Enterprise Financial Services Corp (EFSC) 2020 Q1 法說會逐字稿

Good day, everyone, 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 Jim Lally, President and CEO of Enterprise Financial Services Corp. Please go ahead, sir.

Well, thank you, Sarah. Well, good morning. Welcome to our 2020 first quarter earnings call. For all of you on the call, I hope that you and your families are healthy and safe under these unprecedented times.

Joining me on the call this morning is Keene Turner, Chief Financial 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's 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 entitled 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.

The first quarter of 2020 will be a quarter that will soon not be forgotten. For EFSC, it was a quarter that showed the financial strength and resiliency that we've built over the last several years, the operational proficiency punctuated by the culture of incremental improvements and prudent investments and entrepreneurial innovation that has been a hallmark of our company. The sound fundamentals of our company were exhibited during the first quarter. We earned record operating revenue of $77 million. We expanded our net interest margin and had a stable efficiency ratio compared to the linked quarter. Our loan and deposit growth are strong. Loans grew by $143 million or 11% annualized and deposits grew $219 million or 15% annualized. In response to uncertain economic conditions, we were able to be proactive and prudent with our provision for credit losses, adding $22 million to reserves.

While we feel good about our financial results from the first quarter, we are unable to estimate the impact of COVID-19 on our business and operations in 2020. As such, we are not going to provide guidance at this time, and our prior guidance should not be relied upon. Keene will get into the specifics of the quarter, but you need to know that I'm particularly pleased with these results amid the rather large provision that I previously mentioned.

As it relates to credit quality, we've been hard at work analyzing certain portions of the portfolio. Doug will speak to what we know currently, but we will obviously know more of the resiliency of our loan portfolio over the next several quarters. We are committed to providing as much transparency as we can, when we can. The good news is that we are starting from a very strong position as evidenced by our credit quality numbers that we reported yesterday. The bottom line is that our strong balance sheet, ample liquidity and high capital levels position us well for continued success.

I would like to take the next few minutes to update you on our approach in response to COVID-19. Through this time, we've been successfully serving our clients, associates and our communities. Slide 3 shows you our time line of action. We have spent years strengthening and testing our business continuity plan. We formed the communication and action task force with swift actions to restrict travel, converted in-person meetings to virtual and ultimately instituted a work-from-home mandate well ahead of restrictions by officials in our markets. I am glad that we took these steps and happy to report that our company has remained operational in support of client success.

We had our relationship and wealth managers make over 5,000 calls to clients and prospects over a 3-day period to hear and understand what their worries were and take the first steps in working to help them with current and upcoming needs.

Earlier, I mentioned our careful consideration for our associates that we have at EFSC. Slide 4 gives you some perspective of what we have done. All of these measures are aimed at maintaining and improving our culture when we work to support clients and individual associate needs, including the recently established Associate Support Fund.

As it relates to our clients and communities, Slide 5 provides you some perspective of our commitment. Our clients are our top priority. And we believe that taking the best care of them now will ultimately drive the greatest potential for long-term value for our shareholders and other constituents. We have taken seriously the implementation of the programs enacted by both the government and our regulators into our role as the financial conduit to keep paychecks in the hands of the American worker. Based on the number of loans that we have processed through the program, we are supporting upwards of 67,000 jobs. Scott will provide the pertinent statistics around the Paycheck Protection Program, but you need to know that the execution of this plan has been especially rewarding for me as I've seen the incredible dedication of our associates combined with the entrepreneurial DNA of our company to create a very successful program. We're also working with clients on appropriate loan deferral strategies, the details of which Doug will comment on.

Our relationship managers are not just thinking about the next 8 weeks. They are leading their clients in discussions regarding the multiple phases that lie ahead, how important cash and capital will be in order to respond to the changing environment and help them see the opportunities to improve their businesses over the next several quarters. Our history shows that out of crisis comes opportunities. The next several quarters will be no different. We'll stay focused on the lasting tenets of our business, sound credit and client acquisition. I'm very proud of what we've accomplished in the first quarter. Like never before, we are living out our mission, guiding people to a lifetime of financial success.

I would now like to turn the call over to Scott, who will provide much more detail about how our teams and regions are flourishing amid these unique times. Scott?

Thank you, Jim, and good morning.

As Jim outlined and as shown on Slides 7 and 8, the fundamentals of Q1 were strong as we grew the loan portfolio by $143 million or 11% annualized. The C&I activity represented over 70% of this growth, stemming from increases across the specialty business lines as well as higher line of credit usage. Borrowers access lines for additional working capital at modestly higher levels with increased usage of roughly $40 million versus the prior quarter end.

