paid out, as you know, corporate borrowers just reduce debt then could offset that a little bit, but overall we feel pretty good about the level that we're at and the ability to make some hopefully a little bit marginal improvements depending on what happens with the low balances.
All right, so maybe flattish to maybe a few basis points higher is maybe the way to think about it.
I think that's fair.
All right. Thanks for taking all my questions.
Our next question comes from Steven Alexopoulos from JPMorgan. Please go ahead with your question.
Hey, good morning everybody.
Good morning, Steven.
Good morning Steven.
Obviously to followup on credit. So if we look at criticized loans are very high right over 7%. Is that understated though because of all the deferrals, and as these deferrals come due, should we expect a further increase in criticized loans?
Steven, I'll comment. I don't think it's understated and I think quite contrary. We really went through extensive efforts to be sure we mark everything accordingly. When I look at the deferrals, our strategy the first time around is, we're pretty linked. I mean, we've really granted deferrals and as David made reference to, this time around it's a different process. And so, I think we can better answer your question about deferrals probably 90 days from now once we kind of work back through this and see, well all right, we were laying in on deferrals the first time around, we're going to really look at it more closely. If someone would like to have a deferral, but they have cash and they can pay, we're going to be sticking closer to the original terms of the loan. Of course, some flexibility still going forward, but I would definitely say I don't think it's understated.
Okay.
I would concur. I think we certainly didn't downgrade some of the deferrals just because of deferral, and I don't think anybody in the industry has gone that far. But to the extent that we identified that there was stress underlying the request, then and we felt criticized was deferral grade we moved it.
And how should we think about the migration now from criticized to nonaccrual? Does this become a third quarter event?
I think it's reasonable to expect some migration there. The extent of it is hard to put your finger on at this point. Its case-by-case, you just have to look. I mean we're seeing some great fruit sprouts here and there and some reason to be optimistic, and some of these credits the longer they are stressed they will deteriorate and just don't have perfect visibility on them.
Yes. So from a big picture view, I think this might be the fourth quarter in a row where you've thought that the peak of credit problems were behind you and this goes back actually to 2Q'19. What gives you a confidence here? I mean, is it only that you're seeing some states are open, that you're confident the credit issues are behind you, because we've heard that story for the last couple of quarters, and then you put up another higher provision, right and more migration. I am trying to really understand what gives you confidence that this quarter, is…?
Yes, that's fair. I mean, well, prior to COVID our first quarter numbers would have shown nice improvement. And so, I guess I would say with COVID being a major impact, we would have been there. So it's the track record is maybe not as bad as perhaps the reference. So, I mean, all I can tell you is, we've been thorough. We are not in denial. I hope we're being more cautious than we need to be. We've got a good underlying portfolio. We've got a lot of good bankers. There is stress. COVID is a challenge, but I think we've captured it.
I appreciate all the color. Thanks for taking my questions.
Our next question comes from Jennifer Demba from SunTrust. Please go ahead with your question.
Thank you. Good morning. Paul, could you talk about the loan severities you saw on some of your larger loan charge-offs this quarter? And also, you mentioned before, it sounds like you're not interested in any kind of bulk sale, but can you give us some more color on that thought process? Thank you.
Yes, sure, Jennifer. So in the quarter, we really had three charge-offs range from $4 million or $5 million range to $10 million to $12 million range that make up for the $32 million in charge-offs for the quarter. So we do see some severity of loss in the restaurant portfolio and energy credit. As was mentioned, we've been through the spring and fall redetermination season now, and we feel pretty good about that process and how things are positioned for the E&P portfolio. Gosh, I don't know. David, anything you would add to that?
No, I would acknowledge that there were elements of higher loss given defaults experienced in the second quarter charge-offs relative to what the characteristics that we see in the rest of the non-performing portfolio. But, again, two of the three that Paul referenced were final resolution on those credits. So I don't have any incremental exposure on those.
[Indiscernible]
Right, so never say never. But it's my belief that our portfolio is going to be well managed over a period of time and we've seen it come down. Our measuring portfolio as was referenced is performing nicely. So actually it's unlikely that we'll pursue that.
Excellent.
Our next question comes from Brady Gailey from KBW. Please go ahead with your question.
Yes, thanks. Good morning, guys.
Good morning, Brad.
Good morning, Brad.
When you look at deferrals was on - as of June 30th, they were $2.4 billion, maybe an update on where those are at today? It sounds like only $150 million have entered into the second deferral. Has there been a lot of deferrals that are now back paying, I'm just wondering if that deferral number is a lot lower as of today?
Yes, and Brady, this is David. So 20% of that total population has had a payment post-deferral. And as you mentioned, only a small percent or 6% of that total $2.4 million has entered into a second deferral request. And following on both referenced it is hard to gauge what the real activity will be through the remainder of the quarter in terms of the second request. Anecdotally, it feels like it's coming down fairly materially that we're not seeing the activity on the second request that we did on the first request.
