FIRST BANK (Hamilton) (FRBA) 2020 Q4 法說會逐字稿

Good day, and welcome to the First Bank FRBA Fourth Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Pat Ryan, CEO. Please go ahead.

Thank you. I'd like to welcome everyone today to First Bank's Fourth Quarter and Full Year 2020 Earnings Call. I'm joined today by Steve Carman, our Chief Financial Officer; Peter Cahill, our Chief Lending Officer; and Emilio Cooper, our Chief Deposits Officer. Before we begin, however, Steve will read the safe harbor statement.

The following discussion may contain forward-looking statements concerning the financial condition, results of operations and business of First Bank. We caution that such statements are subject to a number of uncertainties, and actual results could differ materially, and therefore, you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described under Item 1A Risk Factors in our annual report on Form 10-K for the year ended December 31, 2019, filed with the FDIC.

Pat, back to you.

Patrick, are you muted?

Yes. Thanks. Sorry. So since we're at year-end, I'd like to take a couple of minutes to expand the lens a bit and focus on the bigger picture. It takes time to build a great bank. Thankfully, when we got started a dozen years ago, we started off having a great base of contacts and potential customers. For several years, we focused primarily on growing the business, both organically and through acquisition. Understandably, that focus put pressure on our funding sources. Then heading into 2020 on the heels of completing our fourth acquisition in 5 years, we began to shift our mindset from an early-stage company focused on customer acquisitions, growth and scale, to a more mature model with greater focus on bottom line results.

To achieve that goal, we laid out a plan that included solid but more moderate loan growth, even sharper expense control and major funding cost and mix improvement initiatives. I'm pleased to report that despite the operational challenges and credit uncertainty from the pandemic, we were able to deliver strong results, consistent with those strategic priorities, while also contributing meaningful dollars to our allowance for loan losses.

The most important foundational change during the year came in the funding side of our business. We wanted to significantly lower our funding costs relative to peers and improve our mix. We did both. Our cost of deposits dropped to 0.5%. Noninterest-bearing deposits now make up over 22% of our total deposit base, up from 16.8% at the start of the year. And CDs now account for just 27% of total deposits, down from 40%.

So I'd like to talk a little bit about results for the year. As many who've seen our earnings release know, we had excellent revenue growth in a difficult rate environment. Our net interest income for the year was up almost 20%, and we got there in an interesting way. Our interest income benefit from loan growth was basically offset by the declining earning asset yields as a result of the lowering rate environment, but the major reduction in improved deposit mix drove our overall deposit costs down significantly, which led to that almost 20% increase in net interest income. We were also able to realize significant growth in noninterest income. That category was up almost 60% in 2020 compared to 2019. Loan swap income and gains from recovery of acquired loans helped drive that outperformance.

We also stuck with our trend of strong expense control during the year. Overall, noninterest expense was up only 2.6% compared to the prior year. That growth rate increases to -- closer to 13% if you back out the merger-related costs from 2019. But obviously, that 13% expense growth is well below the revenue growth of 20%.

We did see elevated provisioning in 2020 to help build a pandemic "rainy day" fund. Total provisions in the year were $9.5 million, which is up about $5.5 million from the prior year or an increase of 140%. As a result of that added provisioning, our allowance to nonperforming loan ratio actually increased to 243% by year-end.

Also during the year, we had PPP fee income amortization of $3.3 million, which helped to partially offset the increase in the loan loss provisioning and reserves during the course of the year.

Regarding the quarterly results, I'll let Steve, Peter and Emilio dive into the details a little bit. I'd just like to make a couple of quick comments. I would mention that even though there were a lot of different unusual onetime items during the quarter, both from a revenue and an expense side, the actual results came in, I think, fairly close to what we would consider to be a core number.

Specifically, I'd like to highlight what we saw in the margin. Obviously, our stated margin increased significantly from the third quarter where our margin was 3.23% and our margin in the fourth quarter was 3.56%. Those numbers are obviously impacted, to some degree by, PPP interest income and PPP fees.

So I'd like to share a couple of rough calculations that we did where, when we looked at the third quarter, if you actually adjust it for PPP, we think our margin or our "core margin" in the third quarter was probably closer to 3.3%. And if you do that same calculation, what you see in the fourth quarter, because we had an acceleration of fee income amortization with significant loan forgiveness that happened during the quarter, that core margin was probably closer to 3.40% to 3.45%, but still significant 10 to 15 basis point core improvement in the margin during a difficult operating environment is something we're quite proud of. And we also think that our quarterly pretax numbers that we achieved in the fourth quarter should be similar or consistent with what we think we can do heading into the first and second quarter of next year.