Slides 9 and 10 break down the change in loan balances by category and business unit. Commercial real estate activity was steady as we captured opportunities with investors to both refinance and purchase properties, particularly in St. Louis and Kansas City. Higher construction loan fundings mainly represent steady activity on projects originated over the past 3 or 4 quarters. St. Louis growth in the quarter also reflects increases in the affordable housing tax credit sector and new business originated by the agricultural lending team. We continue to see a steady flow of new project opportunities in the affordable housing business, which was further bolstered in this quarter with some refinancing. The ag team was able to successfully onboard 3 new relationships and significantly expand another during the first quarter. As a reminder, the clients in this unit represent traditional row crop, pork and cattle farms, which have a history of solid operations and are well-known to our experienced ag lenders.

In the specialized lending unit, enterprise value lending started the year strong with a solid pipeline and new growth from both M&A and recapitalization activity. This activity quickly slowed as deals were put on hold by sponsors in the latter part of Q1. Life insurance premium finance experienced growth from several new policy referrals and the funding of existing premiums.

Moving to deposits on Slide 11. Total balances were up $219 million in the quarter or 15% annualized. The growth reflected net increases in balances from new account origination as well as solid seasonal inflows from existing accounts. Year-over-year, the deposit portfolio is up 8%. Growth in our commercial and business banking lines continued to be the main driver here, positively impacting our portfolio mix as DDA continues to be around 23% of total deposits. Behavior from depositors shifted within the quarter with account closures slowing substantially in March and average balances of new accounts totaling roughly 5x that of closed accounts and at a lower cost.

The growth in mix is even more encouraging given the significant reduction in deposit costs, which Keene will review in more detail during his comments. We were able to react swiftly as the Fed reduced interest rates and our sales teams have been able to execute well, reaching out proactively to large depositors and shifting the conversation from rates to financial strength and service. This type of proactive client communication is a theme which has been strongly reinforced this quarter. As Jim discussed, we reached out to businesses very early at the onset of this stressed environment to understand their concerns and express our support. The takeaways from these conversations are helping us both offensively to develop unique marketing content and defensively to analyze our portfolio based on the risks and stress points identified. At a high level, we are hearing some themes. Certainly, revenue continuity is at the top of the list.

The unknown duration of this downturn is creating significant concerns. Access to liquidity is also a major focus for these businesses. However, roughly 65% of our clients believe that they have sufficient cash and working capital to weather the storm without relief program assistance. This manifests itself in a relatively modest percentage of our business clients requesting deferred payments, as Doug will address in his comments.

Within industry sectors, demand for most of our manufacturing clients remain strong, although labor shortages due to illness, child care needs and mandatory shutdowns are creating significant challenges to executing on the orders. For manufacturers and distributors, supply chain issues are challenged with internationally dependent companies running out of inventory. Other key themes include stalled construction projects, limited access to labor, maintenance and sterilization for real estate owners and lower productivity overall.

Given the current environment, I'll provide some commentary on our execution of the Payroll Protection Program and turn it to Doug to discuss some specifics on key sectors and other aspects of the credit process. Our deployment of the PPP program outlined on Slide 12 was executed by experienced professionals from the sales, operations and credit sides of our organization. As a bank built on serving private businesses, early on, we made a decision to manage this process internally and to commit significant resources. Our existing partnerships and our investment in technology proved invaluable as we were able to position ourselves with clients as a key point of contact for information and guidance, including instructional webinars, website resources and video messaging. Our teams were highly effective in executing this program for our clients. And as of April 20, we've obtained approval for over 1,500 loans, representing more than $680 million and, as Jim mentioned, impacting over 67,000 jobs. Overall, credit quality remains sound and key performance indicators are at acceptable levels, as Keene will further detail.

Taking a more focused look at where the portfolio could most be impacted by the economic slowdown, Slide 13 shows roughly 22% of loans are to C&I borrowers with an additional 27% in niche lending. At a high level, the loan portfolio is well diversified by industry with no significant concentrations within the heavily threatened industry types.

Now I'd like to turn it over to our Chief Credit Officer, Doug Bauche, for some further comments. Doug?

Thanks, Scott, and good morning.

During these challenging and uncertain times, our relationship approach to credit reveals its true value. While we are pleased with the solid performance of our credit portfolio during Q1, our attention has turned squarely to working with our clients. In particular, those who have been most severely impacted by the pandemic and the related economic effects. Scott touched on the diversification of our overall credit portfolio. And I thought it would be helpful if I spend a few minutes talking more specifically about our exposure to the higher risk sectors, including CRE retail, EVL, hospitality, oil and gas and agriculture.