Okay, then yes, actually you guys talking about 2Q hopefully is the peak provision. But as you look to the back half of the year, I know there is a lot of moving parts, but do you expect for Cadence to be profitable in the back half of this year?
Brady, I would say that I think that's a reasonable expectation that we can be profitable in the third and fourth quarter. Yes.
Brady, I think that the thing that's so important here is just to remember the strength of our pre-tax pre-provision net revenue, and the consistency that we've had in that and the stability of our margin and so forth. And we feel very confident about really that underlying core earnings power. And so, as things migrate out of this environment, then that foundation is resilient and that really gives us our confidence.
Got it. That's a great point Valerie. And then lastly from me, just when you look at period and if you stripped out the growth related to PPP, I think period in loans were down a decent or maybe about 5% linked quarter. Is there something else probably planned and strategic, as you guys run off some loans that you no longer want, and I heard the comments about how you're expecting your loan growth to be kind of soft now, but you think that there is some continued kind of strategic loan shrinkage that could send loan balances down a decent amount from here?
I do, yes. I think we're going to see just overall slower loan demand, prepayments from stronger borrowers and that it'll be a period of time that will shrink loans before we begin to build them subsequently.
So how much do you think - how much shrinkage do you think will be there, Paul, and you're talking down another 10%, another 20% until you kind of bottom out from a loan balance point of view?
I don’t think 10% or 20%. I think perhaps it's more like in the 5% to 10% range.
Brady, one thing to keep in mind this quarter, we saw a tick up in loans in the first quarter really as there were customers that had defensive draws. We had about $450 million of that. We saw a lot of that pay back down this quarter, and people got a better sense of the environment. And so that had pretty meaningful impact on the decline this quarter. So it is just important to keep that in mind.
Great, thanks, guys.
Our next question comes from Matt Olney from Stephens. Please go ahead with your question.
Yes, thanks for taking the question. I want to go back to the core earnings power that Valerie mentioned that the PPNR was that $95 million in 2Q and its maintained that over the last few quarters. Can you just talk about the puts and takes around maintaining that $95 million quarterly level over the next few quarters? Thanks.
Yes, well, I think a couple of things that are really important there. One is our expense base, and our ability to manage that. We continue to have levers that we can pull should we need to and keeping that expense base, the efficiency ratio 48% we felt very confident keeping that in that range.
The other thing is on the margin, as I mentioned. I think that we've got a pretty stable environment right now and LIBOR can't go any lower and we got ability to bring down our deposit costs. We're - there is an impact obviously with the decline in the loans, but we're putting that to work in securities and over time the environmental shift and we'll be making loans again. So yes, we felt very good about that.
Our non-interesting income took a little bit, we had a couple of million dollar write down that's a onetime kind of item related really to the COVID environment, and once business activity starts to resume and consumers are making card charges again, we expect that will also rebound a little bit. So that's really the great foundation for us and something that shouldn't be overlooked.
Okay, thanks. And going back to the discussion around the loan deferments, let me ask Brady's question a different way. Can you give us an idea of how much of the deferred borrowers have now seen their initial 90 days expire and you complete the full review? We're just trying to understand what portion of the initial deferred balances are requesting the second deferral when you completed that review?
David?
Matt, I know the numerator to the question. I don't know the denominator of what has rolled off. It - my sense is relative to the $146 million that have entered the second phase, because our April number was at 1.5. That is a relatively small percentage that are making the second deferral request.
Okay.
As we said today, I don't know that exact price [ph].
Got it.
And Matt, I may comment a little bit too there. From what we're hearing from our borrowers in our surveys and actually reaching out on a regular basis is that the numbers that we told you so far are going to be consistent through the quarter. We may see some upticks if we see a decline in our close of shut-ins or closed downs in the markets, but as far as the second phase coming in and being as big as the first I think David is right on point.
Okay, thank you.
Our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead with your question.
Great, thanks. I guess is there a way to break out how much of the reserve build came from the sort of that deeper dive credit review that you did versus just actual deterioration in the portfolio, you know, the known sectors like restaurant, energy, something you wouldn't have been surprised by in your deeper review?
How can I make this [multiple speakers] all done.
Oh, yes, I was just going to say it. It's all intertwined. It's all part of the quarterly assessment of where our credits are.
[Indiscernible]
Got it. Understand. Okay, so presumably, as you have pointed out a few times on the call that so next quarter, you're not doing a deep review, you don't need to since you already did one and hopefully we should see less provision expense going forward?
Ken, I'd just like to clarify that. I mean, clearly, we get a deep dive into our credit, but that in this environment is going to be an ongoing process. It's not - I mean, we certainly added some layers, but it's really relative to the environmental stress that we're seeing. So it's - the credit valuation will be what the credit evaluation is, it really has nothing specifically to do with the extra layers that were taken on in this quarter.
