Fulton Financial Corp (FULT) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Fulton Financial Second Quarter 2020 Results Conference Call.

(Operator Instructions) Please be advised that today's conference may be recorded.

(Operator Instructions)

I would now like to hand the conference over to your speaker today, Matt Jozwiak. Please go ahead, sir.

Good morning. Thank you for joining us for Fulton Financial's conference call and webcast to discuss our earnings for the second quarter of 2020. Your host for today's conference call is Phil Wenger, Chairman and Chief Executive Officer. Joining Phil Wenger is Curt Myers, President and Chief Operating Officer; and Mark McCollom, Chief Financial Officer.

Our comments today will refer to the financial information and related slide presentation included with our earnings announcement, which we released at 4:30 p.m. yesterday afternoon. These documents can be found on our website at fult.com, by clicking on Investor Relations and then on News. The slides can also be found on the Presentations page under Investor Relations on our website.

On this call, representatives of Fulton may make forward-looking statements with respect to Fulton's financial condition, results of operations and business. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors and actual results could differ materially. Please refer to the Safe Harbor statement on the forward-looking statements in our earnings release on Slide 2 of today's presentation for additional information regarding these risks, uncertainties and other factors. Fulton undertakes no obligation, other than as required by law, to update or revise any forward-looking statements.

In discussing Fulton's performance, representatives of Fulton may refer to certain non-GAAP financial measures. Please refer to the supplemental financial information included with Fulton's earnings release announcement released yesterday and Slides 14 through 16 of those non-GAAP financial measures to the most comparable GAAP measures.

Now I would like to turn the call over to your host, Phil Wenger.

Thanks, Matt, and good morning, everyone, and thank you for joining us. Today, we will follow our usual call format, beginning with some prepared remarks. First, I'll provide a high-level overview of the quarter. Next, Curt Myers, our President and Chief Operating Officer, will share some thoughts on our business performance for the second quarter of 2020. And then Mark McCollom, our Chief Financial Officer, will share the details of our financial performance. And after that, we'd be happy to take your questions.

COVID-19 continues to have a significant impact on our world and our company, but all things considered, we are pleased with what Fulton was able to achieve in the second quarter. I want to start out by thanking our employees for all they've done to serve our customers throughout the pandemic. It was truly inspiring to watch our team members who had their own questions, fears and challenging personal situations, manage their own needs while continuing to fulfill Fulton's purpose of changing lives for the better for our customers.

Thanks to the dedication of our team, the flexibility of our customers and our investments in technology and digital platforms, we have continued to provide needed banking and financial services throughout the pandemic. We successfully administered the SBA's Paycheck Protection Program, or PPP, of providing more than $1.9 billion in loans to businesses and nonprofit customers. We offered loan deferrals and payment relief to consumers, and we put in place new benefit programs to help our employees throughout this confusing and difficult time.

When I spoke with you in April, Fulton had responded very quickly to keep employees and customers safe, while continuing to deliver essential financial services to the communities we serve. Now 3 months later, while our unwavering focus on health and safety continues, we now view the virus as just one more factor we need to deal with as we go about our day. We're working hard to ensure that our team's energy remains focused on achieving our longer-term priorities of growth, operational excellence, and effective risk management and compliance.

In June, we gradually began to expand lobby access for our customers, and currently, we have resumed regular lobby hours at 146 of our 223 financial centers. And a team of leaders from across our company has put in place a plan to gradually re-onboard employees who have been working remotely. This process will take place over the remainder of the year and can be adjusted or reversed at any time, depending upon the progression of COVID-19 and the associated safety protocols that health experts recommend.

Turning to our financial performance in the second quarter. Our consumer and commercial lines of business performed relatively well, given the environment in which we're operating. In consumer, we saw increases in deposit balances, growth in residential mortgages and relative strong performance in wealth management. In commercial, our loan pipeline remains stable, deposits increased even after factoring out funds received through PPP. And we saw continuing resiliency in a number of fee income businesses, including merchant services, investment management and trust services and swaps.

Several credit metrics improved during the quarter, and you'll hear more detail about that in a few minutes. However, we'll need to wait until we know more about the depth and duration of the COVID-19 pandemic over the next 6 to 9 months to be able to understand the longer-term impact on our customers. We have been and will be very actively managing our expenses over the remainder of the year to help mitigate the anticipated negative effects of the pandemic.