Slide 14 shows a breakout of our C&I and CRE portfolios. Of the investor-owned real estate, approximately $356 million includes retail CRE. Of that, the average commitment is $1.8 million with a weighted average LTV of 64% and personal recourse on 98% of the portfolio. In our segment stress testing, it was determined that 88% of the loans can be serviced for a period of 12 months from borrower and guarantor liquidity reserves. Our enterprise value lending, or EVL, portfolio consists of senior debt exposure to private equity, primarily SBIC-owned middle-market companies.

As referenced on Slide 15, our $441 million portfolio includes both $299 million of senior secured term debt and $142 million of borrowing-based secured working capital lines of credit. The portfolio is well diversified with approximately 90 unique borrowers, resulting in an average exposure of nearly $5 million per relationship or $2.5 million per loan. Industry segmentation includes manufacturing at 34%, wholesale trade at 15% and professional and technical services at 15%. We have enjoyed long-term relationships with our proven SBIC sponsors, and this portfolio performed quite well during the prior economic downturn. Our general underwriting space leads to a conservative senior leverage position of 2.0 to 2.5x and total leverage of below 4x. I should note that 60 of our 90 EVL portfolio clients were recently approved for a total of $75 million in round one PPP funding for an average of $1.25 million per portfolio company.

Slide 16 demonstrates our hospitality portfolio, consisting of approximately $358 million of bank-owned commitments, $218 million of which is hotels and $75 million is restaurants. We recognize that the hotel industry has been severely affected by the travel and shelter-in-place restrictions. We have responded to the needs of our hotel clients through our accommodative 90-day payment deferrals in the funding of much-needed PPP loans. The average existing hotel loan size is $4 million and the weighted LTV is just under 61%. 86% of the portfolio includes personal recourse to the owners. These are in large part your typical flagged 80 to 100 key non-convention-center-type properties located within our metro markets.

In the oil and gas sector, I'd simply point out that we have not provided credit directly to producers. Rather, our $140 million in exposure, as shown on Slide 17, is largely to end-market convenience stores, fuel wholesalers and railcars used for transportation of oil as well as some manufacturing companies that sell product directly to the oil and gas industry.

And finally, on Slide 18, our $168 million ag portfolio is well balanced between crop, primarily corn and soybeans, cattle and contract hog operations with minimal exposure to dairy. We have a seasoned team of bankers that are very well-known and respected in the ag communities we serve. Since our acquisition of JCB back in 2017, we have selectively onboarded top-performing local ag producers with good debt-to-equity ratios, collateral coverage and ample operating cash flow. While we have experienced minimal delinquencies or defaults in the portfolio to date, we continue to closely monitor performance in light of the international trade disruptions, depressed commodity prices and the recent announcements of temporary shutdowns at large meat processing plants around the country.

We are keenly aware that we have clients outside of these high-risk sectors that are feeling the brunt of the economic conditions on their businesses just the same. The length of this uncertainty will ultimately determine the severity of the impact to our credit portfolio. Fortunately, as Jim commented, we entered this environment with our clients reporting very favorable results and strong balance sheets. With the infusion of $680 million in liquidity to our clients from the PPP stimulus, we believe delinquencies and defaults will remain manageable in the near term. In the meantime, our bankers, aided and supported by our highly experienced resolution management team, will continue to take prudent measures that both protect our capital and maintain our reputation as a truly great banking partner to businesses and individuals alike.

And with that, I'll turn it over to Keene Turner.

Doug, thanks for your comments, and good morning, everyone.

My comments reflect Slide 21 of the presentation. Net income for the first quarter of 2020 was $12.9 million and earnings per share was $0.48. Total revenue compared favorably to a seasonally strong fourth quarter and was a solid beginning to 2020. Net interest income added $0.03 of earnings per share in the linked quarter, both through the continued average asset growth as well as 11 basis points of total net interest margin expansion. Core net interest income was essentially stable while incremental accretion added $0.02 per share. Also, we would have expected fee income and expenses to compare unfavorably to the fourth quarter due to the seasonality. Nonetheless, there were some environmental items that help make up for the expected trend in both categories, which I'll highlight further in my comments. Our strong revenue and expenses resulted in pretax pre-provision net income of $38.1 million for the first quarter of 2020 and allowed us to be proactive with our provision for credit losses at $0.63 per share while still netting $0.48 per share of earnings.