So looking forward to 2021, I have a couple of brief comments. Obviously, COVID remains a big unknown, but the downside risk today will look quite manageable compared to some early stress test scenarios that were run. Our lower funding cost should continue to offset lower earning asset yields. And if it materializes, a steeper yield curve could actually help drive some margin expansion during the year.

PPP income and expense management will go a long way towards offsetting the potential impact of any higher credit costs that could materialize as we continue to work through the impact of the pandemic. As we look into next year, we still have about $3 million of unamortized PPP fees from the initial round of funding that happened in the spring. Plus we're also estimating at this point that as we work through applications during the first quarter of this year with the new round of PPP that we could generate up to an additional $3 million in fees based on the demand we're seeing from the current program. Now not all of that $3 million might get recognized in 2021 based on the timing of the amortization and forgiveness.

We believe that we'll have opportunities to revisit the overall level of the allowance if a strong economic rebound materializes, and we've also taken steps to make sure that our expenses remain under control. We announced the closure of 2 branches late last year, and we've also recently terminated a lease that came due for back-office space here in our hometown in Hamilton, New Jersey. As a result of all that, we do believe that overall EPS growth for the year could come in 20% to 25% higher than what we realized in 2019.

At this time, I'd like to turn it over to Steve Carman, our CFO, to discuss the financial results in a little more detail.

Thanks, Pat. As we enter 2020, we had several key financial objectives, which included enhancing net interest income and core profitability through the continued generation of quality commercial loans while lowering our cost of funds by growing noninterest-bearing deposits and lower cost commercial deposits. Effective expense control was also a priority.

As reflected in our full year 2020 and fourth quarter results, we were able to achieve these objectives in a much different business environment than we originally projected. Net income for 2020 was $19.4 million or $0.97 per diluted share compared to $13.4 million or $0.69 per diluted share for 2019. The increase in earnings of $6 million, excluding the impact of merger-related expenses associated with the Grand Bank acquisition, which closed on September 30, 2019, was primarily due to net interest income growth of $11.2 million or 19.2% and higher noninterest income.

Average loan growth for 2020 of $336.1 million was the primary contributor to the $5 million increase in interest income. Lower interest expense of $6.2 million was driven by a 62 basis point decline in the cost of interest-bearing liabilities, principally interest-bearing deposits. Partially offsetting this higher net revenue was a higher provision for loan losses and higher noninterest expense due in part to the full year impact of certain Grand Bank expenses. Our higher provision for loan losses of $5.6 million for the comparative period was due to the uncertainty created by the pandemic. That said, our asset quality metrics remained strong and stable at December 31, 2020.

We finished 2020 on a strong note, with net income of $6.2 million or $0.31 per diluted share for the fourth quarter 2020 compared to $5.2 million or $0.25 per diluted share for the same 2019 quarter. The primary driver of Q4 results was net interest income of $19.7 million for that fourth quarter, an increase of $3.5 million or 21.8% compared to $16.2 million for Q4 2019. Lower interest expense on deposits was the principal driver for the growth in net interest income for the comparative period. Our cost of deposits for Q4 2020 was 50 basis points, which is now in line with our peers, which is a reduction of 89 basis points from our cost of deposits of 1.39% for Q4 2019. Our net interest income has been supported by a stronger net interest margin.

Our margin has steadily improved since a significant lowering of interest rates in March. Our tax equivalent margin for the fourth quarter of 2020 was 3.56% compared to 3.34% for Q4 2019, an increase of 22 basis points. The improvement in the margin was primarily due to a 103 basis point decrease in the cost of interest-bearing deposits, partially offset by a 58 basis point reduction in earning asset yields, particularly loans, and a notably different and much lower interest rate environment.

On a linked quarter basis, our tax equivalent margin for the 3 months ended December 31, 2020, was 33 basis points higher than our margin for the 3 months ended September 30, 2020. The improvement in the margin was primarily due to both an increase in our loan yield due principally to PPP loan fee amortization and a further drop in the cost of interest-bearing deposits, which declined to 65 basis points in the fourth quarter, a decline of 26 basis points from Q3.

We are projecting a modestly declining cost of funds over the next several months based on the current interest rate environment, which we believe should translate to a modestly improving margin as we move into 2021.

Throughout 2020, we've taken actions to effectively manage the level of noninterest expense growth. During 2020, we managed the timing of new and replacement hires, which resulted in a slower growth rate in salaries and employee benefits, our largest component of noninterest expense. The current business environment has translated also to lower marketing and travel and entertainment costs.

