Enterprise Financial Services Corp (EFSC) 2020 Q2 法說會逐字稿

Good day, and welcome to the EFSC Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Jim Lally, President and CEO of Enterprise Financial Services Corp. Please go ahead, sir.

Well, thank you, Katrina, and good morning, and welcome to our 2020 second quarter earnings call. For all of you on the call, I hope that you and your [family] continue to be well and safe. Joining me on the call this morning is Keene Turner, Chief Finance and Operating Officer of our company; Scott Goodman, President of Enterprise Bank & Trust; and Doug Bauche, Chief Credit Officer of Enterprise Bank & Trust.

Before we begin, I would like to remind everyone on the call that a copy of the release and the company presentation can be found on our website. The presentation and earnings release were furnished on SEC Form 8-K yesterday. Please refer to Slide 2 of the presentation titled Forward-Looking Statements and our most recent 10-K for reasons why actual results may vary from any forward-looking statements that we make today.

Given the unique circumstances that the second quarter presented, I am pleased with our results. For the quarter, we earned $0.56 per diluted share, which compares favorably to the $0.48 we earned in the first quarter. Net income and EPS from the current quarter increased from the linked quarter primarily due to the earnings we recognized from the PPP program and a slight reduction in our provision expense.

Slide 3 shows our time line of actions and key milestones. During the quarter, we focused our efforts on (inaudible). First and foremost, we continue to focus on the health and safety of our associates. The byproduct of our associate surveys has guided us on our decision to continue to work from home for all non-branch personnel until at least after Labor Day, readying our lobbies for their eventual opening, and coaching our client-facing teams how to safely blend in-person meetings with virtual interactions.

Secondly, we work closely with our clients to navigate the opportunities and challenges presented by the current economic environment. Execution of PPP was a focus for the first part of the quarter. We had previously provided some initial statistics on our success that Scott and Keene will provide much more color on the impact that our performance had on our quarterly financials. In addition, Scott will spend some time on how we have used this to successfully onboard many new clients and the recently kicked off company-wide initiative to build on existing relationships as a result of our PPP success.

We know that our future's success will hinge on close monitoring of our loan portfolio, especially areas we had previously identified as potentially challenging. Doug will spend some time on these portfolios, but our credit statistics would tell you that many of our clients continue to perform well and the ones that potentially could be challenged have been aided by the federal stimulus programs and the deferrals we provided early on.

That being said, we did take the opportunity of continued strong earnings to bring our allowance to total loans to 2.07% by provisioning an additional $20 million, which we believe is prudent and positions us well to continue to weather the current environment. Another key focus for the quarter was preserving our net interest income by aggressively adjusting deposit pricing in response to the Fed's monetary policy and continued focus on establishing pricing floors for floating rate loans. Our efforts resulted in a record level of net interest income of $65.8 million for the second quarter, continues to drive strong pretax pre-provision earnings, which was nearly a 2% return on average assets thus far in 2020.

Finally, we took advantage of the attractive debt markets and completed a $53 million subordinate debt raise, the proceeds of which fortify our capital position to take advantage of essential opportunities and/or challenges that the future might hold.

As we continue into the second half of 2020, we will remain focused on building and preserving our strong core earnings momentum, while remaining vigilant on the quality of our loan portfolio. This is indeed a delicate balance, but one that our diversity, both in terms of lines of businesses and geography, affords us this great opportunity.

Now I would like to call -- turn the call over to Scott Goodman, who will provide much more detail about our PPP success along with (inaudible) and business line updates. Scott?

Thank you, Jim, and good morning, everybody. The second quarter was a particularly unique and challenging one in many ways. And those factors certainly impacted client behavior and portfolio dynamics. While PPP dominated our attention and the dollar impacts for Q2, overall movement in the loan and deposit book also reflected a business mindset, which was characterized by a flight to quality, preservation of liquidity and opportunistic positioning around declining rates.

As I mentioned in the call last quarter, given our company's focus on privately-held and family-owned business, we made an early commitment to devote significant resources toward the payroll protection program. At quarter end, we had closed nearly 3,800 PPP loans, resulting in $808 million in outstandings with an average loan size of $224,000. A decision to build and manage our own internal process, together with an automated solution to interface with the SBA, were key factors in our successful execution.

In addition to assisting our current clients with PPP, we were able to process over 600 other businesses within our existing markets through the program. So now as we approach the forgiveness phase, we are leveraging these conversations to convert these businesses to full relationships as well as expand revenue with our different clients. We're using the same project-based approach, the same collected data and the systems that we've built to manage PPP to guide this sales campaign. And we expect this discipline to help ensure greater consistency, visibility and accountability. Early results are encouraging, with over half of these nonclients moving other business to the bank.

Loan balances, which are outlined on Slides 5 and 6, were up $683 million for the quarter and 19% year-over-year, with the major impact being over $800 million in outstandings in the C&I category from PPP loans. While some borrowers drew lines up at the end of Q1 as a defensive move, we saw this behavior reverse itself dramatically in Q2 as PPP funds were dispersed and businesses built cash reserves.

