FNB Corp (FNB) 2020 Q2 法說會逐字稿

Hello, and welcome to the F.N.B. Corporation Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note today's event is being recorded.

I would now like to turn the conference over to Matthew Lazzaro, Manager of Investor Relations. Mr. Lazzaro, please go ahead.

Thank you. Good morning, everyone, and welcome to our earnings call. This conference call of F.N.B. Corporation and the reports it files with the Securities and Exchange Commission often contain forward-looking statements and non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with GAAP. Reconciliations of GAAP and -- to non-GAAP operating measures to the most directly comparable GAAP financial measures are included in our presentation materials and in our earnings release. Please refer to these non-GAAP and forward-looking statement disclosures contained in our earnings release, related presentation materials and in our reports and registration statements filed with the Securities and Exchange Commission and available on our corporate website. A replay of this call will be available until July 24, and the webcast link will be posted to the About Us, Investor Relations section of our corporate website.

I will now turn the call over to Vince Delie, Chairman, President and CEO.

Good morning, everyone, and welcome to our earnings call. Joining me today are Vince Calabrese, Chief Financial Officer; and Gary Guerrieri, Chief Credit Officer. On today's call, I will provide an overview of second quarter results and update you on FNB's participation in the Paycheck Protection Program. Gary will discuss asset quality and provide further detail on our loan portfolios. Vince will address our financial results and cover relevant trends. I will then provide an update on our digital platforms and physical operation; and finally, discuss our organization's $250 million commitment and continuing initiative to address economic and social inequity in our community.

As a company and on a personal level, we have endured significant challenges and change this year. Our thoughts are with those who have been impacted by the pandemic and unrest in our communities. I am proud of how our company has rallied in support of our customers and neighborhoods where we operate. We're resolved to work together to emerge and be stronger and united and our demand for a more successful future for all of our constituents.

FNB's second quarter results increased significantly. Operating earnings per share increased 63% to $0.26, which included an additional $17 million or $0.04 per share of COVID-19 reserve build in the quarter. And PPNR improved to $130 million. Core revenue trends remained solid throughout a challenging interest rate environment, with total revenues increasing 6% annualized to $306 million, and total assets growing nearly $3 billion to end June at $38 billion. Compared to the first quarter, loans and deposits increased $2.3 billion and $3.6 billion or 10% and 15%, respectively.

On a linked-quarter basis, double-digit second quarter loan and deposit growth were supported by organic commercial production and originating nearly 20,000 PPP loans totaling $2.6 billion.

Our fee-based businesses performed exceptionally well, with capital markets and mortgage banking establishing revenue records of $13 million and $17 million, respectively. Our efficiency ratio was 53.7%. And operating expenses were well controlled, down 3% from the first quarter.

Even though there has been disruption across our footprint due to COVID-19, we've still seen good commercial loan origination activity across most of the footprint. This is a testament to our teams who continue to serve our clients and meet their borrowing needs while dealing with a challenging operating environment. The strength in our balance sheet and ample liquidity enables FNB to support our clients' capital needs. We continue to apply our consistent underwriting standard aligned with our strategy and overall risk profile as we evaluate business opportunities in the current climate.

On a linked-quarter basis, total average loans increased 9%, largely driven by growth in commercial loans of 14%. Commercial line balances, when compared to historical levels, contracted as we saw much lower line utilization of 36%. The utilization rate decreased as PPP funds were utilized to support working capital needs by many existing clients, and economic activity declined during the period.

Commercial loan balances were also impacted by large corporate borrowers, paying down bank credit facilities with increased liquidity in the bond market. Average deposits increased 11%. As we had solid organic growth in customer relationships, the large inflow of deposits for PPP funding and government stimulus activities also occurred.

As part of our business strategy, we have been focused on reducing the level of wholesale borrowings by continuing to gain depositors and expand existing relationships. As a result, we were able to fully eliminate our overnight borrowing position, replacing it with customer deposits. Noninterest-bearing deposits were up $2.1 billion or 33% from prior quarter end.

Looking at June 30 spot balances. Our loan-to-deposit ratio was 92%, including the funded PPP loans, which positions us more favorably in the current rate environment. Growing noninterest-bearing deposits has been an integral part of our long-term strategy, and we've consistently been able to grow organically through various interest rate environments, further strengthening our overall funding mix. In fact, transaction deposits have increased $4 billion or 20% from March 31 and now represent 85% of total deposits, which compares very favorably to 79% 5 years ago. With the Fed taking near-term rate increases off the table, there is opportunity to offset net interest income headwinds by continuing to reduce deposit costs.

As we have stated previously, continuing to grow our fee-based businesses is essential to diversifying our revenue sources and to mitigate pressure on net interest income in an extended low-rate environment. With interest rate expectations now reflecting lower for longer, it is important we continue to build on our recent success in capital markets, mortgage banking, wealth management and insurance. This quarter's record mortgage banking income of $17 million better reflects the fundamentals in the results without MSR impairment as the mortgage banking business set a new production record for the quarter of $869 million.

Turning to our participation in the Paycheck Protection Program. I would first like to recognize our teams for their support of our customers and communities throughout these extraordinary circumstances. Our employees have worked tirelessly to ensure businesses receive critical funding during a time when regions within our footprint experienced extended shutdowns, particularly in our metro markets in Pennsylvania and the Mid-Atlantic, and when many borrowers turned from larger banks to FNB to accommodate their needs. As part of the PPP origination process, each borrower opened an FNB account, which supports our efforts to bring in new households. Looking ahead, we are optimistic that borrowers will be able to deploy these funds as businesses around the footprint reopened.

As an organization, we leveraged our technology infrastructure and expertise already in place to quickly adapt and accommodate our customers in a challenging remote environment. Coupled with significant financial aid, and employee volunteerism in our communities, our efforts have helped tens of thousands of small businesses during the pandemic and supported the retention of hundreds of thousands of jobs.

From the beginning of the COVID-19 crisis, FNB has upheld consistent volumes of total transactions -- deposit transactions by providing customers with a seamless transition from physical to online and mobile engagement. This was made possible from the significant investment we've committed to digital -- our digital and online platforms over the last decade. In fact, the appointment-setting feature on our new website that went live in January enabled FNB to continue serving clients safely in our branches throughout the crisis. We grew from 26 monthly appointments in January to 2,700 appointments in April. The rapid shift to remote services accelerated the enhancements to our digital strategy that were already underway and minimized disruption for our customers. As the operating environment remains in a constant state of change, we will continue our innovative approach to better serve our customers.

I will now share some updates regarding our operations and delivery teams. Together with the uptick in online appointment setting, our website's increased -- our website increased traffic by millions of daily visitors. As we are deepening relationships with customers throughout our digital capabilities, we are also generating significant opportunities. By synchronizing the physical and digital customer experience, we can take customers who utilize a single product and broaden the relationship to include products such as savings, credit card, private banking, mortgage, wealth management and insurance. At the end of the day, it provides tremendous value to the customer to have multiple product relationships within FNB on a single platform connected through digital capabilities.

Overall, the acceleration of digital and remote banking volume demonstrates our versatile and integrated multichannel strategy. Customers have been more active in FNB's mobile and online channels, with monthly average users up by 50,000 in both categories compared to the average for 2019. While our customer adoption rates for online and mobile have accelerated, our customers have still expressed a strong desire to conduct business within our branches. As an essential business, it is important for FNB to remain available and accessible. Our business continuity team, in collaboration with other units, including data science, human resources and retail banking, developed a monitoring system in which we can evaluate data related to the health care crisis on a locational basis.

On July 13, 2020, we had reopened the majority of our branch lobbies to customers, adhering to the most stringent safety measures, including social distancing and cleaning protocols, as we begin to move forward to the next phase of operation.

With that, I'll turn the call over to Gary to cover asset quality.