Effective management of expenses has contributed to a lower efficiency ratio. Our efficiency ratio of 52.54% for Q4 2020 compares to 5.264% for Q4 2019. For the entire year, the efficiency ratio is 53.21% compared to 57.28% for 2019. Looking to 2021, we expect continued effective expense management with projected quarterly run rate of about $10.5 million for noninterest expenses.

We are well positioned to build upon 2020 results as we enter 2021. We expect continued strong net interest income growth based on projected loan growth and a modestly higher margin driven by lower interest expense. Combined with strong asset quality metrics and ongoing expense control, we expect to move performance metrics higher during 2021.

Next to discuss lending results is Peter Cahill, our Chief Lending Officer. Peter?

Thank you, Steve. As outlined in the earnings release, total loans in 2020 reached $2.05 billion, obviously, assisted by $190 million in PPP loans, which we began funding in the first quarter and which stood at year-end after some forgiveness by the SBA at $137 million. I think the major story in the numbers for the lending area was our growth in the fourth quarter, exclusive of the impact of PPP forgiveness.

You might recall that last year, our fourth quarter growth was a negative number, declining a bit due to large payoffs in our commercial real estate portfolio. This quarter, however, was the opposite. After growing our portfolio approximately $50 million in the third quarter, we followed that up with growth of almost $97 million, exclusive of the PPP forgiveness. That's a big quarter for us. It came from a combination of C&I loans and investor real estate loans. If you strip out the impact of PPP altogether in 2020, loans grew by $187 million, well above our growth goal for the year. That $187 million, if my calculations are correct, represents growth outside of PPP in excess of 10% for the year.

I think timing did help us a bit at year-end 2020. We had a number of loan prepayments scheduled for December that did not take place. Those prepayments have been pushed to the first quarter of 2021. So we'll see some prepayments as we head into 2021, offset by normal loan generation, plus the addition of new PPP loans that we have in process. In any event, if we do experience some slower net loan growth initially, I'm confident that with our backlog, we'll make up for that as we move further into the year.

Regarding our backlog for new business right now. As you can probably guess, we're in the middle of the second generation of PPP loans, and that's keeping us busy. Our estimate at the moment for new PPP loans, as Pat alluded to, was around $100 million to $110 million, and we feel pretty certain that we're going to reach that level.

Outside of PPP, we have what I'd call our normal business, and our pipeline for these non-PPP loans continues to be in good shape. At year-end, adjusted for probability, the pipeline stood at $142 million. That's down a bit from the previous month, understandable due to the large number of loans booked and removed in the pipeline in December. And the level of $142 million in the pipeline is still in line with the 12-month average during -- throughout 2020 of around $154 million.

Another item on the pipeline that's worth mentioning is the level of C&I business in comparison to investor real estate. Like many community banks, much of our portfolio was tied to real estate lending, including investor real estate. We've been working hard at finding new C&I relationships, which will help us drive deposits as well as loans. And as such, we set a target a while ago to get investor real estate at or under 50% of our pipeline. And at year-end, and actually for each month during the fourth quarter, investor real estate loans have trended down just under 50% in the 40% to 49% range.

I could also comment on asset quality briefly. There's a lot of good data in the earnings release, and Pat and Steve both mentioned it. I'll just reiterate that things are looking pretty good. Nonperforming loans are down, and charge-offs for the year were up only slightly, basically in line with 2019. Past due loans at year-end were down due in part to loans impacted by the COVID-19 pandemic where we've agreed to defer loan payments. The allowance for loan losses exclusive of PPP, which began a year around 1%, ended up at 1.25%, unchanged from the third quarter.

Our deferred loans related to COVID-19 are outlined in the release as well. From our high point earlier in the year, our deferred loans approximated 25% of the total loan portfolio. Deferred loans at year-end dropped to $37 million or 1.8% of the portfolio. We're in continual contact with this diversified group of customers, and we're very optimistic that as things improve, deferred loans will continue to shrink.

All in all, compared to where we thought we might be 6 to 9 months ago, we're very pleased with where things are as it relates to the impact of COVID-19. As we always have, we continue to monitor the portfolio closely. Our underwriting standards have tightened a bit. Obviously, the impact of the pandemic has created the need to not only review how our customers did historically, but we're also focused on how they're doing right now and couple that with what they think's going to happen as we move forward.