Turning to Slide 22. Net interest income increased to $62.1 million in the first quarter. Core net interest margin was 3.71%, an increase of 7 basis points from the linked quarter. Net interest income was aided by $1.3 million of noncore acquired loan accretion, particularly related to CECL adoption and $0.8 million of discount accretion related to prepayments on core PCI loans in the period. Overall, margins were stable during the quarter prior to the actions by the Federal Reserve in March. Portfolio loan yields were lower versus the linked quarter primarily as a result of interest rate resets during the period and a 38 basis point decline in 1-month LIBOR. This was partially mitigated by higher average loan balances along with 5 basis points of yield related to the aforementioned prepayments on core PCI loans in the period.

Our cost of funds declined 18 basis points compared to the linked quarter and benefited from higher average customer deposit balances and lower levels of wholesale funding and CDs. Core noninterest-bearing DDA accounts were stable at 23% of total deposits and deposits, excluding brokered time deposits, increased $130 million on average compared to the fourth quarter. The cost of interest-bearing DDA accounts was 9 basis points lower while money market rates were lower by 30 basis points. The reduction in deposit rates was primarily due to action taken in response to decline in the Fed funds rate and other short-term market rates during the quarter. Wholesale funding costs also declined during the period for similar reasons.

The drastic change in the economic environment and decline in interest rates at the end of the quarter placed downward pressure on our net interest margin in coming period. While we realized strong loan and deposit growth in the quarter, our balance sheet is asset sensitive with approximately 60% of loans with variable rates. We responded aggressively to rate reductions by repricing deposit accounts swiftly and also securing other sources of low-cost funding. Additionally, the impact of the SBA PPP loans on net interest margin could be substantial in the near term. We've also experienced deposit inflows, and we're increasingly vigilant about our on and off-balance-sheet liquidity, which will likely affect net interest margin results over the coming quarters. Nonetheless, as you heard from Jim, Scott and Doug, we're in a strong financial position and we remain focused on helping our customers during these difficult times. We believe that execution on these fronts will further solidify loyalty with existing clients and have the potential to attract new clients that also see the value of having a trusted partner to help them navigate both the prosperous and challenging times. We are committed to this principle which we know can help us build long-term value for all the constituents.

And with that, I'll just spend 1 more minute on liquidity. Our liquidity position remains strong. Our focused efforts to generate core deposits provided funding for loan growth in the quarter. The investment portfolio is expected to generate $40 million to $50 million of cash flow each quarter. And we have adequate capacity for additional wholesale and brokered funding, if necessary. As of March 31, we had access to nearly $2 billion of funding through our secured lines of the Federal Home Loan Bank and Fed discount window along with holding company liquidity and Fed fund lines. We anticipate that loans issued in conjunction with the SBA Paycheck Protection Program will be funded through the Fed's Paycheck Protection Program liquidity facility.

With that, I want to spend a minute on Slide 23, which reflects credit metrics and asset quality changes during the quarter. We have several moving pieces that affected credit results. First, as part of the adoption of CECL on January 1, we elected to remove some PCI loans from pools and account for them individually. This caused nonperforming loans to increase by $8.5 million as well as classified loans to increase by $26 million. We believe that because these loans were and continue to be identified individually that they are well marked and reserved. However, there is a gross-up in terms of asset quality and allowance for credit losses. We also immediately charged off $1.7 million on those loans according to our accounting policy for loans individually accounted for that had immaterial balances.

On that note, the day-1 adoption increased the allowance for credit losses by $28 million. This is nearly dollar-for-dollar increase in absolute balance of the classified loans noted above. Thus, day-1 coverage improved by more than 50 basis points with the resulting allowance for credit losses to total loans of 1.34% on January 1. Comparatively, classified loan levels improved from January 1 while nonperforming loans experienced a modest increase of $4 million due to an accruing troubled debt restructuring of $3.7 million.

Turning to Slide 24. As Scott noted, loan growth was solid to start the year. Under the day-1 methodology, the related provision for credit losses would have been approximately $1.5 million as we experienced nearly $1 million of net recoveries during the first quarter. With that said, we recorded a provision for credit losses of $22.3 million as a result of the rapid deterioration of economic -- of the economic forecast associated with the current conditions. Resulting allowance coverage increased another 35 basis points to 1.69%, and the reserve for unfunded commitments includes another 7 basis points of coverage. It's important to note that we have successfully implemented the SBA PPP program with our customer base, and we continue to work with our customers to support their near-term operations through deferrals and other methods. The provision for the quarter is nearly entirely reflective of forecasted deterioration that might occur in the environment absent consideration of this or any other mitigants. With that said, we also can continue to see the expectations for conditions worsen, which, in that case, we are well positioned to continue to proactively provide for future potential credit losses. I will reiterate that although we are combing through the portfolio, talking to customers and working hard to identify any issue, we have not seen material credit stress manifesting at the current time.