Thank you, Vince, and good morning, everyone. During the second quarter, our credit portfolio continued to perform in a satisfactory manner as the COVID-19 global pandemic continues to evolve. Our credit metrics have held ground in this challenging economic environment, which I will cover with you in greater detail on both a GAAP as well as a non-GAAP basis, exclusive of our loan volume funded under the PPP program. I will also provide some updates on the status of our loan deferrals and the steps we are taking to manage our book, particularly those borrowers tied to COVID-sensitive industries.

Let's now review the quarterly results. The level of delinquency ended the second quarter at 92 basis points on a GAAP basis, down 21 bps over the prior quarter, as early-stage delinquencies returns to more normalized levels. When excluding PPP loan volume, the level of delinquency would have ended the quarter at 1.02%, down 11 bps from the prior quarter.

The level of NPLs and OREO totaled 72 basis points in June, an 8-basis-point increase linked quarter; while the non-GAAP level was 80 bps, excluding PPP. The migration was due primarily to a few previously rated credits that were further impacted by the current COVID environment that we proactively moved to nonaccrual during the quarter. Of our total NPLs at June, 48% of these borrowers continue to pay as agreed and are current.

Net charge-offs remained at a good level at $8.5 million for the quarter or 13 basis points annualized, resulting in a year-to-date level of 12 basis points. Provision expense totaled $30 million in the quarter, which includes additional build for macroeconomic conditions tied to COVID-19. Inclusive of the Q1 economic-driven build, our COVID-related provision for the first half of the year totaled $55 million. Our ending reserve stands at 1.4%. And excluding PPP volume, the non-GAAP ending ACL totals 1.54%, representing a 10-basis-point increase over the prior quarter, resulting in NPL coverage of 215%.

When including the acquired unamortized loan discounts, our coverage excluding PPP volume, is 1.87%. Under the preliminary severely adverse DFAST scenario, the current reserve position inclusive of unamortized loan discounts would cover 78% of stressed losses.

As the pandemic continues to pressure the global economy, our approach to managing the book in this COVID environment remains in line with what I communicated on last quarter's call. We continue to conduct thorough borrower level reviews within our commercial book to track key performance indicators for those that operate in economically sensitive industries or that have otherwise been impacted by the pandemic. These ongoing targeted portfolio reviews allow our credit teams to quickly identify and proactively address emerging risks at the borrower, industry or overall portfolio level.

Additionally, we continue to conduct a series of scenario analysis and stress test models under our existing allowance and DFAST frameworks as we work through this challenging environment.

As it relates to our borrowers requesting payment deferral, 10% of our loan portfolio, excluding PPP loans, were approved during the initial deferment request window. Of these deferments, 98.4% were current and in good standing prior to the pandemic. Of the remaining $39 million, $12 million is already on nonaccrual. Our request for initial deferrals are essentially nonexistent, and we have only seen a small amount of second requests for payment deferral at this time. That said, we are carefully monitoring our credit portfolio and remain vigilant to identify borrowers that could face further pressure during uncertain economic conditions. This approach allows us to quickly identify and manage risk in the portfolio while still meeting the credit needs of our customers.

The composition of the portfolio remains diverse and well balanced across several product lines, geographies and industries. As shown on Slide 10, our exposure to highly sensitive industries remains low at 3.8% of the total portfolio, which includes all borrowers operating in the travel and leisure, food services and energy space. And the level of payment deferrals granted to these borrowers remains at 38%. Additionally, we have been tracking our retail-secured IRE portfolio closely to assess the emerging challenges on this asset class as well as the nature of the tenants' operations and insulation from certain economic strain as essential businesses. Our weighted average LTV position in this book remains strong at 65%.

In summary, we continue to manage our credit portfolio through this difficult economic environment by drawing on our strong credit fundamentals and our risk management strategies, which we continue to enhance as the COVID situation plays out. Considering these challenges, our portfolio is in a satisfactory position entering the second half of the year. Realizing the uncertainty of the economic environment as we look ahead, we continue to draw on the strength of our experienced banking teams to manage through this environment as we move into the latter half of the year. I would like to recognize our teams for their tireless efforts as we continue to work through this challenging environment.

I will now turn the call over to Vince Calabrese, our Chief Financial Officer, for his remarks.

Thanks, Gary, and good morning. Today, I'll review the second quarter results and trends in our operating environment and then discuss our capital management approach and current position. I'll note that our tangible common equity levels entered the year in the strongest position we've had in nearly 2 decades, and we are comfortable with our current capital position.

Looking at Slide 5. GAAP EPS for the second quarter is $0.25, including $0.05 related to significant or outsized items. These included $17.1 million of COVID-19 reserve build and $2 million of COVID-19-related expenses. The TCE ratio ended June at $6.97, reflecting these items as well as a 52 basis point temporary impact for the $2.5 billion in net PPP loan balances at June 30. Without the PPP balances, the TCE ratio would have been 7.49%. Additionally, our CET1 estimate ended the quarter at 9.4% compared to 9.1% at March 31 and 9.4% at the end of 2019, as PPP loans carry a 0% risk weighting for risk-based capital purposes.

Pretax pre-provision earnings increased to $130 million, providing more-than-adequate earnings power as we declared our third quarter dividend of $0.12 earlier this week. With a dividend payout ratio of 48% in the second quarter, we are well below historical levels of previous payout ratios. I'll touch on our capital management approach in more detail later in my comments.

Turning to the balance sheet on Slide 14. A key theme is the impact of $2.5 billion in net PPP loans. [comprise] 9.5% of total loans and leases at June 30. PPP was the primary driver in the linked-quarter average increase of $2.1 billion or 9% and as well as strong organic activity across most of the commercial footprint. Our commercial line utilization ended June at 36% below historical levels, down from the mid-40s spot utilization rate at the end of the first quarter, as we clearly saw some customer borrowing activity shift over to the PPP and our large corporate borrowers access to capital markets to reduce their bank debt.

Average consumer loans were essentially flat with direct installment loans increased $65 million or 14% annualized, and residential mortgage increased 6% annualized, 2 bright spots that continue to perform well. The increases in direct installment and mortgage loans were offset by continued declines in indirect auto loans and consumer lines, 2 loan classes heavily affected by the pandemic.

Continuing down Slide 14. Average deposits increased $2.7 billion or 11% on a linked-quarter basis, led by $2.9 billion or 15% in transaction deposit growth. Transaction deposits equaled 85% of total deposits as our managed decline in CDs continued and transaction deposit balances benefited from stimulus programs and PPP customer-driven inflows.

Noninterest-bearing/interest-bearing demand and savings account balances each increased significantly, up $1.8 billion, $854 million and $226 million, respectively.

Now focusing on the income statement on Slide 15. Compared to the first quarter, net interest income totaled $228 million, a decrease of $4.7 million or 2%, as loan and deposit growth mostly offset the impact of lower rates. The net interest margin narrowed 26 basis points to 2.88%, primarily driven by a full quarter impact the March action to lower the target Fed funds range to 0 to 25 basis points. Additionally, average 1-month LIBOR fell to 36 basis points from 1.41 in the prior quarter.

Total yield on average earning assets declined 58 basis points to 3.54%, reflecting lower yields on variable and adjustable rate loans due to the lower interest rate environment and the impact of the PPP balances. Total cost of funds decreased to 67 basis points from 101 as costs on interest-bearing deposits were reduced 37 basis points.

Slides 16 and 17 provide details for noninterest income and expense compared to the first quarter. Noninterest income totaled $77.6 million, increasing $9.1 million or 13.3% as mortgage banking operations increased $17.6 million on a reported basis or $10.2 million, excluding MSR impairment of $300,000 and $7.7 million, respectively.