So in summary, I think lending had a very good year in 2020, all things considered. We learned to deal with the challenges of being out of the office and working remotely but still getting our jobs done. We assisted many small businesses with PPP loans and payment deferrals related to the pandemic. And we stayed on top of credit administration in order to keep up the speed on the quality of the loan portfolio. In spite of these challenges, we grew our -- the portfolio at a very good rate.

As we look forward into 2021, we believe we're starting the year with good asset quality. We're prepared to help our customers with a second round of PPP loans, and we intend to grow as we have in the past.

That's it for my fourth quarter lending report. I'll now turn it over to Emilio Cooper to discuss deposits. Emilio?

Thanks, Peter. We entered 2020 with a set of ambitious goals to accomplish on the deposit side of our business. Our objectives were as follows: reduce cost of funds to get it in line with our peers; grow noninterest-bearing commercial and money market balances; improve the deposit mix; increase fee income; and create efficiencies while improving execution in our branch network. We entered the challenges presented by the pandemic, made tactical adjustments, and in the end, exceeded our objectives.

Total cost of deposits was reduced to 50 basis points as of 12/31. This brings us in line with our peers. It's important to note, we track closely our performance versus our peers, and this is the best performance relative to our peer group that we have had in the past 6 years, which represents the work we did in 2020 to accelerate better than our peers the rate of the reduction. It represents a reduction of 89 basis points from Q4 2019 when our cost of deposits was 139 basis points. We utilized the opportunity provided to us through our strong growth in noninterest-bearing, savings and money market balances to aggressively reduce pricing on CDs and liquid accounts over the course of several months.

Our team played a huge role in managing expectations with customers as we worked rates downward. As a result, we were able to mostly limit attrition by design to our CD portfolio. As Steve indicated, we expect to see additional reductions in our cost of deposits through the first half of the year as CDs repriced lower and we continue to execute on our strategy to grow noninterest-bearing and low-cost core deposits.

As highlighted in our release, we grew noninterest-bearing balances by over 50%. Money market and savings combined were up 45%. Total deposits grew by 16%. This strong performance led to significant improvement in our deposit mix. Noninterest-bearing accounts went from comprising 16.8% of total deposits up to over 22% by year-end. Time deposits were reduced from comprising 41% of total deposits down to 28% for the same period.

Growth in commercial deposits was well timed. We were able to leverage the enhancements to our cash management platform to establish primary operating account relationships. This helped to boost our service fees collected on deposit accounts by over 20% for the year. We restructured our retail leadership team coming into 2020, which powered our performance on a number of key initiatives. The major benefit of this change was the improvement in our ability to execute quickly and effectively with skilled leers who are embedded in our branches in each of our key markets.

In Q4, we announced a permanent closure of 2 of our branches located in the Hamilton market. Customers of these branches have been being serviced since April of last year at our other 2 locations that are equipped with drive-throughs located just minutes away from each of these locations. We do not expect any material attrition due to these closures for those reasons.

As I've shared on previous calls, we made strategic investments and added resources to our business, banking and cash management teams in 2019. These investments returned huge dividends for us in 2020. Primarily, it enabled us to capitalize on the new customer acquisition opportunity that was presented when we stepped up and filled the need for many commercial prospects who had grown frustrated with their existing bank relationships during the first round of PPP lending. Our team was prepared and worked collaboratively to capture this business, which accelerated our acquisition of core operating accounts. I applaud our deposit and lending teams for working so strongly together in 2020 to jointly accomplish these fantastic results. Our team does an incredible job engaging with our customers, actively managing their relationships and providing superior customer service. They persevered in the face of adversity and emerged victorious. Best of all, we go into 2021 stronger than ever and poised for performance.

Back to you, Pat.

Thank you, Emilio. At this point, I'd like to turn it back to the operator to open up for the question-and-answer session.

(Operator Instructions) The first question comes from Nick Cucharale with Piper Sandler.

So I wanted to start with the expenses. It looks like you had some performance-related compensation as the forecast right and throughout the year. Is that $10.5 million quarterly run rate a level you can get in the first quarter? Or do you feel like you'll work down that level? (inaudible)

Yes. That's -- it's a good question, Nick. I think it's important to clarify that the increase in expenses in the fourth quarter really was more of an accrual catch-up win. We saw some of the potential downside scenarios early in the year related to the pandemic.

We took action at that time to adjust back our accruals and try to line up our expenses with more of a downside scenario. And so by virtue of doing lower accruals early in the year, and ultimately, finishing the year at a level that we believe turned out to be pretty strong, we had some catch-up to do in the fourth quarter. So that's why you see sort of an outsized number on a noninterest expense basis compared to where we've been in the past. It was partly related to the reductions that we had made earlier in the year when things were a little more uncertain.