Other highlights during the quarter included the opening of a new financial center in Baltimore, continuing our commitment to growing our presence in urban markets. We also announced the creation of a New Fulton Forward Foundation, an independent nonprofit private foundation, funded by Fulton Bank. The foundation will provide financial impact gifts to nonprofit organizations that share Fulton's vision of advancing economic empowerment, particularly in underserved communities. The foundation is an extension of the bank's Fulton Forward Initiative, which promotes diversity, equity and inclusion, encourages the building of vibrant communities, fosters, affordable housing, drives economic development and increases financial literacy in the communities served by Fulton.

In April, in addition to our traditional and ongoing support of our communities, Fulton Bank made an extra $500,000 donation to the Foundation to support COVID-19 assistant programs in the markets we serve.

About a week ago, the Foundation announced that it had distributed those funds to nearly a dozen worthy, worthwhile community programs. So as you can see, we've accomplished a lot in the first half of this year under very challenging circumstances.

And now I'll turn things over to Curt so he can discuss our business performance in more detail.

Thank you, Phil, and good morning, everyone. Our second quarter performance saw solid results in certain areas of commercial and consumer lines of business. We also saw challenges as well as the full quarter impact of COVID-19 was felt throughout our footprint. Our participation in the Paycheck Protection Program, or PPP, was a highlight as we stood up processes, redeployed team members and helped preserve over 100,000 jobs during this critical time.

In total, we originated a little over $1.9 billion in loans due to the issuance of more than 10,000 PPP loans. As noted last quarter, we continue to work with our customers during this difficult time and are providing payment relief ranging from 3 to 6 months, depending on the product.

Slide 3 provide you with an update on the loan deferral programs we have been offering our customers during this time. New deferral activity has slowed considerably since mid-April. For our commercial customers, we are just now starting to see the expiration of those 90-day deferrals. If an additional 90-day deferral is requested, a thorough risk-based underwriting and approval process will occur. While it is too early to determine the level of second deferral requests, we are confident that the total will be meaningfully less than the initial deferrals.

Shifting to loan growth. Our overall loan growth trends for the quarter were strong, but were impacted materially by the PPP program. Excluding PPP, commercial loan balances declined for the quarter with average balances decreasing $420 million during the period. This was largely driven by reduced line utilization during the second quarter. We have seen a decline in commercial line use from 33% to 25% or $340 million. With PPP funding and the gradual reopening of the economy within our footprint, certain businesses were able to pay down their borrowings. As you can see, this decrease in line utilization accounted for the majority of the commercial loan decline when you excluded PPP funding during the quarter.

Looking forward, our commercial loan pipeline at June 30, 2020, remains relatively flat from the first quarter and is essentially unchanged from a year ago. In our consumer lending business, our residential mortgage results continue to be very strong, producing linked quarter loan growth of approximately 5%, in spite of significant refinance activity.

Deposit growth has been very strong for the quarter as well as PPP funding to date has largely remained in the customer deposit accounts, and consumer deposits have also benefited from stimulus checks and the reductions in consumer spending. Deposits grew over $2.5 billion during the quarter with $1.7 billion of this growth coming in noninterest bearing accounts. We are also pleased with our progress in repricing our deposits. Deposit costs declined 26 basis points during the quarter from 62 basis points down to 36 basis points.

Turning to fees. Our mortgage company had a very strong quarter with both elevated originations and strong gain on sales spreads. Total residential mortgage originations for the second quarter of 2020 were $811 million, an increase of 67% from the same period last year. Refinance activity accounted for 54% of originations in the second quarter of 2020 compared to 18% for the same period last year. Our mortgage pipeline sits at $879 million at quarter end, which is the highest level ever.

Our wealth management business also performed better than we had anticipated this quarter as the stock market has rebounded quicker than we had expected, and we continue to see the benefit of our high level of recurring fee business. Our assets under management and administration were at $11.1 billion at quarter end.

Moving to credit. Certain credit metrics showed improvement over the quarter. Our nonperforming loans were flat linked quarter and down $8 million from a year ago. Net charge-offs were $4 million, down from $11 million last quarter and represented 9 basis points on an annualized basis. Despite these positive near-term credit trends, our outlook remains cautious. It is too early to fully assess the impact of COVID-19 on our regional economy and the related impact on our borrowers.