Balances on revolving lines of credit declined $165 million in the quarter. This compared to a $57 million increase in Q1. Sector level and business unit details are outlined on Slides #7 and 8 with PPP isolated as its own category. Pay down effect from PPP loan proceeds most impacted the general C&I loans across all markets as well as the enterprise value lending sector. Payoff activity on investor-owned CRE was also elevated in the quarter due mainly to borrowers moving to low fixed rates in the permanent debt markets. Despite these factors which did suppress net growth, loan production during the quarter, net of PPP, was generally solid. April and June posted typical levels of production, while the May volumes were down following the height of the PPP process.

Activity was most prevalent in the C&I, CRE construction, agricultural and mortgage sectors. Life insurance premium finance activity was also stable with growth in the quarter from scheduled premiums on existing loans and several new closings.

Deposits are outlined on Slide #9. And they were up significantly in Q2, rising by $710 million or 21% over the last 12 months. Much of the increase remained in noninterest bearing accounts, which represented 29% of total deposits at the end of the quarter. While the majority of the growth is related to PPP proceeds, roughly $60 million of the increase can be linked to our ongoing sales process focused on new relationships and deepening balances with existing clients, while also lowering our cost of deposits, as Keene will expand upon during his comments.

Growth remains a key objective for our company. And as we've proven over time, we will continue to position ourselves to take advantage of opportunities which capitalize on disruptions within our existing markets. That said, we will not look past credit for the sake of growth, and we are focused squarely on maintaining the quality of our loan portfolio.

For the quarter, credit quality remains sound with stable NPA and NPL levels, modest net charge-offs and slightly lower classified loans.

Slide #10 provides a breakdown of the loan portfolio by product, industry and rate structures, and Doug will provide more details in his comments. But from a high level, diversification remains a hallmark of our portfolio and a strong buffer against material geographic or industry-specific economic weakness.

And now I'd like to hand it over to our Chief Credit Officer, Doug Bauche, for more color on credit. Doug?

Yes. Thanks, Scott, and good morning as well to everyone. In addition to our success in the PPP program, which as Jim and Scott mentioned earlier, was a primary focus in Q2, we continue to support our clients most severely impacted by the pandemic by providing payment relief via loan modifications.

As reflected in Slide 12, Enterprise has provided payment modifications on just under 600 loans, totaling $685 million or 12.8% of total outstandings, excluding PPP. 53% of the payment modifications were full contractual P&I payment deferrals, while 47% were principal-only deferrals. Over 98% of the principal payment deferrals were for a period of 90 days or life.

While we continue to communicate regularly with our clients, requests for second round payment deferrals to date have been limited to a handful of loans that are primarily in the hospitality sector. Those requests are being considered on an individual basis and in the context of more comprehensive longer-term solutions that may include enhanced financial participation from the owners, guarantors in the form of increased guarantees and/or debt service reserves.

During our Q1 earnings call, I provided in-depth comments on certain portions of our loan portfolio that were viewed as most susceptible to the changing economic environment. The Enterprise Value Lending portfolio, highlighted on Slide 13, which represents our senior secured term and working capital credit to private equity-sponsored companies saw considerable paydowns, as companies reduced outstanding balances on working capital lines that had been drawn up in the prior quarter.

We did engage an independent third party to conduct an evaluation of the EVL portfolio during the second quarter. The independent firm's final report has substantially confirmed our internal view of the risk in the portfolio with minimal risk rating changes and no material impact to our provision or allowance for loan loss reserve calculations.

Our $375 million hospitality portfolio, highlighted on Slide 15, had begun to report some modest financial improvements through June with hotel occupancy rates climbing back up into the mid-40% range and restaurants reopening to the public. However, as a result of new governmental restrictions ordered in early July on restaurants, bars and other travel-related businesses, we anticipate a more prolonged environment of operating stress within the industry. Overall, we remain confident in the relative quality of our hospitality portfolio, given the weighted average LTV, personal recourse and depth of our relationships.

Other industries previously highlighted, including aircraft, oil and gas, agriculture and life insurance premium finance, have demonstrated stable performance that is consistent with our overall strong asset quality results for the second quarter. Updated charts on those portfolios are provided in the appendix.

As Keene will further comment on, our asset quality results for the second quarter remain solid. The 30-plus day delinquency below 20 basis points, classified assets moving modestly lower to $97 million from $105 million, and nonperforming loans rising slightly to $41 million from $37 million. Net charge-offs for the quarter totaled only $309,000, bringing year-to-date net charge-offs to around $1.5 million.

And now I'll turn it over to Keene Turner.

Thanks, Doug, and good morning, everyone. I'm going to start my comments on Slide 16, which is the quarterly earnings per share trend.

As Jim noted, we posted $0.56 of earnings per share, which advances from $0.48 a share in the first quarter. This slide certainly reflects and demonstrates the challenges and the opportunities of the current economic environment. Fees and net interest margin challenges have been mitigated by PPP loan interest and expenses have benefited from some reduction in travel and client entertainment, and we'll explore those a little bit further later.