Okay. Great. I appreciate the loan growth commentary. I'd love your thoughts on the mix. Given the opportunity, is it likely for the growth this year to diversify more out of commercial real estate? Or is that what the market's giving you at this time?

Well, I'll give you my two cents, and then let Peter add. But listen, at the end of the day, given our current size, the mix doesn't shift drastically in any given quarter or, quite frankly, in any given year. I think we'll continue to be busy with new commercial real estate opportunities. I think we'll also continue to see some paydowns and payoffs in that category. So I think we'll probably have a similar year, although it might end up being a little bit back-end weighted in terms of new production given the strong finish we had in Q4 of '20 and some payoffs we know that are coming in Q1. But I'm also optimistic that we'll have strong growth in C&I and owner occupied. So hopefully, we'll see a little bit of maneuvering of the mix towards C&I and owner occupied, but I don't know that it will be a huge difference.

Certainly, the relationships and connections we've developed through PPP should help accelerate that a little bit. But it's also important to note that C&I tends to be smaller loan, tends to be lines of credit that aren't always fully drawn. So you're not going to see massive shift in that portfolio overnight.

But Peter, why don't you jump in and add anything you think would be relevant here?

Yes. I mean, you covered it pretty well, Pat, for Nick. But yes, I mean, when I say C&I, I really think C&I -- you've got your classic C&I, lines or credit term loans, but also owner-occupied real estate. It's like -- basically, I view the business as being investor real estate, C&I and then 10% or less for us has been consumer. We appointed RMs a couple of years ago now and at -- to goals and objectives that are much more focused on C&I business. I mean, we have a separate group that follows investor real estate. And I think that's kind of paid off where the RMs are out there focusing on C&I-related stuff. So we're always going to be doing investor real estate.

It's always going to likely be 45% to 55% of our business anytime of the year, but that's basically it.

Okay. And then swap fees took a breather after being elevated in the middle of the year. I know it can be difficult to predict, but given what you're seeing, is your expectation that line strengthens off the fourth quarter level?

Yes. I mean, I would say, you probably get a bounce back, but it's certainly -- it's lumpy in terms of 1 or 2 sizable deals could generate significant fee income. I don't know, Peter, from the pipeline, is there any visibility you have there, at least in the first half of the year?

I don't have it in terms of dollars, but I do sense like you -- like I think you were suggesting, Pat, I know in recent weeks, we've approved a few deals that are -- when the pricing tied to a swap. So yes, it's lumpy. It's going to be our -- tends to be the larger real estate deals, the better ones. And they don't always flow through in this even a pattern as we'd like. So I think we'll be back for sure.

Okay. And then lastly, just given where cash balances are at the end of the year, can you give us some color on how you're thinking about your liquidity position and the potential timing of deployment?

Steve, you want to take that one?

Sure. I think, Nick, as we take a look at it, we've been kind of managing to a level of -- somewhere in the $60 million to $65 million in excess liquidity to make sure we have adequate liquidity. Obviously, we -- as we look at PPP loan forgiveness, that has an impact on exactly how that affects excess liquidity. But what we've been doing over the last several months is, as we've had some excess liquidity, we've retired some more expensive Federal Home Loan Bank advances, for example, or brokered deposits that we've had at higher rates. So we continue to monitor that based on our loan growth projections. That's a good sign for us, obviously, because it's very much of a challenge from an investment standpoint. So I think we're good from a liquidity standpoint, and we manage that very actively.

The next question comes from Christopher Keith with D.A. Davidson.

So I think I'd like to just dig a little bit into the loan growth. We've had some good news over the last couple of months, vaccine, some stimulus. When do you think that kind of translates back into the pre-pandemic growth rate?

Well, I mean, it's hard to say at a market level. I'm not sure how much demand right now is being cut back based on uncertainty and other things. Certainly, in general, the capital markets have been pretty active and pretty strong. More specifically to First Bank, I think we haven't necessarily seen a big drop-off in activity in our markets. There are certainly sectors of commercial real estate where there's significant uncertainty, but there's other areas that are very robust in terms of their development. So we really haven't seen a drop-off in activity. And I don't know that -- we're obviously hopeful like everybody else that the vaccine distribution starts to pick back up and that we're looking at a much better situation from a health perspective 6 months from now, but I don't know that, that's going to necessarily translate to a significant change in loan demand in our market. And we're busy, and we think we can hit our goals based on current levels of demand. So...