As you can see on Slides 4 and 5, we have limited portfolio exposure to some of those industries that have been impacted the most by COVID-19. We have expanded our disclosure from last quarter to provide additional subsectors and details on areas of focus. Most of the loans are secured by real estate or other forms of collateral, which should help mitigate losses in the event of default. Our loan portfolio is diversified from a geographic, product and collateral perspective.

I will remind you that our internal house limit is $55 million to any one borrowing relationship, which we believe is lower than other banks our size. This strategy has helped us maintain a diversified portfolio. In addition, our owner-occupied commercial mortgages represent close to half of our overall commercial mortgage portfolio. We continue to generally lend to experienced borrowers that have stable cash flow and sizable equity positions.

Now I'd like to turn the call over to Mark to discuss the financial results in more detail. Mark?

Thank you, Curt, and good morning to everyone on the call. We have taken feedback from many of you to provide additional COVID-related disclosures during the past 2 quarters, and this is reflected in today's presentation. Unless I note otherwise, the quarterly comparisons I will discuss are with the first quarter of 2020.

Starting on Slide 6, earnings per diluted share this quarter were $0.24 on net income of $39.6 million. Second quarter earnings in comparison to the first quarter benefited from a lower provision for credit losses. Our fee income also produced strong results, and our operating expenses were better than our expectations on a core basis. These positive trends were offset by a linked quarter decline in our net interest income.

Moving to Slide 7. Our net interest income was $153 million, a decrease of $8 million linked quarter and in line with our guidance, a full quarter impact of the 150 basis point decline in interest rates as well as a decline in commercial loans, excluding PPP loans, due to the rapid decline in line utilization drove this overall decline in net interest income quarter-to-quarter.

Our net interest income for the quarter was 2.81% versus 3.21% in the first quarter. The 40 basis point of linked quarter compression in our net interest margin was slightly higher than our internal projections and was driven by the sharp decline in interest rates for the quarter, the influx of PPP loans, as well as excess liquidity we are currently experiencing. Our loan-to-deposit ratio declined during the quarter from 98.5% to 95.1%.

On the liability side, in addition to the progress we made this quarter in lowering our deposit cost, we believe our deposits can still reprice lower as CD maturities occur during the second half of the year. These maturities total approximately $900 million over the next 2 quarters at a blended average rate of approximately 1.5%.

Turning to credit on Slide 8. Our second quarter provision for credit losses was $20 million versus $44 million last quarter and $5 million a year ago. This decrease in provision was driven by the pace of decline in the economic outlook during the second quarter as compared to the first quarter as well as lower net loan charge-offs during the quarter.

Our CECL methodology utilizes Moody's for the macroeconomic assumptions that drive our models, and we also consider and employ qualitative overlays to our models based on a comprehensive review of additional financial and economic data.

Nonperforming loans as a percentage of total loans decreased to 83 basis points, excluding loans originated under PPP compared to 90 basis points a year ago and declined to 75 basis points, including the PPP loans. Our allowance for credit loss related to loans at June 30 was 1.53% as a percentage of total loan balances, an increase of 13 basis points from the prior quarter. This ratio excludes PPP loans from the calculation. The allowance for credit loss coverage ratio as a percentage of total nonperforming loans was 183% at June 30, 2020.

Moving to Slide 9. Noninterest income, excluding securities gains, were $53 million, down 3% from $55 million last quarter and $54 million a year ago. This result was better than our guidance, which had predicted a decline of between 5% and 15% and was driven by outperformance in mortgage banking, capital markets and wealth management revenues. Mortgage banking revenues were up $3.7 million from the prior quarter, despite recognizing a $6.6 million mortgage servicing rights impairment charge during the quarter as interest rates rapidly declined and expectations for prepayments increased.

With respect to mortgage loans that we originate for sale, our new commitments were $573 million for the quarter, an all-time high for the company and our gain on sales spread of 2.89% for mortgages sold was significantly higher than our recent trend as the sharp drop-off in interest rates has increased demand for mortgage assets. Capital markets revenue, which is primarily composed of swaps revenue, was also higher than we anticipated, coming in at $5 million compared to $5.1 million last quarter.

Despite the decline in line utilization, which impacted loan balances, we did see solid originations otherwise, which drove this result. We did execute on a small investment portfolio restructuring during the quarter involving the sale and reinvestment of $85 million of investment securities. This resulted in recording approximately $3 million of securities gains during the quarter, offset by a similar amount of expense to prepay some higher cost FHLB advances.