Mortgage production established a new quarterly record at $869 million, increasing $306 million or 55% from the prior quarter, with large contributions from North Carolina and the Mid-Atlantic region. Capital markets also set a new record of $12.5 million, increasing $1.4 million or 12.6%, with strong contributions from interest rate derivative activity across the footprint. As expected, service charges decreased $6.2 million or 20.5% due to noticeably lower transaction volumes in the COVID-19 environment.

Turning to Slide 17. Noninterest expense totaled $175.9 million, a decrease of $19 million or 9.7%, including $2 million of expenses associated with COVID-19 in the second quarter of 2020; and $15.9 million of outsized, unusual or significant expenses occurring in the first quarter. On an operating basis, expenses declined $5.1 million or 2.9% compared to the first quarter of 2020 as we have realized lower variable expenses, such as travel and business development and increased FAS 91 benefits given the amount of loans originated in the second quarter. Additionally, we recognized an impairment of $4.1 million from a second quarter renewable energy investment tax credit transaction. The related tax credits were recognized during the quarter as a benefit to income taxes. The efficiency ratio improved significantly, 53.7% compared to 59%.

Starting with the recent trends on Slide 18, we continue to observe daily changes in external factors, including multiple aspects of potential economic recovery, changes in government programs and regulation changes over current programs. Saying that, we are providing our current directional outlook for the third quarter based on what we know today, which is subject to change, as we all know.

We expect period-end loans to increase low single digits from June 30, assuming no forgiveness of PPP loans, given the SBA's current expected time for processing forgiveness applications. While we expect deposits to decline from second quarter '20 levels based on an expectation that customers increase their deployment of funds received through the government programs, we do expect to see continued organic growth in transaction deposits.

We expect third quarter net interest income to reflect the full impact of lower 1-month LIBOR rates on variable rate loans partially offset by a full quarter benefit of higher commercial loan balances, continued reductions in the cost of interest-bearing deposits. We expect positive trends in capital markets and mortgage banking although lower than the record levels this quarter. We expect service charges to increase if recent transaction volume trends continue. We expect expenses to be stable to up slightly from the second quarter. Lastly, we expect the effective tax rate to be around 17% for the full year 2020.

For the remainder of my comments, I would like to discuss our risk-based capital position and overall management philosophy given the current environment, beginning on Slide 20. We continue to be very comfortable with our capital ratios as they stand today with the benefit of entering this crisis from a position of strength. As demonstrated in the new capital slides we have added to the deck, we have ample internal capital-generation cushions for all of our capital ratios in relation to well-capitalized thresholds.

For example, with a total risk-based capital ratio to fall below 11%, total capital would have to drop by $258 million, [7.9%] of total capital of $3.3 billion. Our risk-weighted assets would have to increase by $2.3 billion, which is 8.5% of total risk-weighted assets of $27.5 billion. We'd comment also that $258 million is in after-tax dollars.

On top of our capital position, we have a conservative bias in how we build reserves, especially given the consistent underwriting philosophy that has been in place for well over a decade. With CET1 of $2.6 billion and an allowance for credit losses of $365 million and a remaining PCD discount of $77 million, we have a substantial base available to absorb credit losses.

Put that in context, our reserves plus remaining discount on previously acquired loans would cover 62 quarters of net charge-offs that averaged $7.1 million per quarter in the first half of 2020. This is before considering the $2.6 billion in CET1.

Another way to look at this is relative to severely adverse charge-offs in our last stress test. Again, using $442 million in reserves plus remaining discount, we cover 75% of the $586 million in charge-offs projected under the severely adverse scenario for a 9-quarter period. To put the $586 million in context, that compares to $64 million over 9 quarters using the first half of 2020 net charge-offs or 9.2x the current levels.

As far as dividend sustainability, we are governed by the Federal Reserve and the OCC. From a Fed perspective, we currently pay out $39 million in common dividends and $2 million in preferred dividends for a total of $41 million per quarter. The Fed fourth quarter test currently shows in excess of $153 million after paying out the third quarter dividend just declared.

From an OCC perspective, there are significant cushions to support the $46 million the bank is projected to pay up to the holding company. [3-part] test shows a cushion of $913 million relative to net undivided profits; $517 million relative to net profits for the current year, combined with retained net profits for the prior 2 years; cushions above well-capitalized levels ranging from 228 basis points to 384 basis points.

In addition to looking at our capital position, it's important to consider PPNR generation. Year-to-date PPNR of $236 million more than supports the incremental reserve build through the first 6 months of the year. We generated ample capital to cover the preferred and common dividends, and our CET1 ratio was consistent with where we ended 2019 at 9.4%. Earlier this week, we announced our third quarter dividend of $0.12. Given the earnings level through the first half of 2020, you can see there's capacity to continue to return capital to shareholders.

Overall, our capital management philosophy is grounded in a conservative and consistent underwriting and credit management philosophy throughout varying economic cycles, supplemented with robust and comprehensive enterprise risk management, including very active credit monitoring processes.

With that, I will turn the call back to Vince.

Thanks, Vince. Looking at everything we've managed through over the last few months, the efforts of our team has been nothing short of exceptional in assisting our clients and communities in which we serve. Recent events highlighting persistent inequities in our country have affirmed our important mandate to support those who are vulnerable and traditionally underserved. As an organization, we continue to place a strong emphasis on being inclusive and demonstrated by our recent $250 million commitment to address economic and social inequity in low- and moderate-income and predominantly minority communities.

As we continue to deploy these investments, our shareholders will benefit as we have continued to prudently manage risk, liquidity and capital action to better position our company. During the quarter, FNB originated nearly $500 million in Paycheck Protection Program loans in low- to moderate-income and rural neighborhoods, assisting thousands of small businesses and employees. Our success is a direct result of our bankers' proactive outreach to over 100 organizations and nonprofit entities that work directly with these communities. This is just an example of how committing our resources this way leads to good business results.

I encourage everyone to learn more about our ongoing initiatives and commitment to diversity and inclusion through the links contained on the slides within today's presentation.

As we look ahead to move into the next phase of COVID-19 recovery, we will continue to focus our response on 4 key pillars to meet the needs of each of our constituents. The pillars are: employee protection and assistance; operational response and preparedness; customer and community support; and risk management and actions taken to preserve shareholder value, given the extreme challenges presented.

Through these unprecedented conditions, our employees have consistently delivered a superior experience for our customers. In June, FNB was ranked among the best banks in Ohio and North Carolina by Forbes and Advisory HQ, respectively, a testament to the consistency of our customer-centric culture across our footprint. The company was again named the top workplace in Northeastern Ohio for the sixth consecutive year by the Cleveland Plain Dealer. This recognition, which is based solely on employee feedback, joins a list of nearly 30 such awards received over the past decade. All of this has been made possible by our dedicated employees.

In closing, I would again like to thank my fellow team members as they have demonstrated throughout this time exactly why they continue to be our most valuable asset. Our dedication to cultivating a superior culture directly translates into a better customer experience, greater financial performance and higher returns for our shareholders.

With that, I will turn the call over to the operator to open the call for questions.

(Operator Instructions) And the first question comes from Casey Haire with Jefferies.

I'll start with a housekeeping question. I've gotten this a lot. The -- so the purchase accounting, Vince, in the quarter and the outlook going forward?

Sure. The accretion was $13.2 million of the kind of the remaining discount from CECL approach there. And maybe remember, that was $17 million in the first quarter. So down a little bit, but still a pretty good healthy level there.

Okay. Great. And then, Gary, on the credit quality front. So the deferrals at 10%, sounds like the new requests have dramatically slowed. I believe you guys were on a 3-month program. So I mean they should be either extending or going back to normal. What is sort of -- based on your indications and discussions, what -- how do you expect to -- that 10% to trend in the next quarter -- this quarter?