Got it. Got it. And then I guess just at the deposit composition, time deposits, do you feel that you have more room to move down in either the absolute balance or the cost of deposits?

Yes. I mean, Emilio could answer better, but I think the answer is we probably have seen most of the mix shift that we're going to see, maybe a little bit more, but we continue to reprice our CDs lower. And during the early part of the year, the price reduction was drastic, and we saw some runoff. That seems to be stabilizing. But Emilio, why don't you jump in and add a little color on that?

Yes. I would agree with Pat's comments. What we're seeing is we've been able to, at our current price levels, retain at 80% of our CDs that come due. So we may see some continued slight reduction, but we're backfilling strategically with brokered CDs that are way less expensive than what we're finding in the market. But the first half of the year, we have about $250 million balances that are coming due that are still priced significantly higher than the rates that we're going to renew them at. So that's what set our comments relative to where we expect to see continued reduction in costs through the first half of the year.

Got it. So you got $250 million in the first half of the year, and you expect to retain around 80% of that?

Exactly. Yes.

Got it. Got it. And then I guess, guys, if I could just turn to the securities portfolio and follow up on the question on liquidity. The -- I'm not sure if you're finding attractive rates in this environment, but obviously, anything is better than the kind of 10 basis points at the Fed. So what are your thoughts around continued -- I mean, you took the securities portfolio down in 4Q, but what are your thoughts around that?

Well, Chris, it all centers around our liquidity position, right? So we're -- we have no desire, if our liquidity position bumps up based on loan forgiveness, to sit at that, as you said, the 10 basis points. However, we're very opportunistic. We're generally buying mortgage-backed securities, where generic type of marketable securities, where the yield is anywhere between, I'll say, [1 10 and 1 25]. So we still like to take a look at that opportunity. So we kind of balance that with our liquidity position. And if the opportunity presents itself, we'll probably be looking to get in the market.

Next question comes from Bryce Rowe with Hovde.

Wanted to maybe drill down a little bit on the cost of funds. Emilio, I appreciate you noting the $250 million coming due here over the next 6 months. Just curious where those are priced right now, and then where you kind of see current pricing for that type of deposit?

Yes. So the highest rate we're offering in the market is 50 basis points. And on average, those are going to be coming due off of rates that are right around the 105 to 110 space.

Okay. That's helpful. That's great. And so, Pat, I think you mentioned some potential upside here to the NIM on a -- kind of on a core basis when you strip out everything that's going on with PPP. Just wanted to kind of get a feel for what's behind that expectation. I mean, is it the core -- or the funding costs coming down? And then what are the expectations from a kind of a core loan pricing perspective? Where are you originating loans today?

Yes. So just to be clear, we don't have enough visibility to know that the margin is absolutely moving higher. But I think our view on the opportunity for margin enhancement heading to next year is better than it was for a couple of reasons. One, we think we'll continue to see some benefit of some reduced funding costs. With the stretching out of the yield curve, we're hopeful that, that will reduce some of the pressure on the pricing for new loan production. And then obviously, if that yield curve expansion and/or the long end of the curve starts to move even higher, that could certainly mean even better news from a margin standpoint.

So at this point, I think we feel like there's some potential for upside in the margin. If you look at 3.40% being kind of a rough estimate of the core, excluding PPP, my expectation isn't that, that number is going to move a lot higher into next year. But I think if we can keep it at 3.40% compared to where we were earlier in the year, we're at a size now where every couple of basis points in margin leads to meaningful bottom line improvement.

So I don't suspect that we'll see huge margin expansion. I think we've probably already seen more than I would have thought. If you had asked me 6 months ago, I was sort of hopeful that the margin would improve. And if you'd ask me then whether we would have gotten to 3.40% core in the fourth quarter, I'd said that sounds ambitious. So I think in some ways, the good news is we've already squeezed a lot of the juice out of that orange and has left us in a pretty good position as we're heading into 2021, but there are scenarios where we could see it even improve a little bit more as we move forward.

Okay. That's helpful. And maybe, Peter, you can take the question about where you're originating loans today. I also wanted to ask you, obviously, nice, healthy loan growth on -- from a core perspective in the back half of 2020. That's a bit counter to, I think, what you might see from most participants in the industry. So just kind of curious what the source of the growth is in terms of market share takeaway, newer clients and how you're going about sourcing those new loans?