Moving to Slide 10. Our noninterest expenses were $143 million in the second quarter. Included in this amount was $2.9 million of FHLB prepayment penalties as noted above. Excluding this cost, total expenses were at the low end of our guidance and declined $2.5 million from first quarter levels and $4 million from the second quarter of last year. While many of our expenses have been declining as a result of COVID-19, certain expenses have increased as a result of the pandemic, including special bonuses for frontline personnel, contributions to COVID-related charities, PPE expenses to keep our employees and customers safe and certain other costs. These expenses totaled approximately $3 million for the quarter. Our effective tax rate was 14% for the quarter as compared to 10% in the first quarter of 2020. This was primarily due to higher pretax earnings in the second quarter.

Slide 11 focuses on our liquidity. Since mid-March, we've maintained excess cash of approximately $200 million to $600 million per day. This number has increased throughout the second quarter as we have not seen the runoff in PPP funding that we originally expected. This impacted our net interest margin moderately, and despite stabilization in the markets, we would anticipate maintaining extra liquidity until we have a clearer picture on when PPP funds will be utilized. We're currently registered to use the PPP loan facility through the Federal Reserve, but we have not yet had to tap that funding source as we have had strong deposit balances throughout the quarter.

Slide 12 gives you more detail on our capital ratios. We've evaluated our capital and liquidity under a variety of stress scenarios, and in all models, both the bank and holding company maintain sufficient regulatory capital and liquidity to maintain our current common shareholder dividend, which is our intention.

Lastly, on Slide 13, we would like to provide our thoughts about forward guidance for the third quarter. With significant uncertainty still existing in the economy, we are not providing guidance beyond the third quarter at this time.

Our third quarter guidance is as follows: For loans, for the third quarter, we expect overall loan growth to be plus or minus 1% to 2%. Residential mortgages will continue to lead the way with positive growth, with commercial loans producing flat to modest declines in growth.

Deposits. We would expect deposits to experience growth of 1% to 2% in the third quarter with seasonal municipal deposit inflows, offset by modest PPP deposit runoff.

We expect our net interest income to be in the range of $150 million to $153 million for the third quarter of 2020. We are not anticipating material amounts of PPP loan forgiveness to occur in the third quarter as we currently expect loan forgiveness activity to increase in the fourth quarter.

We expect our noninterest income to stay similar to second quarter levels in the range of $50 million to $53 million.

Mortgage banking should continue to be a bright spot as our pipeline is very strong, and our third quarter is a seasonally busy time of the year. Overall, we expect operating expenses to be consistent or slightly lower than the second quarter in the range of $139 million to $142 million. Lastly, we expect our effective tax rate to be between 11.5% and 12.5% for the third quarter.

With that, I'll now turn the call back over to the operator for questions.

(Operator Instructions) Our first question comes from Frank Schiraldi with Piper Sandler.

Starting with just -- and I asked the last quarter too, and I know it's really the wildcard for the back half of the year. But Mark, if you -- just wondered if you could maybe update us with your thinking on provisioning. I realize you guys aren't going past the third quarter in terms of guide, so maybe any color you could give for your thoughts in a CECL world provisioning in the third quarter.

Yes. So Frank, as you know, under a CECL model, you're providing each quarter for your current expected future credit losses. So if we get things exactly right then our provisioning in future periods, we've already covered all the loans on our books. So our provision really becomes the entry once you calculate what your allowance needs to be for the third quarter, that just becomes the last part of that equation. So you factor in loan growth, you factor in changes to your portfolio mix, you factor in net charge-offs, and then the wildcard that you're referring to is, you factor in changes in our forward look on what macroeconomic assumptions are being used in your model.

So based on all of that, you would say that if we think we -- and I say, we being both our company and the industry have gotten things right this quarter, that could imply then that next quarter, if you're not changing those macroeconomic factors, then you're just accounting for those other things, which is changes to your portfolio, which we're giving guidance on that and net charge-offs, which you've seen what our performance was this quarter in terms of net charge-offs, in terms of nonperforming levels, et cetera. But another wild card in all this certainly is going to be as loans start to come off deferral, what our incidence rate is of those loans staying current, second round deferrals or whether we start to see [deterioration].

Okay. So in the CECL world, the way you're thinking about it, if you've gotten things right, the model is right, and even in the face of higher charge-offs potentially at some point in the third or fourth quarter, we might see -- you could see provisioning not even cover charge-offs as those reserves have already been taken in the life of loans sort of world. Is that reasonable?

That is a possibility, yes.