Although provision was favorable to the first quarter, it still cut otherwise strong earnings in half during the second quarter. Overall, the earnings profile that we worked hard to build is paying dividends and helping to advance the strength of our balance sheet.

On Slide 17, the net interest income trend, you can see that it expanded to $65.8 million, with core coming in at about 95% of that. That's aided by $4 million of interest and fees from payroll protection loans, which yielded about [3.6%] in the quarter. You'll note that we transitioned this slide in the presentation to be reported net interest income and margin, given the minimal impact of noncore acquired book.

Net interest margin at 3.53% did decline by about 25 basis points, ex PPP loans, that was 3.62%. So we think that trend, given all the pressures on interest rates, loan paydowns and excess liquidity, is reflective of the strength and the flexibility of the balance sheet that we have. Our liability management and the trends that we experienced as a result of PPP and customers gathering liquidity did aid our funding costs. Total liabilities came in at 50 basis points, and total deposits were at 27 basis points, with DDA rising to 29% of total deposits.

From a net interest margin perspective, we remain modestly asset sensitive. And given where, notably, LIBOR has trended at June 30 and where we are seeing the LIBOR curve, we do expect NIM to stabilize moving forward, excluding the potential impact of PPP forgiveness.

Slide 18, we'll review briefly credit trends and really more specifically here our posture on provisioning. I think Doug and Scott covered the asset quality, which was modest -- trended modestly better in the quarter in our view. Despite that, we had another quarter of significant provision, which is largely driven by the Moody's baseline forecast, and I'll dig into that here in a second.

So allowance for credit losses improved to $110 million, which is roughly 2.07% of loans, excluding PPP balances and a 38 basis point build from March 31, and that trend reflects largely the changes in the economic forecast since that time. So we use a blend of the Moody's baseline F1 stronger and F3 moderate recession at 80%, 10% and 10%. We do not adjust the qualitative factors to be less stringent. If anything, our qualitative factors adjust for more specific and severe items in the forecast. And I would just say that the baseline in the second quarter reflects a steep decline in GDP through early 2021. And unemployment peaks this quarter remains greater than 8% throughout '22.

I think when you really look at the models and you compare the data from 3/31 to 6/30, I think the biggest change is that the severity or the length of time that we are going to -- that we are projected to experience stress, both on unemployment and GDP is longer than it was previously. So where you had a more aggressive or optimistic recovery, I think that recovery assumption has shifted out slightly from the first to the second quarter, and that's why you're getting another quarter at essentially $20 million of provision for credit losses.

Just from an overall perspective, we believe our application of CECL is reflective of the intent, which is to aggressively build reserves when the forecast suggests and in advance of the actual deterioration in the loan portfolio. Again, with that said, the asset quality metrics are stable, and we've really not experienced any specific -- significant stress related to the current environment at this time. And we are positioned well as we move forward, whether the economic forecast plays out or gets worse or in the event it improves. So we feel good about where we sit from a reserve and capital level and coverage at the end of June here.

And Doug had mentioned that there was some nonperforming loan activity in the quarter. It's really driven by one EVL relationship that got placed on nonaccrual, and that credit was struggling pre-COVID and between a $3 million charge-off and another $1 million of specific reserves that credit has been clearly identified and marked accordingly. So sorry for the deep dive there on credit. I just thought it was pertinent given everything that's going on.

On Slide 19, fee income came in at $10 million in the second quarter. And that's down from $13.4 million in the first quarter, largely due to seasonality in the tax credit book. And then also, the second quarter includes the full implications of overall economic activity. So cash management and service charges and wealth have all been negatively impacted either from levels of the market in wealth or deposits with earnings credits from PPP funding and then just overall lower volumes within our business customers, both in the card space as well as the service chart space.

Swaps and mortgage continue to be strong, but swaps were following up our record first quarter for us to decline sequentially from the first to the second quarter, and that's really reflective if you think about the overall volume in the loan book, it's a consistent theme. And then in miscellaneous, in the first quarter, there was a BOLI gain of about $700,000.

Slide 20, on expenses, they dipped under $38 million in the second quarter. It was largely supported by reduced travel and client entertainment as well as seasonal payroll taxes that we paid in the first quarter. And then the offsets for the current quarter moving forward were merit increases, and we did do some premium pay for associates who were on the customer-facing side of the business, it's consistent with the industry trend there. And then in the first quarter, the FDIC credit was exhausted. And so we're back at sort of full strength on the FDIC insurance premium. But nonetheless, we continue to support employees' families in the community where impacted and we're still resulting in a 51% core efficiency. So that's a solid start to the year, and we are happy to see some modest improvement in the expense run rate from the first to the second quarter.

We continue to do the things that we've always done, which is spend prudently, support our associates and operate efficiently and with high levels of customer service with our business continuity and our current operating environment built on a remote strategy that serves 4 markets and [international] verticals.