What we're sourcing on new loans has really been the same thing we've been doing all along. It's really -- it's been a combination of additional/new business with customers as well as on the C&I side, a few new customers that we brought in where, instead of our -- I don't know, our average C&I loan, again, including owner-occupied real estate, may be less than $1 million to $1 million. You bring in a couple of $5 million to $6 million C&I loans near the end of the year, that's going to help drive that number.

So it was decent marketing on the part of RMs and working with existing customers who are involved in new projects, that kind of thing. From a pricing standpoint, again, most of our loans, if they're longer-term, real estate-related, or -- we fixed -- or we try to fix the rate for 5 years. We'll do a 15- to even 25-year AM, depending upon the asset quality. But we're probably in the 3.5% to 4.5% fixed rate range right now. Floating would be different. And we'll put floors on those, too. So if come due in 5 years to get repriced, we won't get caught at Treasury's plus [2 50] kind of scenario like we might today.

Okay. Okay. That's helpful. Let's see. And then I wanted to ask about -- you guys have given some good information on what you expect for this round 3 of -- of this next round of PPP. In terms of kind of the pace of forgiveness, I mean, we're almost a month into the first quarter now. Just wondering if the pace of forgiveness has picked up relative to what you might have seen in the fourth quarter. And then on that point, what's the loan -- the balance of loans in the PPP bucket that are in excess of $2 million?

Well, forgiveness actually has slowed with the onslaught of new applications in this kind of second round. I mean, I think the SBA came out the other day and even stated that they're not going to be addressing forgiveness for a while. So they keep -- on first round so they can get their hands around processing the second round. So I see that slowing early on.

The -- as far as the amount, it's funny, the average size of the loans we're looking at, I think the first round, our average loan size is around $178,000. This -- so far in the second round, it's $172,000. So it's amazingly similar.

But as far as over $2 million, I don't have that. We did a handful over $2 million -- I mean, less than $5 million in the first round. And I think we've seen one in the second round so far. I don't have that data in front of me.

And Peter, the reason I asked that is we've heard that -- and we know that the SBA is adding scrutiny in terms of the forgiveness process for those loans. So it may take even longer with those loans over $2 million. That's why I asked that.

Yes. (inaudible)

Bryce, I think you'd also asked about kind of where we are in the process. And I think we've submitted over 50% of those first round loans for forgiveness. I don't know, Steve, you might know, but how many of those we've actually gotten forgiven. But I think if we were at roughly $135 million at year-end versus the $190 million, that's about $55 million out of the $190 million. So a little over 25% has already been forgiven, another 25% has already been submitted for forgiveness, and you got roughly half that the borrowers still need to complete their forgiveness applications.

Okay. And I would assume, Pat, that you guys are reacting to those borrowers in terms of completing those apps and getting the apps into you all to start that process.

Yes. I mean, we've streamlined it a fair bit. I mean, the first time around, everything we were doing was sort of the old-fashioned manual paper-based system, and we had some time in between the original application forgiveness to work with a technology company to get a portal and a website set up. And so I think that part of it on the forgiveness side seems to be working fairly well, partly because the forgiveness process is just a lot more spread out, right? You had -- we had over 1,000 applications within a few week period on the front end. Whereas now, the applications for forgiveness are coming in a few week or what have you. So it's just much easier to manage it.

Yes. Okay. Okay.

I would add, we're not seeing a lot of issues in terms of forgiveness applications getting kicked back or denied. So I think that's good news.

Yes. Yes. Yes. That makes sense. I wanted to ask one more just on the level of deferment. Obviously, you called out the deferments in the press release. Was curious with the nature of the deferments, are they P&I or just interest-only? And then what -- maybe what's the outlook there? I mean, if you get to a point that you can't necessarily defer anymore, do you see them moving into that TDR bucket? Just trying to get a gauge for what charge-off activity or loss activity might be relative to those deferments.

Yes. I mean, it's hard to say, but what I would tell you sort of in general is, for the most part, anybody that's still on deferral is at least paying interest-only. So kind of the natural evolution was folks got P&I for 90 days, some that needed another 90 days, some of them went to interest-only, some of them got another 90 days of P&I, but almost everybody went to paying something if they got a deferral that extended them into 2021. So I think that's good news that folks have the capacity and wherewithal to at least resume making payments in some fashion.

And based on what we're looking at and hearing from our borrowers, they all feel confident that once the vaccine is distributed and things return to somewhat normal that they believe their businesses will come back on track. So we don't have any situations where we did a deferral, but we just know it's a dead end, and it's not going anywhere.

And I think in every case, the deferrals were granted because we got strong operators, a great history, good personal strength and guarantees behind the deals. And we felt comfortable that there was a very good business case for why this borrower would be strong on the back end of this.