Yes. Hey, Casey. In reference to that, we did do 90 days. And it really got active in late April -- mid- to late April into May. June flattened out significantly. There was very small numbers of activity in June. So what we did, we had a significant number of our clients made the April payment. March was already made. They made the April payment, and we kind of shoved them further into the recovery.

So at this point, we've only seen about 50 commercial requests for second deferrals and about 250 on the retail side. So at this point, it's been very light. And the bankers are working closely with those clients and talking with them on a regular basis. We do expect that to ramp up as we work through the rest of July and into August and September a bit. But at this point, it's very light.

Okay. But so -- I'm -- and so where do you expect -- do you expect that these -- do you expect those deferrals to stay at 10% when you guys report in October? Or do you expect a lot of them to go back to normal?

Yes. We expect a lot of those deferrals to go back to normal payments, and we'll report that going forward. As a lot of those clients are not going to need a second deferral, it's going to be a significant number that will not need it from our perspective at this point.

Okay. Great. And...

I think what you will see, you will see heavier deferrals for second requests coming in the hotel space and in that restaurant space as they have -- they had more pressure.

The other item that I'll mention to you again is, coming into the situation, using the end of the year, 98.4% of these clients who took the deferrals were in perfectly good standing. So it was a very small number, as mentioned in my report, that weren't working in the normal course of business. Naturally, this shutdown has impacted a lot of clients, and a lot of clients were preserving liquidity and being cautious. But hopefully, that answers the question for you holistically.

Yes. Yes. And so on the reserve build, you guys had moderated this quarter. Just when did you -- what forecast -- how late and -- how late is -- how recent is the forecast that you used to build your reserve? And do you guys -- given that the reserve build moderated this quarter, do you feel like you've -- and the deferrals, you're getting decent news there.

Do you feel like the reserve build -- the heavy lifting has been done? Or the -- yes, I know it's a tough question to answer, it changes every day. But just given where deferrals are going and your lower reserve build, it feels like you guys are -- the heavy lifting is behind. So just some color there.

Yes. On the model first, let me address that one for you first. We continue to use a recessionary scenario, Casey, released in mid-June, with the average unemployment rate of 11% over the forecast horizon, with annualized year-over-year GDP not turning positive until the middle half of 2021. So it's a fairly good recessionary scenario that we've used in the model.

As it relates to the second part of your question, with our focus and consistent view on our underwriting and our credit culture around the desired asset classes that we want to put in the book and the position and mix of our portfolio, I feel pretty confident that our book will generally outperform through the cycle as it did in the last. That said, there is a significant amount of uncertainty, as you've mentioned, in the economy. At this point and the economy -- if the economy deteriorates further from here, the portfolio would experience higher levels of stress. Given our position and the performance to date, our portfolio mix, the smaller portfolios across higher asset classes, we'll continue to assess the positions around it as the third quarter plays out.

A few additional comments here. Remember, in Q1, we captured the March 27 forecast when others may not have. So we utilized that most recent bit of information around our forecasted models at that point. And during that first half, we built totaling $55 million now through the first 6 months.

Also of note, we really essentially have no credit card student loan and a very small energy portfolio. Those are tough from a reserve standpoint during this environment, as we all know.

In addition, we had a pretty significant decline in line utilization, indirect auto and some declines in the small business portfolio, which really freed up about $10 billion in additional reserves during the quarter for us. So that helped as well.

And finally, when you look at the macroeconomic environment and looking at it from a static position moving forward, similar performance across our portfolio. We wouldn't expect much if any additional build from a macroeconomic forecast perspective, and we'll continue to manage that accordingly based on how the economy evolves from there.

I would just add, if you looked at -- and I think we commented on this, but the reserve coverage, excluding the PPP, was the $154 million. We have $77 million of remaining discount on the acquired loans that's left in the CECL accounting. So if you -- that's available to absorb losses. So the $154 million goes to $187 million.

And as we had in our slides, we have another $14 million in reserve for unfunded lines, which is another 7 basis points or so. So there's a good amount that we've added to the reserves since the end of the year, to Gary's point.

Understood. And Vince, hey, just last one for me. The total capital ratio, I didn't see it in the release of the deck. It was just -- what was it at 6.30%?

Total risk-based capital ratio?

Correct.

We did not disclose that yet, Casey. We're -- we have the CET1 at 9.4%. I'll probably get that -- be able to get that by the end of the call. I just don't have that handy.

And the next question comes from Frank Schiraldi with Piper.

Just on the -- a follow-up on credit. As you guys point out, if you look at the reserve ratio with the -- include the acquired book, it seems to hold up well versus where peers are. But if I drill down into categories, at first glance, it seems to be a little bit thinner in some areas than I would have expected. So I just wonder if you could give maybe a little bit more detail or color around, for example, the retail CRE book, where I think reserves are still just under 1%.

Yes. When you look at that portfolio, Frank, we have, at this point, very few problem credits in that book. We feel very good about our sponsors across that portfolio. And we've really focused our underwriting in that book at higher cash flow streams and required debt service coverages over the last few years due to the fact that some of it is retail-focused, as we've talked.

One of the things that we have in there is an extremely low level of delinquency today. Naturally, the situation is fluid. But the delinquency in that book is 60 basis points with very low levels of any rate in credit at this point. So that book has been very nicely underwritten from our perspective. And as mentioned in my earlier comments, the LTVs across it are right at 65%. So we're well positioned in that portfolio at this point. So really feel good about it and working with those clients.

What's happening -- at this point, we are seeing rental streams start to increase as the economy has opened up. We'll continue to keep an eye on that and as we move forward. But hopefully, we'll continue to see positive momentum there as we are.

And how are you guys approaching downgrades? Are deferrals pushing downgrades of credits to classified/criticized? Are the deferrals pushing that down the road? Or are you taking them as they come? And just wondering if you feel like there could be -- as these deferrals come off, a migration there that could drive further reserve builds.

Yes. During the first rounds, the credits that were in sensitive industries were generally moved a notch. Other credits that were in a very strong position and were being conservative, those particular ones weren't moved.

During the second phase here, every second deferral will require a 1-notch downgrade, if not 2, in most instances, to a substandard rating. So we'll continue to work that portfolio in that fashion and address those ratings accordingly based on the risk present in each one of those credit situations.

This is Vince. Frank, I will tell you, in the commercial portfolio -- I'll speak to the commercial portfolio here. And I'm not sure if you're crossing over into consumer. But there's very active management, risk rating reviews that go on perpetually. So there's a very aggressive management system in place to ensure that as we review financials and review credit covenant compliance that the appropriate risk rating is assigned to those credits.

So the migration on risk rating, if that's what you're asking, is going on now. I mean it's been going on. When these deferrals come in, it may have been a little early, right, because the majority of the impact for our commercial customers, based upon what I'm hearing, was happening in April, late March into April and May. And then they've kind of rebounded back. Most of the industries have come back well beyond where they were at the depths of April.

So that's an ongoing process, and we have a fairly rigorous process in place to review risk rating.

Vince's point there, Frank, is a very good point. I mean we -- we're known from a regulatory standpoint to be very aggressive from a risk rating touch standpoint. Every. Our focus is that every time a banker touches a credit, no matter what it is, whether it's annual review time, whether it's line of credit renewal time or whether it's a phone call, we require them to assess the situation and downgrade risk on a month-to-month basis. So that proactive approach, I think, has been in place for many years.

Great. And then just a quick one on expenses, if I could. You guys gave some guide for what to expect in the third quarter. Do you -- is there -- if you could just give us a little bit of the puts and takes in terms of getting there from this quarter. I know you had -- the tax credit would have increased expenses this quarter.

So just trying to get a sense of if I look at -- if I take out the COVID-related expense, I guess, I'm at like $174 million for the expense base in the quarter. So is that kind of where you're talking off of in terms of a steady to slightly-up number? And is that a good run rate maybe beyond 3Q? If you can give us any sense there.