I'll conclude my comments on Slide 21, which is a snapshot of the capital trends. Capital is strong, and we increased the flexibility and optionality during the second quarter. We raised just over $60 million. With a Tier 2, 5.75%, [10, no call 5] sub debt instrument, and that's fully included in Tier 2 capital. We did that, opportunistically, given market conditions and all the uncertainty. It affords us additional flexibility at the holding company and the bank level, which allows us to bolster bank capital and moderate dividend activity there. Currently, that cash is sitting at the holding company, and that's where we expect to maintain it for the foreseeable future.

It's probably worth noting there were no share repurchases. We halted that in March. And our modest dividend policy during the current environment is paying off well. We're at $0.18 a share. And we've been there for all 3 quarters of the year.

Combined with our earnings profile, total risk-based capital expanded to 14.4%. CET1 is up to 9.91%, and that's a 33 basis point improvement over the first quarter. And then tangible common equity to tangible assets, when you exclude PPP loan balances, is up at 8.67% compared to 8.42% at the end of the first quarter. So we are operating in a position of strength, both from an earnings and balance sheet perspective, including a $110 million allowance for credit losses at the end of the first quarter. Specifically, our pretax pre-provision return on assets was nearly 2% at $76 million year-to-date and affords us the ability to continue to be open for business while bracing for the additional uncertainty that is ahead of us.

We continue to focus on fortifying the strength of the balance sheet and maintaining the earnings profile, which affords us the opportunity to position us to deliver long-term value to shareholders. So we appreciate those of you who have joined today, and we'll open the line for analyst questions.

(Operator Instructions) And our first question comes from Michael Perito with KBW.

I wanted to start on the credit side. So obviously, another sizable provision. You guys provided a good amount of color in your prepared remarks about it, but I guess my question is just on the deferrals. Based on the chart, I forget what slide it is, but it would seem like a lot of those 90-day deferrals will probably come up in the next month or so, plus or minus. And I'm just curious -- I mean, I'm sure as you guys have gotten your feet under you and the PPP program behind you, you've had some more time to kind of look at these credits and how they've been cash flowing over the last month or so. And what are your expectations for kind of the deferral activity? I mean, do you expect the majority of them to come back to full payment at some point in the near future? And have you noticed any pockets of areas where -- other than hospitality, which I imagine is the obvious one -- where additional deferral help might be needed going forward?

Yes. Michael, this is Doug Bauche. You can see on Slide 12, I believe it is, deferral activity was certainly heavily weighted towards the end of March and throughout April. Most of those deferrals were for period payments of April, May and June. So many of those now are returning to their regularly scheduled contractual payments. As I mentioned, we're seeing a handful right now. It's limited requests for second round payment deferrals. And as you pointed out, it really is heavily concentrated more in the hospitality sector.

And I think we'll continue to see some of that, especially if we experience lockdown version 2.0 for an extended period of time. But as we sit right now, we're seeing limited activity there. Most of the payments are returning in July. On commercial real estate retail, where we saw some payment deferrals in March and April, I think the collection of rents continue to trend upward. And thus far, we've not really seen a second round of requests from those owners or developers for future deferrals.

Got it. And then on this Slide 12, it's been the number of modifications, right? I mean -- were there any larger -- like average loan sizes in any particular month, like as we think about the 383 modifications in April down to 99 in May. Was there a kind of a concurrent fall and does the amount of loan balances that were impacted by those deferrals that we could assume? Or was there some differentiation in kind of the size of loans and when deferrals came in?

So I would say this, I think some of the larger commercial real estate developer-owners took early actions and made kind of preemptive requests in March and April. So larger commercial real estate loans we probably saw early on in the process just to preserve liquidity and capital. And then certainly, other more traditional C&I businesses throughout April and into May. But I don't know that I could tell you from a weighting perspective that larger loans were deferred later in the process than earlier, but certainly, commercial real estate, I think, was early on in the process.

Okay. A couple more questions from me. One, just kind of on the economic outlook in your local markets, less to do with kind of the assumptions you're making for CECL. But more so -- I know mid-quarter, there was some optimism, Jim, about some of your markets and there's been quite a few areas of the country now that have kind of backtracked a bit. I'm just curious if you can maybe provide just kind of an updated view of your 4 kind of core markets and what you're seeing on the ground level from an economic standpoint at this point, given any government restrictions on economic activity?

Yes, sure. So I'd say this, and I'll have Scott comment as well, but going around the horn, there are certain industries that obviously have greater impact than others relative to slowdowns, lockdowns and things of that nature. But our recent survey of our clients and distribution manufacturing would show that the performance continues to be good. But as it relates to the economies in St. Louis and Kansas City, which kind of mirror each other, we've seen some upticks recently like many communities in the country in cases. Optimizations have trended up slightly. But really, there hasn't been a great reversal in terms of economic activity currently. And I would say that we'll first see it, obviously, in restaurants and hospitality and things of that nature.

Phoenix, Mike, got hit pretty hard. And -- but I would tell you, in general, the operating businesses and real estate developers and things of that nature have forged ahead. And then Northern New Mexico took a very cautious, conservative approach from the get-go and probably to the detriment of its hospitality business, because it really has never fully opened, frankly. And -- but our exposure there is de minimis in those categories. And so I think they'll be slow and cautious to open fully. But I think, in general, those outside of those industries that I've mentioned around hospitality and restaurants and things of that nature, they haven't had layoffs. They continue to operate. The numbers as we see them currently, and we do get numbers on all these companies, are pretty decent.