With that, we'll turn to Slide 25 and reflect on fee income, which was seasonally strong at $13.4 million for the quarter. We started to see some impact of the overall economic environment on our credit card and wealth businesses, and we expect that they will continue to experience softness as commercial spending remains low and the market indices remain depressed from 2019 levels. With that said, tax credits, swaps and mortgages all started the year well. Combined with a gain from bank-owned life insurance of $0.7 million, first quarter fee income proved a strong start to 2020.

Expenses on Slide 26 were similarly strong, coming in at $38.7 million for the first quarter. Lower incentive accruals, travel and FDIC insurance mitigated seasonal payroll taxes of nearly $1 million and some related expenses for our efforts to aid the community and employee families affected by current economic conditions. Core efficiency at 51% to begin the year compares favorably to a year ago and is an encouraging start to 2020. We continue to work hard to ensure that we're spending prudently in this environment, but we're also committed to supporting our associates and their family through this challenging time. I would also add that operationally, we are faring well. Our business continuity was built around working remotely. With our geographic dispersion, we were already used to working virtually while in the office. This is clearly another level and completely broad-based, but our teams are successfully and safely serving clients while collectively working through this challenge.

I'll conclude my remarks on Slide 27. In terms of our capital, our capital level remains strong with common equity Tier 1 at 9.6% and total risk-based capital at nearly 13%. As part of our ongoing capital planning process, we have stressed our capital position using adverse economic forecasts and our own historical loss experience through the downturn. Under these scenarios, we projected our capital levels would still meet well-capitalized units and we could maintain our current dividend level. However, in this economic environment, we temporarily suspended our share repurchase plan and kept our second quarter dividend at $0.18 per share. Prior to suspending our share repurchase plan, we returned $15 million in capital to our shareholders through the repurchases in the first quarter. Our tangible common equity and tangible assets ratio of 8.4% at March 31, down from 8.9% at the end of 2019. This trend was due to the impact from adoption of CECL and building our credit reserves in the quarter, which, combined, totaled $35 million or 48 basis points on our TCE ratio. Our significant level of capital, strong liquidity and strong pre-provision income all support the overall strength of our balance sheet.

I just want to conclude by saying that it's clear to us than ever that we value our relationships with our customers, and we're utilizing the strength of our talent, balance sheet and overall financial strength to support them. We're more focused than ever on ensuring that we make long-term financial decisions that are in the best interest of all of our stakeholders. It is also evident that what we have work so hard to do, build a robust revenue profile combined with an exemplary expense management will allow us to serve our clients and our shareholders over the near and long term. We will continue to be who we are, proactive and client-focused, in order to create the best possible enterprise in the years to come. I appreciate those who have joined us this morning.

And at this time, we'll open the line for analyst questions.

(Operator Instructions) And our first question will come from Jeff Rulis with D.A. Davidson.

On the capital just in terms of -- look, you've doubled the loan loss reserves, so the capital comes from different sources. But any thoughts on that sort of TCE comfort level of that 8.4% here and acceptable levels if that comes in further? You guys did a good job outlining the liquidity and other sources of capital. But just per that metric, kind of any thoughts on comfortability levels where we sit today at 8.4%?

Jeff, this is Keene. I think we're extremely comfortable with capital at these levels. I think particularly when you look at the confluence of factors here in the first quarter, you had day-1 adoption of CECL, you had what we feel like is a proactive day-2 provision, and we were also buying back some shares in the quarter. So we're ending up at 8.5% TCE, I feel like that's strong. And then I think it's worth noting just in terms of CECL, I mean there is some regulatory relief in phase-in that you get. So TCE is one indicator, but the rest of the ratios from a regulatory perspective remains strong. And again, I think the earnings profile is sort of that first line of defense on potential future provisions that we'll need to take. So I think we feel good right here at this 8.5% level. And moving forward -- obviously, we've been stable and paused on kind of the capital management. So I do expect that the capital position will be sufficient here, and we can have a few quarters like this. And if you had, call it, a $0.5 quarter here with an $0.18 dividend, you're building TCE every quarter.

And then another one on expenses. And really just a color, I know that you're not looking to provide guidance, but there are a lot of moving pieces in Q1 and things moved rapidly towards the end of the quarter. But if you could touch on this level of expenses in the first quarter, given thoughts of branch closures and travel limitations, is that figure a good level? Or would you expect that to kind of come in or increase if it's not indicative of maybe 2Q?