Sure. Yes. On the slide, we mentioned that we had the $4.1 million impairment. And then going the other way, because you didn't see much movement in that other noninterest expense line item, we had lower business development. We had lower OREO -- good quarter for OREO. We had lower miscellaneous losses in miscellaneous. So they kind of net out. As you can see, it was $21.9 million in the first quarter and $21.9 million in the second quarter.

So when you look forward to the third quarter, I mean, the comments that I made in my prepared remarks kind of in the mid-170s. I'd say kind of somewhere between $175 million, $177-ish million or so. There's -- that includes commissions on mortgage activity, which has been very heavy. So that comes through that line item, and you'll see some of that come through in the third quarter.

So I mean, it's really right around -- I think last quarter, I used like a $178 million. I think we'd be south of that. We came in at the $176 million kind of on a total basis, $174 million, like you said. So it's somewhere around there, Frank, $175 million to $177 million, I'd kind of use as a run rate for the third quarter. And in the fourth quarter, we're not really giving any other direction there, but there's nothing unusual on the horizon that would hit that.

And the next question comes from Michael Young with SunTrust.

A quick follow-up question to start, just on credit. On Slide 9, you guys present kind of your historical charge-off peak rate going back to the last crisis, which you obviously performed well through ex-Florida. Is that kind of the right way to think about charge-offs this time around, Gary? Do you feel comfortable with that? Or do you think that, given kind of the severity in the shock that -- and potential length of this crisis, that could be worse this time around?

I feel similarly confident, Michael, around how the portfolio will perform through a cycle such as this. When you look at our models, as we mentioned in terms of the stress testing and -- that we're doing and all of the models that we're running across the portfolio and the build of $55 million during the first 6 months of the year. If you would add that to normalized charge-offs, you're looking at charge-offs on an annualized basis in the 45-basis-point range or so at that stress level. And the models are confirming that. It feels, to me, quite good.

Naturally, the economy has to stabilize at some point and the volatility needs to move away. But at this point, it feels good from that perspective.

Okay. So just to kind of put everything together, I mean, if we took a charge-off rate similar to that and then assume the -- kind of the macro conditions have maybe stabilized in terms of the CECL allowance outlook, then you would just be kind of accounting for downgrades and those charge-offs that we kind of already mentioned. And that's kind of how we should think about credit and provisioning going forward?

I would say that's appropriate.

And providing for growth.

Right. Growth.

Sure. Yes, we're hoping for that, I think.

We're hoping for that, but...

Yes. And then maybe switching gears, Vince, just on the PPP loans and the fees associated with those. Was there any recognition of those fees on an accelerated amortization basis this quarter? And then what is your outlook for that on a go-forward basis?

Yes. No, I would say the forgiveness process hasn't started yet. The SBA is still working on how they're going to receive forgiveness applications. So kind of we're ready for that once it comes, but it's not -- we're not ready to be able to start that process yet.

So the fee recognition that came in would be just kind of a normal accretion of the fees over the -- the vast majority of the loans are the 2-year terms. We had a handful with the 5 years. But -- so I guess, well the one way to look at it is just the yields for the second quarter was 3.15%, 3.15%, which is the coupon plus accretion of a portion of the fees. So we don't have any acceleration that's coming in there yet.

And you really don't know. It's hard to predict. I mean in our heads, we've been kicking around, maybe you get 15% forgiveness in Q4. It probably won't get any in the third quarter just because of -- they're not ready yet. So and then they have 90 days to respond, and it pushes it out into the fourth quarter. So I guess for like modeling purposes, we've been using 15% as an assumption in Q4. And then maybe you get 3/4 of it by the end of March and then maybe 90% by the end of June. And then you have some tail -- and those are just reference points, Michael. Nobody really knows. But we do expect to get some level of forgiveness that'll happen in the fourth quarter. And then depending on the magnitude of that, that pulls some of the fees forward. So those are kind of the key points there as far as the PPP balances.

And in the third quarter, I should just comment too, so the average balance was $1.9 billion. The average balance in the third quarter will be the -- kind of the $2.5 billion net is what we'll have because you didn't have all of it throughout the second quarter.

The other thing I'll say -- this is Vince Delie. I'll put a pitch in for our IT folks and Sam Kirsch in digital channels. We built out a fairly robust system for clients to upload the information, and to walk -- it walks them through the forgiveness process, which keeps changing and is fairly sophisticated but very nice process. And then Gary Guerrieri hired a team of people and has assembled a team that will focus on acting as liaisons for clients to help facilitate the forgiveness process.

So we're still hoping for an easier process on those smaller loans, that I know is being kicked around instantaneous forgiveness for under $150,000. That would help tremendously. But we have systems in place to help facilitate the forgiveness for our clients.

The only other thing I'll point out is when you look at the balances, our loan balances overall were -- if you subtract it out, the PPP loans, would be down slightly. It was at 1%. I think, 1%, 1.5% overall. It's kind of a hard equation to do because we have smaller clients. If you look at the dispersion of deployment of those PPP loans, the relative size of our loans are smaller. Typically, those customers would borrow through the PPP program, pay down their working capital facilities, right, because there's -- the rate differential is fairly significant and then borrow back on their lines with -- if they have confidence that they're going to be able to do that.

So I think it's -- when we look at the transfer from PPP to our own revolver balances or line balances with the small business customers, that explains some of the decline in the portfolio. The overall activity across the company, as I mentioned in my prepared comments, was pretty good. And there are still financeable enterprises out there. There are entities that we would certainly consider providing credit to. There are other industries that are distressed and we don't play significantly. As you can see from the breakdown of the portfolio that we provided in our disclosures, we're not very active in a number of those areas.

So I'm a little more optimistic about the activity moving forward. Of course, we haven't seen the fallout yet. That will happen, I think, from a credit perspective and then in the third and fourth quarter. But so far, it looks okay for us. Anyway, I thought I'd share that with you, some additional commentary.

Yes. And then just maybe last one for me, just on the net interest margin. It looks like you guys still have some room to bring down the deposit funding costs from here. Could you maybe just talk about the timing and opportunity with that? And then if there's any kind of lingering roll-down in loan yields from this point?

Well, on the liability side, I mean, I think if there's opportunity within the deposit base. I know we've had significant deposit growth even outside of the PPP, the growth related to PPP balances coming on. Our demand deposits were up significantly or we're trending up over the last few years. So that has continued. I think there are opportunities there to bring down our overall cost. And I'll let Vince talk about the asset side of the equation in terms of margins. But on the liability side, there is room for us to continue to improve. Go ahead, Vince.

I -- just a couple of comments. So when you look at the performance for the quarter, so net interest income declined $4.7 million. Given that we had 105-basis-point reduction in 1-month LIBOR from 141 to 36 basis points, that's a $22 million reduction in interest income on $8.5 billion. And you look at the net decline, given that $22.3 million, that's not a bad outcome there.

And then as I mentioned in the beginning of the call, the accretion coming in a little bit lower from $17 million to $13 million had some impact, just comparing the second quarter to first quarter.

When you look at the -- we had $2 billion growth in average earning assets, largely funded with $1.8 billion in noninterest-bearing deposits. And that's been continuous growth. Obviously, has additional influx from the programs, but we've been growing DDAs every year. So when you look at the cost of the interest-bearing deposits, as we had on the slide, we were able to bring that down 37 basis points to help mitigate the impact on LIBOR. So we're able to offset a good chunk of that, which is a positive.

If you look at the kind of entry point into the third quarter, on a spot basis, cost of interest-bearing deposits of 61 basis points. The average for the quarter was 72. So you have an 11-basis-point kind of head start going into the third quarter. And there's still buckets of deposits that were -- we've targeted and we're looking at and continuing to expect to bring those rates down some more. So there's definitely some more impact there.