Got you, understood. Okay, yes, as you can imagine, I'm just trying to make sure I understand the difference between just the existing say, restaurant portfolio as it deteriorates you're going to build reserves against that which are sort of normal versus trying to pull out this sort of extra credit review that you're doing. That would imply that you're digging deeper into things, but I do understand how they're intertwined.
Sorry, it's just me, my second question really quick. Following up on I think it was that PPNR question about operating expenses. Valerie, I think I did hear you say you wanted the efficiency ratio of 40. It was 48%. But just if we think about dollar numbers, because obviously I guess there was a capitalized PPP expenses this quarter. There was lower incentive comp, lower marketing et cetera. It seems like some of that though should probably reverse back to more of a higher level come to reach you. How do you think about dollar expenses heading into 3Q?
Now, that's a good question. And I think there is a correlation between the increased business activity that would drive from increased expenses, but it should also drive some increased revenue. And so, to that end, that's where it may not be 48%, it may be 49%, 50% within the range, still very highly effective efficiency ratio.
From a dollar standpoint though, you're right. I mean, it is as soon as, I mean, I used to travel a ton, I haven't left my home office in a long time. So as soon as the business activity starts to evolve, there will be additional expenses there, but that's all in generating revenue. So I think it goes hand-in-hand.
Okay, great. Thank you very much.
And our next question comes from Brad Milsaps from Piper Sandler. Please go ahead with your question.
Hi, good morning guys.
Good morning, Brad.
Thanks for joining us, Brad.
Thanks. I was just curious, I think about 14% of the general C&I portfolio is in modification, just curious if there was any kind of particular theme or sector within that portfolio that was driving that? And I think if I recall State Bank had about $1 billion ABL book, just kind of curious kind of how that's performing? Do you have anything that would cause you concern there one way or the other?
David, would you comment on that?
Sure, I'd be happy to, good morning, Brad. In terms of the general feeling, I would say that that's relatively diverse across that entire portfolio. No meaningful concentrations in those modifications. The ABL book has continued to perform really well. It has not been a driver of modifications or significant migration in the quarter. I am very pleased with that line of business. And Hank, anything to add in that regard?
I would definitely echo that David. I appreciate the comment. We have seen that portfolio come down. We had a change in leadership there and with the credits that they originated, the ones they have been placed, we feel good about the outlook in the ABL platform.
Great, and then just maybe two quick follow ups. I think you commented in the deck that the restaurant or the QSR piece is about 80% or 85% of the pre-pandemic revenue. I'm not sure what the measurement period is there. Is that a level where debt can start to be repaid at that kind of level of revenue or do you need to see further improvement?
Hi, Brad, this is Sam. Did you say the QSR was 80% of prior year's comps?
I think that's what I read in your deck. I may have misread it, but that's what I thought I saw.
Got it. Well, actually, our QSR which is almost 70% of the book has been by far the most resilient in the portfolio. We look just quickly run down some comps for you over QSR pizza exposure was up 10% in April, 22% in May, 15% in June, Popeye's was up 25% in April, 45% in May, 38% in June, and all the rest are also showing favorable year-over-year store sales.
So, while a lot of them had a bad April and certainly a bad March when the shutdowns initially happened, they've rebound really very well. So I think on the QSR side, yes, we expect them to - that's where we had the fewest payment deferral requests, of course, and I think we're going to be in pretty good shape there.
Okay, and final question. Valerie I was just curious, what were the reinvestment rates on the new bonds that you're buying aids the balance sheet at this point?
Yes, it's below 2%. We're doing mostly mortgage backed, probably around 170. We are doing some high grade municipals and those of course have a little bit higher level, but probably around 170 is a decent number.
Great, thank you.
Okay.
And ladies and gentlemen, with that we will conclude today's question-and-answer session. I'd like to turn the conference call back over to Paul Murphy for any closing remarks.
Okay, well so thank you all for joining us. Just in wrapping up, I would close with saying that I really am honored to serve with a great team of bankers, really proud of the critical support that we provided. So many of our clients with these PPP loans, certainly challenging times for the industry and for the world, but I have to tell you, I've got a lot of confidence and our deep relationships that we have with our clients, a lot of confidence in our bankers and the experienced team that we have with a lot of experience managing through the previous cycles.
And I like our strategy and I like the markets that we're in. And so, in spite of the challenges and navigating this difficult time, I think we are positioned to come out of this and really have a bright future. So we're at our posts. We're working hard to do a good job for shareholders and we thank you for support. With that we stand adjourned.
Ladies and gentlemen, with that we'll conclude today's conference. We do thank you for attending. You may now disconnect your lines.