Yes. Jeff, I would just say, normally, first quarter expenses are high because of seasonal payroll taxes and a myriad of items that go along with it, including merit increases late in the first quarter. We do have that kind of normal trend, but I would say that the environment has given us some natural mitigant to that and also adding to that was reduced incentive accruals. So I think the first quarter level here felt pretty comfortable, and really, it only had, call it, a month of some of the more extreme expense measures in it. I would also just say, with that said, there are some -- there is some variability. We're definitely going to see some more professional fees as we consult with attorneys and counsel on either specific credits or how to navigate challenges that the current environment provides that we just -- we haven't seen that specifically before. So there's a little bit of give and take there, but there's nothing that I would say as a material upside or downside to the level we're at. We feel pretty good about it at least in light of current profitability. And then to the extent that things were to get better and we would have customer growth and things like that, obviously, the teams would be in line for some level of incentives there, and that would have to be accrued up later in the year.

And one last, just want to clarify, I think it was in Doug's comments, about the average PP balance of your EVL-approved clients. Is that $1.25 million per? Did I get that wrong?

Yes. Jeff, you're right. It was $75 million total for the portfolio of clients with an average of $1.25 million per portfolio client.

And our next question will come from Andrew Liesch with Piper Sandler.

Just a question on the margin here. I'm just curious if you know what percentage of your floating rate loan book is currently at floors?

I do. We've got -- I've to find my page here, I apologize. We've got $3.2 billion in total variable rate loans. $1.2 billion of those have a floor and you've got almost 50% of those currently on the floor. So that's where it sits, and we'll provide some more detail when we file our Q on that as well.

Okay. That's still helpful. And then just on the provisions here, just trying to get a sense on your macro outlook. Is that based on an economic outlook at March 31 or maybe later on in this quarter? Just trying to get a sense of if there could be some further reserve build just from an economic factor in the quarters ahead.

Yes. Let me try to give you as much flavor as I can there, Andrew. We felt like it was important to use the most updated information we had in terms of our economic forecast. And so with that, we blended some both downside and upside scenarios. And let's just say, our base forecast includes nearly 9% unemployment in the near term and it includes almost 5% decline in GDP. And then those extend out, respectively, to nearly 13% unemployment and an additional almost 7% decrease in GDP. So I think it's safe to say that we felt like getting ahead of this or taking as much information as we could and incorporating them to the forecast and working that into the results early was the best approach, and it allows us to be positioned to either continue to add to that or if the efforts to mitigate borrowers' stress continue to stretch out will be sort of status quo until we get some clarity. But we felt like this was the right posture and the right start to use the most updated forecast, which is I think, clearly, a little bit or maybe more of a conservative view than we could have taken.

(Operator Instructions) We'll now hear from Michael Perito with KBW.

I wanted to spend a little bit more time on credit. Keene, in your prepared remarks, you mentioned that you had not seen any material credit stress manifest at current time. I was wondering if you could maybe extrapolate that comment a little bit further. I mean are you suggesting that -- I guess what is your assumption in terms of these businesses? I mean it seems you have quite a few that are taking some form of intervention or forbearance. I mean what kind of assumptions in terms of their ability to return to kind of full operation later this year are you guys making in kind of the reserve build that you already have?

Yes. Let me maybe handle that high level, and then I'll have Doug or Scott to kind of color in maybe the borrower specifics. I think -- to us, I think it's been pretty clear that the idea that has been behind much of the relief has been to provide initial liquidity and relief. And when we've been looking at deferrals and things like that, that's really not an income event. Now certainly, there's a collectibility element that I think right now is just uncertain, and it's going to depend a lot on how people get back to work and the speed of recovering. We're clearly not in a position to forecast that. So I guess what I would say is our provisioning level is based more on broad-based economic information and potential that it could have across the portfolio. And clearly, I think our lens was intended to be more conservative than more optimistic. And what we'll work on through the next quarter or 2 is how certain sectors, certain businesses, certain industries perform and borrowers as it relates to our portfolio and their ability to get back to business and make those payments. And then our expectation would be those will start to meet in the middle, right? But I think we're starting with a good coverage at 1.7%. We're double -- more than double from where we were at the end of the year for a variety of factors. And from our perspective, I think we just feel like that's the right approach and posture because there really is no other approach. There's no information in real detail to be had to be able to estimate those losses within the portfolio other than using the broader economic indicators.

And Keene, I'll add to that. Mike, I think we transitioned from here, which is portfolio analysis, into -- in, what I'd call, case management, which you go customer by customer. And that's sort of my comments talking about. We're getting through the first 8 weeks, but we've got to think beyond that. And sitting down with those clients, understanding where they stand and when does the economic slowdown impact them, if it does, and then what do we need to do to prepare for that is how we think about it.

Okay. This is Scott.

There's not a whole lot...

Go ahead, Doug.