I think as far as the asset side of it, I mean, LIBOR is at 18 basis points. So it was down to 16, so it's up a couple. So we'll take a couple of basis points, but I don't think there's anything unusual that will come through kind of third quarter versus second quarter just other than mix, the mix of the loans that we put on it. So nothing really kind of beyond that. And the spreads have kind of been stable in the recent months.

And the next question comes from Baron Shaw (sic) [Jared Shaw] with Wells Fargo.

It's Jared here. So just a question, I guess, on the reserve build. So that $17 million of incremental build from the macro forecast, Gary, is that just taking the model with the macro assumptions that you laid out and that's what's flowing through? Or are there some qualitative overlays, some of those other items that you discussed, that offset what the model would otherwise have spit out for the macroeconomic expectation for the reserve?

No. It would include some overlays around our normal modeling process, Jared. So yes, it is inclusive of overlays, qualitatives.

Okay. Yes. I guess if we see the macro model deteriorate in third quarter, should we assume that there's potentially some additional overlays that would offset just the pure impact of that move or not necessarily?

It's going to remain fluid. I mean I can't speculate on what the situation with the forward view is going to be at that point. Based on where we are today, we feel good about the position of the portfolio. We'll continue to keep an eye on it and manage it as the macroeconomic environment changes going forward.

Okay. Vince, the -- earlier in your commentary, you had mentioned something about evaluating business opportunities and as you go forward. Can you give a little color around what that could look like?

Yes. I mean we -- there are certain areas -- for example, we just booked a fairly large credit in the retail -- believe it or not, it's a developer that has tenants, 99% occupied, $25 million deal that an insurance company was looking to get out of retail exposure. The loan-to-value is 55%. The debt service coverage is 2.2x or greater. So there are transactions out there that you would do.

The tenant base is largely large investment-grade banks. There's 4 banks and out parcels on the property. So there -- and there's a grocery store that's very solid long-term lease. I mean these are all long-term leases. There are opportunities to do business. I mean we're just going to have to be extraordinarily selective on what we go after.

We also recently won a large credit facility for a AA-rated, higher education institution. So there's still activity going on with billions of dollars in reserves. So we're just going to have to watch what we do. And I know that our folks are very in-tune with the appropriate opportunities to go after. We have the capital and the liquidity to continue to move forward, and the conservative nature of our underwriting puts us in a position today to continue operating. And we've said that all along. That's our business model. We're not as flashy during the expansion periods, but pretty solid during the downturns. And I think that creates stability for lending from our perspective than continuous business activity.

So I'll tell you, our employees, not to -- I made prepared comments, but these people have worked countless hours doing the PPP program, managing the credit risk. I could go on and on and on. I mean I'm so impressed with what they've been able to do. And our pipeline -- if you look at our production over the last quarter, our production was pretty comparable to the previous quarter, the post-COVID quarter that we were comparing to.

So again, they're not just sitting at home, which is what I was afraid was going to happen. They're working very hard. And my hat's off to our employees. They're passionate about their customers. They care. And they're very eager to make sure we get through this and get through it soundly. There is a lot of activity.

And so as we look forward, though, that's the type of stuff we should be assuming, not bank M&A? Is that correct?

At this point, I don't -- we've said for the last 3 years, we're not focused on -- I don't think this would be the appropriate time to focus on it. We need to right the ship here from an economic perspective as a country, and we need to get a better feeling for what's going to happen.

I -- where is there's a lot of uncertainty as we move forward, but the one thing I'm certain about is the quality of the people that we have in our ability to manage through it. We've proven it before during -- it's the same management team through the last crisis, and many of the bankers are the same. So I feel very confident that we're going to get through this, and we'll be in a great position to decide what we want to do on the other end of it. Maybe M&A after we're through this is a distinct possibility for us, given the strength of the company. So I -- we'll play that card down the road. I think as we sit today.

The other thing I will mention, Jared, is we opened our PPP program up to nonclients in our newer markets because we felt that some of the larger institutions were incapable of delivering. And in the first round of PPP, our people originated $2.1 billion. We were able to convert 83% and fund 83% of the applications that we've brought in. Most of the large banks were in the low 20s or 30% range.

So we brought over a lot of clients or prospects that are now clients that will lead to future opportunities for our bankers because they're now part of the capital structure of these companies. So I'm optimistic once we get through this about that as well. There's at least 2,000 middle-market prospects that we now have a relationship with. So we'll see how that all plays out down the road. But very good execution by our employees, and that's why we're where we are.

And the next question comes from Russell Gunther with D.A. Davidson.

Just a follow-up on the deferral conversation earlier. So I understand your kind of holistic view on this exposure. So the 98% that's current and in good standing coming into the pandemic. But do you guys consider these customers to be higher risk, given that they are in a forbearance program currently? And if so, is that accounted for in the current reserve?

The answer is, yes. I mean most -- many of those customers, Russell, with the onset of the pandemic and the shock to the economy and the shock to everyone in the business community, a significant number of them were wanting to be cautious. Some of them drew their lines up. Our line draws went up to about 46%, 47%. They wanted to grab liquidity. They looked for deferrals. 75% plus of our commercial deferrals decided to pay the interest, not take interest deferrals. So they paid the interest at their own volition.

The more compromised industries took P&I deferrals, as we've talked about. The books are relatively small. Hotels, I'm sorry, and restaurants have been severely impacted. I would expect those clients in those industries to be taking second deferral opportunities due to the volatility in opening, reopening, closing down and what does the future look like.

That all being said, the deferrals in the restaurant business has been remarkably low at -- I think it's about 32%. That has been quite surprising to us that it's not been higher. So the risk ratings have been dealt with. The risk ratings continue to be dealt with. Second requests will cause additional further downgrades. And we feel that we have the appropriate risk classifications across the credits in the portfolio at this point.

And then apologies if I missed it, but did you guys disclose where criticized and classified assets are this quarter? I'm not sure I saw it in the release.

We did not, but that should be in the Q, I'm sure.

And just directionally, can you just touch on whether there's a significant migration?

They're up moderately.

Okay. And then from a timing perspective on charge-offs, whatever the magnitude. Obviously, a lot of unknowns with stimulus and forbearance. But I guess just your assumptions around timing in terms of the way we could see charge-offs begin to start going up from -- you still had a very solid first half of the year.

Yes. I would tell you, Russell, that you're going to see that impact in Q4 and into 2021. You may see a little impact delayed in Q3, but I would tell you, Q4 and into 2021 would be my view.

Okay. And then last one for me guys. You've provided some broad strokes on the PPNR guide for the third quarter and tightened up the expense range for us. So appreciate that. But trying to tie it all together, do you think you can maintain this level of PPNR Q-Q based on this -- the puts and takes of that PPNR guide?

I think we gave you all the drivers, Russell, right, so I think kind of given you the moving parts there. I think if you kind of go through some of the elements, if you think about net interest income, for instance, right, we're going to have 1-month LIBOR today is at 18 basis points. So we've averaged 36 in the second quarter. So if you bring that down in the $5 billion to $8.5 billion, it's about $3.8 million a quarter of net interest income just from the LIBOR adjustments there, okay?

And then you have -- the purchase accounting, I mentioned, was $13 million. I would still expect it to be strong in the third quarter, probably a little bit lower than that, but it's still kind of a good level. I would expect it to still kind of be in the double digits, at least. So that's an element to net interest income.

And then the PPP loans, you'll have the full $2.5 billion. Those are additive to net interest income and additive to margin the longer they're funded with DDAs. So -- and as I mentioned earlier, we're going to continue to work down the cost of the interest-bearing deposits. So that clearly will have a positive impact.