So all that being said, I think that means we're optimistic. We don't think there's big known issues where these companies won't have a chance to come back. But obviously, there's uncertainty there. So we're going to have to keep a close eye on it.

(Operator Instructions) The next question comes from Erik Zwick with Boenning and Scattergood.

Apologize if any of my questions have been answered already. I've been bouncing back and forth between a few calls this morning. Want to circle back on the expense discussion. And I heard that earlier comments about most of the fourth quarter increase being due to the comp line and the accrual of some of the incentive comp. Just curious, as we move into 2021, when do you award merit increases? And just trying to figure out what's kind of the starting run rate for the expenses that we get back to that $10 million level where you had been running, or is there some natural inflationary pressures from some other sources in there as well?

Yes. I think you hit the nail on the head. There are definitely some natural inflationary pressures. I mean, at the moment, I don't think they're as strong as they might be, but it is pretty standard for us in February, March to make structural adjustments and/or look at promotions were warranted, et cetera. So we always see a little bit of a tick up in -- not always fully reflected in the first quarter because those changes get finalized towards the end of the first quarter, so that tends to show up more in the second quarter. But we -- factoring all that in, we sort of estimated that 10.5 was a decent run rate for quarterly expenses, factoring in some of those adjustments we just talked about.

Great. And then turning back to the loans. In terms of the 5% to 7% outlook that was mentioned in the press release, is that inclusive or exclusive of the PPP, I guess, kind of outflows here at the beginning or kind of inflows and outflows that will be?

Yes. That's a good question. Important clarification. That is sort of -- the way we think about it, as Peter described, our normal business. So the 5% to 7% is looking at our loan portfolio, exclusive of PPP. So sort of where that book of business was at the end of the year and then what we think we can do in terms of net growth, specifically related to that core business. So actual loans, we don't really know, right? I mean, some of the old PPPs are going to get forgiven. We'll fund some new ones. I don't really know, and we're not modeling PPP impact on any of that with the exception of understanding that there'll be some additional fee income. So the 5% to 7% sort of just on the core business.

Great. And then last quarter, you had mentioned some projects underway to increase deposit-related fees. Just curious, any update you can provide on those? And what type of impact you might see to the income statement at the fee income from those efforts?

Yes. I mean, I think it's sort of little things here and there. So I think you'll see some slight benefit. But I'll let Emilio talk more specifically to some of the more critical initiatives there. I think they're going well.

Yes. So we did launch, as we talked about it, some initiatives related to increasing our fees on deposit account. And we are seeing a nice boost, but they were small. I mean, one of the specific initiatives related to our remote deposit capture and making sure that we were collecting fees appropriately and in line with the marketplace. So we executed on that towards the end of the third quarter, and we're continuing to monitor the impact of that, but that certainly drove some slight improvement in the fourth quarter. We also tightened up our rebate policy on overdraft, and that represented a nice boost for us and some opportunity there as well as our tech reordering policy. So we're continuing to review and look under every rock versus opportunities relative to the competition where we can enhance our ability to collect what is fair. And I would expect that we're going to continue to see modest improvement in our service fees, particularly as volume returns relative to what we had seen when the pandemic had hit. So I would expect to see continued growth for this year in that category.

That was helpful. And then just last one for me, just thinking about uses of capital in 2021, sounds like you're fairly optimistic about opportunities for organic loan growth. But then looking for alternate uses such as buyback, potential acquisitions and then maybe even any market expansion, if there's any markets that you're not in today that you've got your eye on, just how you're thinking about that in the coming year?

Yes. I mean, I think, certainly, with the planned growth and the improved profitability, I think our capital base right now is strong. And with strong earnings, we continue to replenish that capital base. And we continue to think that opportunistic M&A can be a good way to use capital and drive earnings and drive value creation. But quite honestly, at our current stock levels, that makes it more difficult.

So I'd say our primary focus is just on executing the buyback. We think the shares at these levels are very attractive, and I'd say that's primary. And then as it relates to organic growth, I mean, we're always on the lookout for good bankers who can either open new markets for us or help us take share in our existing markets. So I'd say that's just kind of standard. It's not a special capital allocation class. It's -- if we have good business opportunities, and it can generate a good return on investment, we are constantly looking for those. So...

This concludes our question-and-answer session. I would like to turn the conference back over to Patrick Ryan for any closing remarks.

I'd just like to thank everybody for joining the call and thank the group that asked great questions, and we look forward to regrouping with everybody at the end of the first quarter. Thank you very much.

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