But...

No. That's okay. I was just going to add, I think the way I look at it is the diversity of our portfolio is the first barrier. And I think, to Doug's comments, we tried to dial in through a lot of the work that our internal folks do to really dial into the sectors that we think are higher risk to do work around liquidity, loan to values, guarantor support to really see how long they can weather the storm. So I think, to Keene's point, the key issue is what is the longevity because that's -- as I talked about, that's the comment, that's the concern that weighs most on everybody is how long are we going to be in this state. But I think diversity of the portfolio is the key factor that helps me sleep at night.

Got it. And then I know it's still early and transaction volumes haven't been high in the real estate arena. But it seems like there's a bit of real estate collateral obviously in the portfolio. And have you guys seen any updated data points yet in terms of how real estate prices in your markets of operation are trending since this pandemic has really started to take hold? Or is it still too early to comment on that?

Now I can let Doug comment specifically if he wants to. I think it's early from a value standpoint. I think what we -- we've monitored cash flows because I think that's -- obviously cash flows lead to valuations. And I think generally, what we've seen is those that are related more to retail and hospitality are certainly impacted, those that are more commercial have a bigger buffer. But I don't think we've seen, for example, an overabundance of CRE take advantage of the deferrals. But I'll hand it to Doug if he has further comments there.

Yes. No, I would say in terms of deferrals, first and foremost, we've entered into a very few forbearance agreements on commercial real estate. And so far, our deferrals have largely been accommodative to those developers that are really just looking for an opportunity to preserve some liquidity during this temporary cash crunch. But I think in general, changes in real estate values, it is early. But certainly, we're mindful of the potential long-term impact that COVID-19 could have relative to demand for, in particular, office and retail space. So we're mindful of that and we're watching it, but I think early yet to determine the impact relative to current loan to values.

Okay. And then just lastly, and I do appreciate all the added disclosures, guidance, really helpful, and all the areas of focus I think where the market interest lies. Just on the aircraft -- just a small quick question on the aircraft portfolio. Can you guys just confirm -- I believe this is true, but none of that -- none of the aircraft are actually used to generate revenues, correct?

Yes. The bulk of that portfolio, overwhelming majority of the portfolio is aircraft taken in on trade, so floor plans, basically short term. There may be less than 10% of the portfolio where the aircraft would be used to generate revenue, but that's not certainly the focus of the business.

(Operator Instructions) We'll now take a question from Brian Martin with Janney Montgomery.

Maybe just a couple of things from me. Just the -- did you guys mention the total deferrals at this point in the portfolio? And kind of what that -- was that asked at some of your question earlier, Keene? Was that as of March 31? Or did it kind of -- looking a little bit after that with the most recent data as far as what the deferrals look like?

Yes. Brian, it's Scott. And I...

Go ahead, Scott. Thank you.

Do you want me to take it? Okay. Yes. The deferrals that we talked about were -- really trying to give some color post 3/31. And right now, I would say, we've done 30 to 60 -- 30- to 90-day deferrals of P&I. And some borrowers will take less than 90 days, some borrowers will take principal not just interest, but impacting less than $500 million of the portfolio, so 110%, probably fewer than 400 loans overall.

Okay. That's helpful. Okay. And the -- how about just secondly, on the PPP program omega. Can you just walk through kind of how -- I guess is this -- do you anticipate this being a margin event, Keene? Or is this a fee income? And then just kind of the timing of how you're thinking about recognizing that revenue just as we kind of model something in on that?

Yes. Sure. So let me just add one thing to Scott's comment, which is on that $0.5 billion of principal balance of that the loan. The amounts requested for deferral is not very big. So we're talking $20 million to $25 million of total payment deferral that's been requested for that period. So just we're sizing relative to the unpaid balance. And then I would just say, on the PPP loans, the potential for the fee income is right now, call it, $16 million, $17 million, $18 million in fees plus the modest net spread we would get once we fund those loans. Our -- we don't -- to be clear, we don't have specific instructions yet on how those get forgiven or necessarily repaid. But that's -- it's probably some combination of second to third quarter recognition of whether majority of those were payoff. And then in speaking with peers and trying to get our arms around maybe what might continue to drag on further, I think 20% to 25% might be around for some period of the full term, but that's just us kind of guessing and modeling and figuring that out. But we do think in the next couple of quarters here, we could start to get some payoffs. But to the extent that we don't, that will be a loan yield and a margin drag, albeit with a 0% risk-weighted asset. So we're not overly focused on that. We're focused on making sure that our clients can stay in business and that we've done an excellent job of executing. But that's how we think about those plans in -- moving back in here to earnings and shrinking down the balance sheet.