So -- but kind of net-net, net interest income I would expect to be down a little bit. The fee income should still be at a very strong level. The guidance, as I mentioned there, we would expect the service charges to bounce back up. I mean they were running in the kind of 40% to 50% year-over-year decline for the transaction volumes, and that's running more in the 20% to 25%. So I would expect to see kind of that element in noninterest income increase some.

I mean mortgage at a $16 million, $17 million is a record high. I wouldn't expect that to be as strong as that, but I would expect that to still kind of be in the double digits, for sure. And we'll see just a lot of pipeline is high. There's a lot of activity continuing to go on. And this is a busy time for that business.

And then the capital markets piece, that number -- we've set a couple of new records in a row. I would expect that to be very strong again in the third quarter. I can't predict another record, but I expect it to be very strong kind of relative to what's in there.

And then some of the other key businesses that were down, the wealth and insurance businesses, I would expect those to kind of bounce back up. So noninterest income in total kind of will reflect all those drivers. So again, there's a lot of moving parts.

In the service charges, we'll see how that plays out. The recent movement increase in the transaction, still down, but it's not down as much, would be helpful.

And then the expense side, as you know, we manage expenses very closely as a company, and we always do. And the expenses have been -- if you look at them kind of on an operating core basis, they've been very, very flat. So I think that, that will help overall.

So I mean where the PPNR ends up net-net, I mean, we'll see -- I would still expect it to be very strong. I think when you look at the -- where it was for the first 6 months, $236 million on a year-to-date basis, I would expect it to still be very strong again in the third quarter. So I know I'm not giving you a number, but I'm trying to give you guys all the different drivers and kind of understand what we're seeing and just what the outlook is from where we sit today.

I want to go back to Casey's question earlier. So the total risk-based capital estimates would be about 11.9%. I think last quarter -- there's a slide in here, I think it was 11.6%. It was 11.8% at the end of the year, 11.6% at the end of March. So the estimate is 11.9% for where we would be at the end of June.

We did have tangible book value per share growth, right?

Yes.

TBV growth in the quarter?

Yes.

So Vince, thank you, guys, for all the color and on taking the PPNR question and for answering all my questions.

Sure. Thanks.

Thanks, Russ.

And the next question comes from Collyn Gilbert with KBW.

It's a long call. I'm going to be quick. So just starting quickly, Vince Calabrese, just a question on the PPP impact. So in terms of the interest income contribution in 2Q related to PPP, I think calculate maybe roughly $16 million. Can you just verify that? And then also related to PPP, what's the OpEx benefit was? You've sort of alluded to it, but from the deferred loan origination costs from PPP loans also in the second quarter?

Sure. That -- the $1.9 billion -- the total interest income on that for the quarter was basically $15 million for the quarter. So 3.15% yield, you'll get to, if you use those 2 pieces, the $1.9 billion. And then we'll have -- like I said, the $2.5 billion average we would have some sort of without any forgiveness yet in the third quarter. So -- and that 3.15% includes accretion of the portion of the fees, as I mentioned earlier.

And then the FAS 91 deferred origination cost went up by $3.7 million from the first quarter to the second quarter, which is just driven by -- the PPP is obviously the biggest driver of that. So that benefit helps on the expense side. And then that's kind of comes in net -- your accretion comes in net of that. That's a yield adjustment over the remaining life as well as the fees. But obviously, there's a net positive, given the fees minus the cost. So that was the delta for the quarter, the $3.7 million.

Okay. Okay. That's helpful. And then just lastly, Gary, great color on some of the credit moves, especially with the retail CRE. Just curious if you could give us a little bit maybe similar credit metrics within the hotel book. I mean it's a small percent of the overall book, I get it, 1.5% or whatever.

But just looking at the reserve on that, that 1.56%, just kind of where you have comfort? Like what about that book gives you comfort that, that's the right reserve level?

Yes. In terms of that portfolio, Collyn, when you look at the performance of it, a significant chunk of that portfolio in excess of $100 million or probably about 40-plus percent of it is what I would call our few core customers in that space. We have never been a hotel lender other than some very strong well-heeled, long-tenured hotel professionals who have built up significant capital. So there's a good chunk of that business that is very, very sound.

The majority of the rest of it came from acquisitions. You'll recall that the portfolio got up in excess of $530 million to $550 million post acquisition. We have run it down to $350 million. We have not lent into the space for over 4 years at this point.

Delinquency on that book, naturally, some of the weaker, smaller hotels. When I say that, I'm talking about small mom-and-pop shops, which we got through some acquisitions, were helped surely by the government stimulus and the deferral programs. But delinquency is at 15 basis points. And we've really derisked that portfolio over the last few years, as I've mentioned.

Is it going to withstand some losses? Absolutely. We understand that. And we'll work through what we can with our clients. And we'll probably have some increases in nonaccrual assets in that book as well. I would surely expect as we move forward. But generally speaking, I feel good about the position of it. We've moved higher-risk assets off the books, and we'll have to deal with some. Hopefully, that helps give you some color there.

And the next question comes from Brody Preston with Stephens Inc.

So a quick question. Could you remind me why the $77 million PCD discount isn't part of the reserve post-CECL?

Look, the discount on the loan portfolio, so when you go through the CECL accounting and you gross up the acquired loans into the loan balance, it's just a discount that gets accreted in. I mean that's just the way the accounting rules will work. And it's basically what -- marks that we had left on the acquired loans prior to CECL...

The pools.

Yes. The pools. You had basically retained gains or remaining marks that were left there because you couldn't bring that into income until the pool was gone or very close to gone.

It was stranded capital.

It was stranded there, right.

Okay. All right. The 1.54% reserve ratio ex-PPP, CECL is supposed to be for expected lifetime losses. So just wondering if you can give us a sense for what that sort of implies within your modeling for, I guess, near-term peak NPAs.

In terms of peak NPAs, Brody, I'm not going to sit here and speculate on that. That's a difficult thing to do. There's so much volatility in the environment. When you look at where is this thing going, I don't think any of us really know. When you look at the economy today and where it's going, I would tell you that you're going to see increases in NPAs as we work through this situation across the industry.

As far as giving -- throwing out a peak number, I don't feel comfortable doing that.

Okay. All right. And then I guess maybe switching gears to PPP, just given the cost of servicing the PPP loans and some of the, I guess, the longer time line of working through forgiveness. Have you all considered selling these loans to a third-party like we've seen some smaller banks do?

Yes. I mean we've received calls on that. And the people who want to buy it, want to kind of get the owned income for free. So it really doesn't work. I mean we've looked at it. For us, we think it's better to keep it on the balance sheet, just given the price points that people are talking about.

The hardest part was originating it.

Yes.

So once you originate it, that -- I think when you have it, that -- I -- it's going to lead to -- for us, first of all, it was beneficial to our clients. So -- and they're very appreciative of it. It helps build loyalty. I think for us to sell it at this point would not go over well. And again, we were able to build out an automated process that made it very efficient. We were one of the few banks that had an end-to-end digital process. We introduced bankers along the way. There were 1,000 bankers that interacted with clients, but they had a fully digitized process, paperless process to bring them on.

So the same is going to happen with forgiveness for us. We invested pretty heavily internally and the resources to be able to do that. That's a differentiator for our company. And we're going to have a very slick system that's online that permits -- forgiveness, walks the client through step-by-step on forgiveness. It enables them to upload documents digitally. And so we're able to do it a little more efficiently.

A smaller bank might struggle. They'd have to outsource probably portions of that or maybe all of it. So at that point, they may be looking to get out from under the burden of processing those loans.

Considering, in most cases, smaller banks, it was a larger percentage of their total assets. For us, it's a substantial portfolio, but we can manage it with the resources that we have. Plus I mentioned the thousands of noncustomers that we were -- had relationships with. Our bankers have been calling on and called in and said, "Hey, I can't get my PPP loan through my large bank. Would you be willing to do it for us?" We accommodated those requests.