I can expand on the [status of deferrals]. Yes, I'd say in addition to what Jim said, certainly it's by industry, depending upon the business owner, but I think there's more optimism than pessimism as a general comment with business owners. Just based upon -- I made the comment that 2 of our three quarters had production that looked a lot like what we're used to. And I think business owners are getting a little more comfortable [dealing] in a remote environment, making decisions, completing transactions. So things like refinancing commercial real estate, continuing with construction projects, moving forward with recaps and buyouts to take advantage of the low rate environment.

Those are all things that we've been doing in the last quarter that gives me, I think, the feeling that businesses are willing to make short-term investment opportunities that are opportunistic. They may be slower to pull the trigger on longer-term capital spending. I think that's where our pipeline -- I'd say, those things are still out there but probably extended.

Okay. Helpful. And then just lastly, Keene, to kind of summarize on the margin, I guess, near term, obviously, but it seems like a lot of the liquidity build in the quarter is going to stick around for a bit. So that will kind of keep margin overall depressed relative to where it was in the first quarter and the fourth quarter, but it sounds like most of the compression that you expected to experience has kind of worked through and you're hoping to be able to keep it more stable than the core NIM dropping experienced in the second quarter. Is that a fair summary?

Yes. I would say that that's accurate. I think that we expect that even though there's some loans that are going to reprice off of a longer index than maybe 1-month LIBOR that there's some opportunities on the deposit side that time deposits, brokered CDs that will provide an offset there. So I think fundamentally, your point is well taken on what does liquidity look like? Where do you go with it? And even if you deploy it in this environment, you're probably going to have some margin dilution.

But when you're looking at the sort of 12/31 or a year ago base and what that looks like, I think we feel like it has bottomed or is bottoming out sort of largely within a few basis points there. Now that's LIBOR behavior sort of notwithstanding, right? So if we get further diminution of 1-month LIBOR, which seems hard to from here, that would sort of be the only point that could cause us a little bit of additional pain, but we're pretty close to 0 at this point.

Got it. Helpful. Just one last quick one if I could sneak it in. Just on the top of the margins, no plans from you guys, right, in terms of the PPP loans and selling or kind of outsourcing the servicing? I know some of your peers have done that at this point. Is your plan just to hold them and service them yourself going forward as we model?

Yes. Our view is that we did these for largely our customers, and we don't want to outsource that experience to the customers. And I think we invested the time on the front end, so initially just in the manpower to get through round one. And then on the systems side, to get a more systematic approach for both round 2 processing and then ultimately, the forgiveness piece. And so for us to give up a meaningful portion of the economics that we have coming to us and also outsource that customer experience, which we think helps differentiate us in each of our markets, we don't feel like that's the right business strategy.

(Operator Instructions) Our next question is from Jeff Rulis with D.A. Davidson.

Question -- maybe a follow-up for Doug on that Slide 12 on the modifications. I think you mentioned deferrals at 12.8% of loans. I suppose you list the modifications by month, certainly, maybe that doesn't reflect a net figure as we got to discussions of deferral extensions or not. Is the 12.8% peak? Is that the peak? Or have we come back from a figure that was somewhat higher as deferral have expired and maybe come in?

Yes, Jeff, I think this -- it remains to be seen what really happens in some of the broader economic conditions that may impact the portfolio. But our view right now is I think that's probably close to the peak. And we'll see a lot of these loans returning now to their regularly scheduled contractual payments. And then those portfolios, hospitality, hotel, restaurants, other businesses more severely impacted, I think, is really where we're focusing our attention on second round deferrals. But I think at this point in time, the broader portfolio, as Jim and Scott have commented on, have really weathered this storm. They maintain good liquidity. They've been aided by the stimulus and successfully tapped into PPP and now are in a position that they can return the payments. So I think we've kind of hit the high water mark and barring any significant changes, I think we'll see those numbers start to come down now.

Okay. So if I follow you -- if we -- maybe this oversimplifies it, but if we think about the percent of deferrals in the hospitality sector, we could -- I mean, a good proxy would be whatever percent of deferrals that is, say those largely seek extensions, but the remainder do not, that's a pretty good subsection of how you think deferrals will play out, all things being equal?

Yes, I think that's a fair view.

And Jeff, this is Keene. I would just add to that very quickly. If what we're seeing in 30-day deferrals, for example, where we kept the deferral short is any indication, we've had very few 30-day deferrals that have come back and deferred one or more times. It doesn't mean that they don't exist, but we're talking dozens or a dozen, not hundreds of those. So I think that's a reflection that people -- and we try to work with borrowers for the length and time of deferral that they needed, and even when we kept them short at 30 days, the multiple requests have been very limited.

So not to beat this up too much, but it begs the question. So as those come in, has that been more driven by you in terms of your requiring more information or say, upfront, you're a little more accommodating. And then as you ask for more information? Or is that more customer-driven that, hey, we took this out of abundance of caution. And as we see it now, we're going to pull back from extending further?