Okay. And then just wanted to try and get a sense of how conservative your fee income guide might be. You talked about the record mortgage pipelines. It seems like the MSR impairment is based off of expected prepayments, which, I guess, is already baked into the model at this point. So just wondered if you could talk a little bit about maybe the puts and takes in -- of fee income in 3Q being sort of in line with the 2Q result.

Yes. I think you're right, Frank. When you think of where -- and again, we always let the folks on the call here judge where we're being conservative or aggressive. But in that, this past quarter, we had mortgage banking revenues that included a $6.6 million write-down in our MSR impairment, the current value of that is written down to kind of the mid-60 basis point range at this point. So how much further -- and if further write-downs might have to occur in the third quarter is really sort of anyone's guess. But depending on the level of MSR impairment in the third quarter, I think that's where there could be to use your word, a wild card, in those third quarter numbers.

We also had swaps revenues in the second quarter that were strong. Our pipeline maintains relatively stable, as Curt noted on the call. So depending on what third quarter originations are, that's another factor. And then the last thing I would mention on fee income would be wealth management revenues and where the stock market is because about 81% of our revenues are really tied to stock market valuations, although a lot of those are kind of paid earlier in the quarter. So the fact that we had a fairly strong stock market in early July should bode relatively well for that business as well.

Right. Okay. And then just one final quick one, if I could. I was just surprised to see within yields in the loan book, the significant compression that we saw in the CRE book linked quarter. And I wondered if there was anything sort of funky there. Is that just related to variable rate loans within that portfolio? Could you just give a little color? It looks like it came from -- down from 4.2% to 3.5% in the quarter.

Right. Yes. So I mean, obviously, with the rates dropping, Frank, we have $6.4 billion of loans tied to 1-month LIBOR, another $1.5 billion tied to 1-year LIBOR. Both of those dropped pretty fast, particularly from kind of mid-May on. And a lot of those commercial real estate loans are tied to swaps. So our swaps revenue is strong, but then with a higher percentage of that portfolio being variable rate, that would account for most of that.

Our next question comes from Casey Haire with Jefferies.

Yes. So I wanted to touch on -- I appreciate the NII guide here, but the NIM outlook, given the wide variance in the loan growth, just some -- the headwinds and tailwinds that might be there. Mark, I know you mentioned you got some CD repricing benefits, but just some help as we think about NIM in the third quarter here.

Sure. Yes. So we don't give NIM guidance. We give NII guidance, but to give you some other data points to help. One thing I would comment is we have -- we show you we have about $10.5 billion of interest-bearing deposits in either demand or savings. Those averaged about 21 basis points for the second quarter, but we've continued to very actively manage that. And for the month of June, those interest-bearing non-maturity deposits were 15 basis points. So in addition to CDs, I would expect to see that nonmaturity demand book continue to price down a little bit lower as well.

When you also consider margin our PPP loans for the second quarter, that impacted margin negatively by about 3 to 4 basis points, and the excess liquidity that we're currently sitting on impacted margin about 7 basis points for the quarter. So the question really then starts to become for margin, again, when do those PPP customers use those funds, or do they not utilize them, in which case, then we will take other measures as other loan maturities and securities come due over the back half of the year to whittle down that cash position. But until we know that for sure, as I mentioned, we're going to continue to hold higher liquidity. We just think it's the right thing to do at this part of still an unknown economy.

Yes, yes, I get that. So on the PPP, sorry if I missed this in the release for the deck, but the blended loan yield on that?

Yes. So as you know, it's a 1% coupon and our fees were just about $60 million. We are amortizing that over 2 years. So that's about $7.5 million a quarter that comes in. So the blended yield on our PPP would be about 2.5%.

Okay. Got you. Okay. All right. Just last one for me. On the credit front, the forecast that you guys used, what can you tell us about it in terms of, like, as we think about talking to you guys again in 3 months and what the -- I mean, I know it's a fluid situation, but like what does your current forecast have in it? Does it have more stimulus? Any sort of macro GDP factors that you can point to that we can look at 3 months down the line and say, "Oh, it's gotten worse or it's gotten better"?