Now I will say something else, too, that I didn't mention -- I mentioned in my prepared comments. Our folks reached out to 100 community groups and nonprofits in low- to moderate-income communities across our footprint. This was before it became an issue. And we were able to originate $0.5 billion in PPP loans in those low- to moderate-income in rural communities where the job retention is critically important. So I was very proud of what we did. And I think we've done a masterful job of underwriting them, ensuring that we have good-quality borrowers on the other end, and we're going to carry that through. That's our philosophy, overall philosophy on it.

All right. And then on the -- just going back to the margin liquidity. You had a pretty significant increase in cash, about $370 million or so. Just wanted to understand how much of that was driven by PPP, if any, and sort of what you expect for cash balances moving forward.

Yes. I -- the influx of the deposits that we had, which exceeded the loans and loans-to-deposit ratio coming down to 92%, kind of captures all that. As Vince mentioned in his remarks, we went from having overnight borrowings to investing that -- a few hundred million that you're mentioning there, which really isn't that big on our balance sheet and kind of just sit here today that's running at about 0.

So as the deposits, at some point, will get utilized, that number will kind of flex up and down as that happens. And then in the meantime, the PPP is such a big driver to the numbers. We continue to add new relationships and new accounts and gaining new business. And to Vince's point, 25% of the PPP customers were prospects, so were not customers. So that's a pool of clients that we're going to be actively and...

And they opened depository relationships with the bank because they needed to fund the loan. Some of them chose to move additional deposits over or expand the relationship. So when you look at -- we actually tracked the PPP fundings. We have a system that we put in place. It's not 100% accurate, but we developed it when we were originating to watch flows of funds, migration of funds. And what we've seen is an expansion in the number of accounts that we have with that pool of customers. So the deposit balances, in certain instances, exceed the amount of PPP loan that was funded.

That's helped us. I mean if you look at the deposits overall, we're up over -- well over the amount of the PPP balances. And some of those balances went and moved over to pay down existing debt. So we're looking pretty good from a deposit perspective. I mean I feel pretty good about our funding base and our ability to gain households.

And our teams are working to expand those relationships, to Vince's point.

Yes. And that's in the midst of a pandemic. So I think -- and social civil unrest -- I think our -- like I said, our people have done a tremendous job, I couldn't be prouder.

And the next question comes from William Wallace with Raymond James.

I'll try to be quick. One quick modeling question. On the PPP, based on the way the rules are written today, what is your expectation of the percent of loans that will be forgiven?

Well, I think -- in total, I would think that the vast majority will be forgiven. I mean it's got to be in the 90s. I mean we don't know with certainty. Vince mentioned the -- you're talking about an automatic forgiveness for loans below $150,000. I'm not sure if that's going to happen or not, but that clears out. I mean, our average, I think, was under that, yes.

$129 million. So the average is $129 million.

Right.

Yes. So I also think we did a pretty good job, Wally. That -- there -- you -- when you brought clients in, there was an opportunity to walk them through what would be required for forgiveness. And I think our folks, based upon what we required, there was a certification by the lender that we required that they validated certain pieces of information and had discussion. That's why we had 1,000 -- we activated 1,000 bankers across multiple lines of business to interact with the clients. That will help in the forgiveness process. That will help us achieve a higher percentage of forgiveness.

And then Wally, just to restate what I said earlier, I mean our assumption right now or our estimate, just based on kind of an informed estimate, was to get 15% in the fourth quarter, have 75% of total forgiveness by the end of March and then 90% by the end of June is kind of at least what we're thinking about.

Okay. And then one big question for you, Vince D. In your prepared remarks, you gave some numbers that suggest a pretty significant increase in utilization of the digital network with your customer base. You guys have been pretty diligent and thoughtful about your branch network over the years, and you've slowly consolidated it. I'm wondering if the increase in utilization of the digital network changes the way you might approach the decisions around the branch network, if you could talk about that. And I'll step out.

Yes. I appreciate the question. It's a great question. I think that, obviously, in this environment, there's been a, let's say, an accelerated educational process for clients. We had such a huge increase in adoption in those digital channels. We have always focused on the interface with the client. We always believe that we've -- what we could control because we're not -- we don't have unlimited budget was how easy it is for a consumer to interact with us. And that's really what we focused on, the interface.

I think our folks did an exceptional job with our website. I'd recommend, if you haven't been on it, go and take a look at our website. It's designed in a way that's very easy and intuitive to purchase products and services or view educational content. The ability to put that out is going to make changes. The educational process that took place through COVID-19 will certainly push users to that platform.

We have had a process. We've closed a lot of branches. I mean, we've consolidated -- I don't even know the numbers. But generally, 15 to 20 a year over the last 5 years have been consolidated, some of it through M&A, some of it opportunistically because of the change in client preferences. I would expect that to continue. But I will tell you that throughout this process, a number of clients had written me a letter, sent me e-mail, stopped me on the street and asked, "When are your lobbies going to be open?" Small business customers still like go to the branch, and they want to go and make their deposits at the branch because, in many instances, they still use cash. They've coin and currency, and they need to come in. Clients, when they have issues, like to stop in.

So I think it's going to be -- there was an article that S&P just did. It illustrated our concept branch. I think there will be fewer branches. The design of the branch and how we deliver content on products and services will change, but there will always be a need. There may be fewer of them. And we're going to continue to look at that to drive efficiency.

So our strategy was to invest in the front-end system; to invest in the ability to provide products and services in a comprehensive manner, focusing on the interface; and then making sure our branches -- branch system is optimized and structured appropriately to accommodate conversations in that content.

So anyway, that's -- I see that continuing -- that trend continuing, and it will afford us with an opportunity to operate more efficiently as we move forward. Thank you very much for the question.

And the next question comes from Brian Martin with Janney Montgomery.

Most of my questions have been answered here. Just a couple of housekeeping. Just Vince, I think you said on the service charge income, you expect -- I know it's down this quarter, but you did expect some bounce-back prospectively. I think you said it was like 40% down, and now it's down to -- it's only down 20%, kind of that range is how to think about that?

Yes. You got it, Brian.

Okay. Okay. So I just want to make sure I got that right. And then just with the accretion number, maybe I guess, just the time frame we should think about recovering that remaining, whatever, $77 million, Vince, I guess, given the -- some of the balance, I guess, the drop-down this quarter. Just most of that is captured by maybe the end of next year? Or is it going to -- I guess is that fair to think about that?

Yes. I mean the vast majority would be, I'd say, over the kind of the 2 years -- 2 to 3 years, I would probably say is probably reasonable. By the end of next year, I would think you'd have kind of the bulk of it kind of coming through. I mean it's a function of prepayments, too, right? So the -- more of the loans end up prepaying or go different refi and government programs or something. You have more of that, that would come in. But I'd say a 2- to 3-year kind of time frame, Brian, is probably reasonable.

Okay. And then just the last one for me, guys. The impact of the PPP on margin, I guess, this quarter, I guess, or just in general, I guess, your comment on that.

Yes. I mean, it's actually additive to the margin. I mean, if you look at -- I mentioned the yield at 3.15%. I mean funding it was about -- basically, deposits are 3 basis points. So you have a spread of about 3.12%. So if you do the math, it's adding 10, 15 basis points, I would say, to the margin during that short period there. So it's going to be a function of how long those are around as far as them coming through and how long we have them funded with demand deposits, right? So at some point, the customers are going to start to use those funds. And then your mix of how you're funding it will change.

But what I can say for certain is what the second quarter impact was, and it was a 3.12% spread, which, as you can see, if you do the math, that is obviously additive to the margin we reported.

And as that was the last question, I would like to return the floor to management for any closing comments.

Well, I'd like to thank everybody for the questions and surely appreciate the time that you've spent with us and the interest in FNB. Please stay safe, and we look forward to meeting with you next quarter. Take care.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.