So Jeff, maybe this would help. As we provided payment relief through modifications to borrowers, we adjusted their risk rating on those credits to what we call our monitor rating, which is just 1 step above our lowest pass rating. And so with that, our communication monitoring financial information requirements, et cetera, ramp up. And so you know, we're in constant communication with those borrowers. So whether it's stimulated by us or by the borrower, it's just part of our normal monitoring and surveillance of the portfolio when credits are downgraded to a monitor rating.

Okay. Yes, I was just trying to get a sense for if it's customer behavior or I guess what you're saying is it's an active conversation and it's coming from both sides.

Yes. We're not encouraging just borrowers to request payment deferrals. So we're not encouraging that, right? We're encouraging borrowers to do the right things in terms of preserving their liquidity and reducing expenses and overhead and what they can do. We're willing to do our part in terms of supporting them to bridge this time gap, but it does require certainly more participation from their perspective. And we're looking at interest rates. We're looking at interest rate floors. We're looking at more collateral, increasing guarantees, debt service reserves, all those types of things are part of our conversations as we explore any additional request for payment deferrals.

Got you. Real quick on the expense side. Did you guys see a comp expense deferral benefit in the quarter? And if so, what was that?

We did not -- we didn't have any workforce reduction. We actually, if anything, had some -- we had our normal merits run through there, and we had our premium pay running through. So if anything, I think the expiration of premium pay for the third quarter should provide a little bit of room moving forward on that line item.

Sorry, I should have clarified. I guess, related to PPP, some banks have kind of booked a deferral benefit on that, but I guess you guys didn't in the quarter?

Yes. I'm not sure I'm following the question on the comp piece of that, Jeff. We -- we didn't...

In terms of loan originate...

Yes, yes. I understand. Deferred FAS 91, old FAS 91. Yes, we really just deferred the income. There weren't a material amount of expenses that were directly associated with that that ended up getting deferred. So what you're seeing on that line item -- yes, yes.

Okay. Fair enough. And then last one, Keene, just you mentioned -- I think you said Moody's baseline is about 80% of the input on the CECL methodology. Just wanted to clarify, you mentioned the June 30 view. But as of that point, I think the latest baseline was actually a June 9 kind of baseline. Is that correct? I mean as in that's even a bit dated as of 6/30?

Yes. And I think that's part of the reason that we layer in -- we're layering in an upside, but we're also layering in the modest recession. So the net of those 2 drives a little bit worse or a more conservative result. And so that's the way we've been really dealing with that. And I think, too, our posture is that we're going to reserve up to what the current model is. And just not to give too much color after quarter end, but I think there was a July update that's available. And that result didn't produce a materially different allowance for credit losses. So we feel like from an overall materiality perspective, we're right there, and we're fully reserved. So if these assumptions play out, we should expect to have a more normalized provision moving forward, but also to the extent that they get worse, we're in striking distance today with our pre [free] earnings to be able to put it away and move forward.

Your next question comes from Andrew Liesch with Piper Sandler.

It could be a tough question at this point, just on credit here. Just looking at the loans that have been modified, sounds like there's been some good progress on the deferrals that with fewer clients not requesting an extension of the deferral. But if you look at those customers, if you look at some of the higher risk of the COVID-affected loan categories and then the collateral behind them seems to be very well underwritten. And I'm just curious how are you thinking about the loss content in these buckets?

Yes. I think, Andrew, just sort of given everything, I think it's our view that the forecast we're using reflects overall the environment. So both the positive from the mitigants in the PPP program as well as the negative that deferrals are being encouraged and that that's increasing loss content. So our current view is that we're building the reserve based on the forecast. And at some point in time, later this year or early next year, we'll start to be able to see the indicators to bring those together. So without perfect clarity -- if there's an individual loan, as Doug noted, that, where they're working through it, it looks like it's not going to make it. That's obviously going through the downgrade process and gets specifically reserved. But from an overall perspective, it's really baked into the forecast, and it's one of the reasons why we're not adjusting downward the forecast to -- for any potential upside there.

Okay. That's helpful. Then just on the PPP loans that are offsetting the $808 million. I mean, just what are you thinking on the -- what are the -- your clients saying on like just the timing of like the forgiveness and then paying down, how long do you expect them to remain on the balance sheet?

And if-- go ahead, Scott.

Andrew, this is Scott -- I was just going to say, it's a prediction, right? I think what I would say is I feel better than I did on the first round of PPP with the change in the terms of extending the amount of time the business owners have to spend the money, increasing the -- or reducing the amount that needs to be applied to salaries. So I think the conversations that we have with business owners, they tell me their confidence in getting more forgiven is elevated from maybe what it was last quarter. Timing-wise, I think that's a little bit of a crapshoot. But, Keene, you may have a perspective on it?