Yes. Sure, Casey. We don't have any additional stimulus in there. We are currently using Moody's for all the macroeconomic variables and that both we employ in our models as well as some of the macroeconomic variables that we look at for our qualitative overlays. So we are using the Moody's model. It was as of June 9. That model assumes an unemployment rate as of the end of December of 10.2%, and at the end of 2021, of 8.5%. Now unemployment is not actually used embedded in our models, but it is one of the larger qualitative overlays that we consider. And then we also use Moody's for all the other economic data for assumptions on the BBB bond rate, housing starts, et cetera, really all comes through their analysis that we rely upon.

Our next question comes from Chris McGratty with KBW.

Mark, I want to go back to the NII comments just to make sure I'm clear. The guidance you gave for Q3, I guess, first question, is that an FTE number? Or is that just a GAAP number?

It's a GAAP number.

Okay. And I know you said most of the fees will come in Q4. Was there any PPP fees realized in Q2? And does that guide assume that 7.5%? Is that the right way to think about it?

Yes, it does. We've been -- as those loans have been on board, and we've been -- we started amortizing over the 2 years at that time.

Okay. Okay. And do you have the average balance of PPP loans in the quarter?

Yes. Average balance was about between $1.3 billion and $1.4 billion.

Okay, great. And then maybe my last question, branches have gotten a lot of attention at the industry level given the revenue headwinds. Can you just remind us where you guys are in terms of thoughts on branches? I know you collapsed the charters a few years back. Just wanted to get your sense on the ability to run any expenses out over the next year or so?

Yes. So we've -- going from 270 branches down to 223, and we continue to look at opportunities for consolidation, and I believe that they do exist. So we do believe we can drive more expenses out.

Our next question comes from Daniel Tamayo with Raymond James.

I just wanted to touch on the deferral information. Appreciate all the disclosures there. How many of those deferrals -- and you said that there's been -- there is an expectation for the amount post renewal, if you will, to come down. But of the amount that you disclosed, are there any re-deferrals, if you will, in that number? And what's kind of the trend in terms of what's going current versus what's being renewed there?

Danny, it's Curt. Just a little more insight to that. We have just started to have those first 90-day deferrals expire, and we are evaluating second deferral requests. Less than 1/3 of them have expired and of those, it's been a meaningful reduction in the request for second deferrals. I think we'll have better data for you in the third quarter, but as we are starting that process, we are seeing a meaningful decline in second deferrals.

Okay. And then as we look at -- I'm looking at the criticized and classified loans on Slide 4. So I was kind of surprised to see no criticized and classified in the hotel/motel bucket within investor real estate. What's your read there on why that segment has held up well?

Yes. Don't have any specific things. I mean, we are very conservative in our underwriting in hotels overall. Again, we have 75% lower of cost or market value at origination, and we have also very strong cash flow when we originate and then that portfolio is performing over time. They have also a large portion of those have received PPP support. That's a business that has been significantly affected, and a lot of those have received PPP.

Our next question comes from Erik Zwick with Boenning and Scattergood.

First, just a follow-up on the deferral discussion. I think, Curt, in your prepared comments, you mentioned that for any of those that have received deferral and make a second request, they'll go through a thorough, kind of, risk-based underwriting process. Given that those that make the second request are likely businesses or consumers who've had their cash flow severely impacted, businesses may be operating with revenue significantly below what would be considered normal. What does that kind of risk-based process entail at this point? What factors are you looking at? And at what point do you make the decision that you may need to take a charge-off? I'm just kind of curious how that plays out since the -- some of these loans, if you were to look at them as new loans today, may not meet your typical underwriting requirements.

Yes, it's a great question. So we are looking at those -- kind of like the market's looking at bank stocks right now. We're looking at it from a capital standpoint. We're looking at it from a liquidity standpoint, borrower and guarantor support to get through the crisis. So it's really those mitigating factors beyond just performing cash flow so that it's very difficult to establish or understand ongoing cash flow with those borrowers right now. So we are looking at capital. We're looking at liquidity, and we're looking at guarantor ability to keep those loans performing through this.

That's helpful. And then just turning to loan growth. On Slide 13, you've got the range of plus or minus 1% to 2%. And I think you mentioned that the pipeline remains stable at this point. Just curious what you're seeing if there is any particular sectors where the pipeline is stronger or weaker than you had expected and what could potentially -- what factors lead to that loan growth potentially coming at the bottom or the top end of that range for your outlook?

Yes. As we look at it, the pipeline is stable. The pipeline is very diversified. There are certain things that are not in the pipeline because they've been impacted businesses, but it still remains a very diversified pipeline. I think the variability in our growth will be essentially the same as this quarter. It's going to depend on how much line paydown that we have, how much early prepayment we have and how much residential mortgage refi that we have. I think that's what will move us towards the lower or upper end of that range.