Yes. Okay. So it's probably fair to say, Keene, in the second half of this year, maybe you get 75% or 70% to 75% of that total revenue and then the remainder is just spread out over the quarters and however we think about it. Is that fair?

Yes. I would hope so. And with the intention of the plan, which is to keep people employed, we're hopeful that it's 75% or more because that means that it went into the communities and paychecks and for really the purposes that it was intended for so that it can be forgiven.

Yes. Got you. Okay. That's helpful. And then just on the margin, Keene, just with the rate cuts and then the proactive efforts you guys have had on the funding side, I mean how much of the 150 basis point rate cut was in the quarter? Just maybe if you talk about the margin, just as a starting point, now that you've had the rate cuts in the -- the cuts that you guys have been proactive on, just kind of how to think about that core margin going forward or just in the near term?

Yes. I mean this is -- it's XXX. I would say, generally, when you look back at our asset sensitivity tables, I think we expect that we'll be able to maybe mitigate some of that effect. The really big wildcard that we've got right now, Brian, is there's a lot of liquidity coming into the bank and into the system. And we're also taking actions to bolster liquidity. So I'd be hesitant to give an answer because I think some of it's about the relative margin and net interest income given the risk profile. And we're working as hard as we can to maintain a highly liquid, a highly capitalized institution to be able to support our client needs. And so I think it would be irresponsible if I tried to give you some sense for that. I will say that March margin was lower than January and February comparatively. But I also think you can see the results here for the first quarter, and they were pretty stellar. So I think we were on our way to having a pretty good year before the Fed actions and the economic conditions kind of started to darken.

Yes. Okay. All right. That's helpful. And just the one housekeeping question, Keene. You guys have talked about for a while that seasonality of that tax credit line. I mean it looks like first quarter was, I guess, it looks like maybe it's more -- your expectation would be it's more streamlined or I guess more stable, less volatile this year, I guess. Is 1Q an indication of that? Or I guess would you still expect some volatility in the next couple of quarters and then 4Q being back up? Just big picture on the changes you've made in the tax product line trying to normalize it.

Yes. I would have said 6 weeks ago, I would have expected it to be more consistent, but still probably weakest in the second quarter. I would say right now, the predictability of that business is a challenge, and it's mostly our ability to source credit as opposed to sell credits. So I think all else being equal, we will expect some fourth quarter activity. And then I would just also add that some of it depends on what happens to rates. Some of the quarter results were driven by the reductions in LIBOR, which caused some of the credits that we fair valued to be adjusted. So there'll be a little bit more clarity on that in the upcoming 10-Q as to those indications. But right now, we don't have -- as Scott indicated on a variety of fronts, we just don't have the clarity of what a 30-, 60-, 90-day delay in business will mean in terms of timing, if it all comes back or if it pushes out or if it mutes the overall level of activity in the tax credit space is I think no different.

Okay. And maybe just last one high level from me. I mean given that these people -- a lot of your clients haven't taken the deferrals or said they really don't need them. In your comments about the exposure, you guys have I mean the greatest level of risk you view today when you kind of look at those buckets. I mean it's really just the 4 you've outlined or is there one in particular, I guess, more concerning at this point from what you've seen on the data you've gathered?

Brian, I can take that. I think it's liquidity to weather the downturn is the theme that regardless of the industry, that was kind of what came through more than anything. But I think the good news is, based upon deposit inflows, based upon the rate at which our clients accepted deferrals, they feel like they're in decent shape. So -- but I think it's definitely the liquidity to weather the downturn.

Okay. And normally, you guys have 1Q seasonality with the deposit base with the tax payments from people. But obviously, with that being pushed back, I mean would you expect some -- I guess does that inflow that normally is in that 1Q fall into 2Q now with the timing change? Is that what your expectation would be?

Yes. I would just say, Brian, we're not -- I don't know that I can wager a guess as to what this looks like moving forward and what we're going to see. I mean, clearly, with lending into the PPP program, we're seeing that go into deposit accounts if clients have borrowings in other places. We don't know if that's come to the bank or not. But we do continue to see a flight to quality and balances grow, as Scott mentioned, as people put more cash on their balance sheet as they're worried about the outlook.

(Operator Instructions) And there are no further questions signaled at this time. So I'll turn things back over to our speakers for any additional or closing remarks.

Yes. Sure. I'll take it. This is Jim. And I just want to thank everybody for their time today and your interest in our company. Please stay well, stay safe, and we look forward to talking to you again in the second quarter, if not sooner. And thank you.

And that does conclude today's conference. Once again, thanks, everyone, for joining us. You may now disconnect.