No. And with that said, I think we were expecting to start seeing material forgiveness at this point last quarter, and we're not seeing it. So I think to Scott's point, I think there's more optimism that less of those balances is going to hang around longer term. But I think as we were thinking most of that was going to be resolved, and we'd know what's still going to be here by the end of the year, that you might have pushed that out one more quarter because, again, we're not deep into forgiveness at this point in time.

Okay. Maybe just a clarification on the tax credit activity in the quarter, seems like it's like a timing difference. Should that line item kind of rebound back to historical levels? Or could it be -- it'd be better than that if there -- if some of these projects are finished up or in the current environment, is this just going to be a depressed line item going forward?

Yes. I think all else being equal, Andrew, we expected the tax credit business to improve from 2019 to 2020. Certainly, that was a book that was growing. This second quarter here was a timing adjusted issue. I would say the only real headwind I see to the potential for '20 for third quarter, fourth quarter being more robust than fourth -- than 2019 is obviously a little bit of the uncertainty of just timing of projects and closings. I think, certainly, everything has kind of gotten delayed a little bit. So that -- we're not immune to that in that part of the business as far as I'm aware.

And then with LIBOR being as low as it is, there are some credits that are held at fair value that there could be a modest headwind to the revenue stream. But I think the sentiment that we expect third quarter and fourth quarter will look more like the prior years is reality.

Our next question comes from Brian Martin with Janney Montgomery.

Maybe one just for Doug or 2 for Doug. Just on that -- on those deferrals and kind of where they shake out, Doug, I mean, I guess it sounds as though, in summary, maybe getting back to a very low single-digit level by October is -- seems realistic with the trends you're seeing today. And then if you're 10% or 12%, depending on what loan balance you're using, getting back to low single digits is conceivable, if trends continue as you get later this year?

Yes. I think in terms of deferral activity, Brian, we will expect that to continue to trend downward. The activity has slowed. We're taking a more cautious and more conservative view. The first round of 90-day deferral activity was more relationship-oriented and just to help customers preserve their liquidity. The second round there is certainly a much deeper dive and require more participation. So I do think that activity will be slowing. And if trends continue, I think realistic to think that that could be back down in the single digit.

Yes. Okay. Perfect. That's helpful. And just the -- Doug, do you have any -- I guess, where your reserve is at is very strong. I guess, just when you look at it by buckets, I mean, the 3 bigger exposures, the EVL, the retail and hospitality, do you have any sense -- can you give us any sense of where the reserve levels for those buckets are at today? I guess, do you have some sense or can you provide any color on that?

So Brian, I don't have the reserve levels by bucket for you. Keene, I don't know from a [seasonal] perspective, if you could comment there?

Yes. I would just say, I think when you think about it, we're considering whether or not to disclose those in the Q, which we expect we'd file later this week or early next week. For purposes of the call, we haven't disclosed that. But certainly, we'll take your query under advisement as we determine what we're going to put in the Q as we finalize it, Brian.

Okay. Yes, I appreciate that, Keene. And then just back to the PPP for a minute. Just -- it sounds as though with the average loan size, the forgiveness, you guys would expect in Scott's comments that that forgiveness is a pretty high level based on that extension of the time period and the fact that you guys have a low average balance and then maybe 80% or above that is kind of a fair assessment with what we know today. I know there's still some uncertainty on all that, but that seems reasonable as we look forward?

Yes. I would just say, I don't think we have any information that would indicate that it's any different than what we thought last quarter, which was really just a high-level prediction. So yes, call it, 75% or 80% get forgiven.

Okay. That's cool. All right. And then just last two. Just on the -- Keene, you already talked about the tax credit, but just on the wealth and the service charge income, just kind of the outlook as you sit today kind of with the activity in customer accounts and then on the deposit side, the growth you had. Just your big picture view on how we should think about those going forward. Is there a rebound? Is it low for a little bit longer? And then look into next year, seeing a little bit of a pickup there?

Well, for wealth, specifically, I mean, obviously, that's tied to the overall value of the equity and the fixed income market. So to the extent that those continue to be at current levels and there's not a lot of growth there, just sort of up and downs in between, I wouldn't expect material growth in the wealth line item.

From a deposit service charge perspective, I think activity is a little bit lower. But I think in the commercial book, the presence of the deposits largely generated from PPP have really caused extra earnings credits that maybe weren't there before. So to the extent that that liquidity gets deployed and we get maybe a little bit more normalization of business activity, I think we could expect those to go back to similar Q1 levels, although I think it is the sense that we have that both consumers and businesses are going to carry extra liquidity moving forward. So it's not like we've lost customers. In fact, I think we've done a good job of booking new customers, but we're just not seeing those hard charges necessarily stick.

And then on the card side, as you know that that's largely a business card program, business spending on travel and entertainment is down. So to the extent that that has to pick up moving forward from an activity perspective, that will drive the revenue. But what you're also not seeing there is some of those carry volume discounts or volume pricing on the expense side. So you're down in card and cash management products but you're also seeing a little bit of abatement and -- through the expense line of a couple of hundred thousand dollars a quarter for each just in the run rate. So just worth noting that, even when you see some of those rebound, you're going to get some processing expense to go along with them.

Yes. Got you. Okay. And then just the last for me, maybe I didn't hear you right, Keene, but when you were talking about expenses, did you -- in your prepared remarks, there was a comment that the expenses were down from 1Q to 2Q, or you thought that they could be a bit lower as you entered 3Q from 2Q? I thought it was the latter, but I just want to make sure I heard you correctly.

Yes. So they're down from, obviously, from 1Q to 2Q. I mean, I think a lot of where we expect the trend to go will depend on how much customer entertainment and travel is going to occur. Certainly, I think for the third quarter, largely travel's out. And that's about $0.01 a quarter that we're saving now. And there's some back to face-to-face customer interactions where it's necessary and makes sense, but I don't expect that customer entertainment where we really drive a lot of the major expenses with big events, returns in a big way. So I think those will be helpful moving forward and they'll continue to persist. And then I think we'll -- some of the premium pay that we had in the current quarter was a positive. So optimistically, we had normal investment in the business overall.

And I would hope that, depending on business activity, that we see those offset, particularly, to the extent that we're not able to use it to generate revenue, right? So I think there's a correlation there, and we're always willing to spend on the activities that drive revenue. So our goal would be to the extent that revenue is challenged for the next couple of quarters to be able to keep expenses tighter.

(Operator Instructions) We'll take our next question from David Long with Raymond James.

Is there a case where deferrals get lengthened past the 180 days that you've illustrated? Are there any industries that could be eligible for deferrals greater than 180 days?

David, it's Doug. I would tell you this, certainly, we're taking the view internally that 180 days is kind of the extent of our flexibility without triggering some accounting treatments. But certainly, our regulators have encouraged us to provide flexibility and to do the right things to assist our borrowers, while at the same time, preserving and protecting our capital. So if it means we have to provide a longer-term deferral to help a good quality borrower through this period of time, we may decide to do that -- decision to do that, but it wouldn't be without us taking appropriate actions relative to risk ratings and accounting treatments on that particular asset.

Okay. Does it sound -- it sounds like maybe if you do go past the 180 days, it would cause you to move it to nonaccrual or another status that could have a different risk...

Certainly, that extended concession, David, could trigger that, of course, but at the same time in the event that we've received something in exchange for that longer-term concession, we can certainly then avoid a nonperforming TDR. So to the extent a borrower wants to provide additional collateral, provide substantial reserves that is an equitable exchange for that concession, certainly, we could provide something longer than 180 days without triggering a nonperforming status.

And those are the types of discussions we continue to work towards in some of the more severely impacted sectors.

Got it. And have you engaged regulators in those discussions?

We have. So we've had discussions with regulators. We are due up for our annual safety and soundness exam. So we'll continue those types of conversations, but everything that we've been provided so far from our regulators is an encouragement to do the right things to support our borrowers during this time.

(Operator Instructions) Our next question is from Eric Grubelich, private investor.

I'll just take a couple of things on the hospitality portfolio. Can you tell me on the lodging end of it, how much of the portfolio is actually under construction versus just an operating mortgage? And then is there any kind of concentration in the sort of the 4 geographies that you're in with that portfolio?

Yes. Eric, it's Doug Bauche, again. I'll do my best to answer that. I would tell you that the construction portion of the hospitality portfolio, without specific numbers, I'll tell you is below 10% of the overall portfolio. So very little on the construction phase. And then geographically, where it's based it would be largely centered in our Phoenix market, some in the Santa Fe, Albuquerque, New Mexico market, and then more so here in St. Louis. It really is a limited hospitality hotel exposure in the Kansas City market. And again, we tend not to go outside of our geographic footprint for hospitality lending.

And on that portfolio, I think earlier on in the call, you mentioned something about a -- I thought I heard you say something about a third-party analysis on some of your loans. Have you done any kind of RevPAR breakeven calculation on that portfolio to see where its susceptibility may be versus where you originally made the loan in terms of what it may -- it's one thing to break even for the borrower to make money on it, but it's another thing to pay you, to pay the bank to service the loan.

Eric, (inaudible) the independent third-party review that we had conducted in the second quarter engaged was on the enterprise value lending portfolio. On the hospitality side, I would just again note that the hotel exposure is about $220 million. It's a handful of larger relationships that we have. I don't have for you precisely what the RevPAR or occupancy levels need to be, but I would tell you this, the trends that we were seeing building up through the end of June and those occupancy levels reaching back up into the upper 40% range, we were approaching the point where those hotels would be achieving near breakeven cash flow, not providing returns to the owners, but close to covering debt service.

Doug, I would just add to that, that these are some of our larger and more deeply capitalized borrowers as well. And so there's alternative source of repayment that comes from guarantor liquidity, guarantor cash flow, a deep balance sheet. So we feel good about that exposure. It's relatively low compared to the total portfolio, and those are some of our strongest borrowers.

And there appear to be no further questions at this time.

Well, great, Katrina, and thank you all for joining us this morning. We look forward to speaking with you all again at the end of the third quarter, if not sooner. And thank you for your interest in our company.

This concludes today's call. Thank you for your participation. You may now disconnect.