Got it. And just one last small one. On the FDIC insurance expense that was down quarter-over-quarter even with the balance sheet getting larger, just kind of curious what's driving that calculation today? And if the 3Q value should be similar to 2Q?

Yes. 3Q value should be similar to 2Q, and it was a function of our sub debt raise actually in the tail end of the first quarter, and we downstreamed some of that money to the bank. So the way that FDIC now calculates that ratio, they look at bank level capital ratios, the leverage ratio at the bank level becomes one of those factors. So with excess capital the holding company raised and downstreaming some of that, it lowered the ratio -- or lowered the assessment, rather.

Our next question comes from Russell Gunther with D.A. Davidson.

Just a follow-up on the deferrals. So given where they stand today, and it sounds like likely headed lower in the second -- in the third quarter, do you guys consider these customers higher risk given that they're in a forbearance program? And if so, is that accounted in the current reserve level today?

For the current level of deferral -- just to clarify the question. So in the current deferrals, are we considering them all high risk?

That's right, yes. I'm just trying to get an understanding -- and to maybe give you some context for my question, very different answers from bank management teams in terms of how they handle the deferral process. And I have received answers to this question in terms of what we think 80% of these are money-good and others a different answer. So I'm just curious maybe more high level in terms of your view of this deferral level, and whether they're higher risk or not because they're in the forbearance program. And if you think they are, is that reflected in the current reserve?

Thanks for clarifying. So our initial deferral program was offered to all customers to accommodate given unknown factors at that time. We made the process very simple for customers to obtain a deferral, and we did very limited credit underwriting to do that. So we were very accommodating to customers for the first round of deferrals. The -- now second round of deferrals will have a thorough credit underwriting to qualify for a second deferral, and again, we are seeing a meaningful decline in those second round of deferrals. So to answer your question directly, the first round of deferrals, we do not feel is a risk factor. It was a customer accommodation. And then this round of deferrals will be more in line with where there is potential emerging credit risk.

And then, Russell, this is Mark. I think your second part of your question related to CECL, and how we think about those deferrals. While the deferrals -- because the loan is not -- it's on deferral, so it's not showing up as a delinquent in our system. It's not reflected in the base model, but it is reflected in the qualitative overlays that are part of our overall CECL methodology. So it would be captured in our provision level for the quarter.

That's great color, guys. I appreciate it, and thanks for bearing with me as I ask the question. My last one, just switching gears on the consumer fee. So I get the full picture guide, but just curious if you could kind of give us an update in terms of what percentage decline was from lower activity versus fee waivers? And maybe what the exit rate was at the end of the quarter, June versus April, to get a sense for run rate third quarter.

Yes, there was a minimal impact from fee waivers. We were very accommodating. We participated in the CARES program for all 5 of the states that we operate. So we were very accommodating to customers. However, the customer request for fee waivers were very limited, and the driver of that revenue was really activity based, overdraft fees and credit card, debit card activity. We do see both of those climbing month-by-month as there is more activity overall.

(Operator Instructions) Our next question comes from Matthew Breese with Stephens, Inc.

A couple of follow-up questions. So on the deferrals that go through the re-deferral "process" and don't meet the hurdles and therefore, need additional forbearance, how are you thinking about moving those loans into either criticized or classified or traditional NPL or NPA buckets? Should we expect those that don't cure on the next round to move into those traditional deteriorating asset quality buckets?

I think you'll see some of that, but again, it's an underwriting process. So some of those borrowers may request the second deferral, and we will grant that based on their capital, their liquidity, their guarantor support. So it won't necessarily mean that they are a nonperforming or distressed borrower at this point. Some of them, as we re-underwrite them, probably will adjust their risk rating and potentially be classified/criticized or nonperforming. But again, it's an underwriting process that we will look at each one of those customers to have us grant them the next deferral.

Understood. And then could you just talk about how much flexibility you have from the CARES Act and/or from the regulators to push deferrals out, meaning it now seems like there is likely going to be businesses and sectors of the economy impacted well into 2021. Do you have the flexibility to extend deferrals out that far into mid-2021, and we could be carrying these for that long?

Well, I would just say, in regards to the regulators, they have much more flexibility and willingness to work with banks that then existed in '09, '10, '11 time period. So I think we'll have the ability to extend. How long it lasts is really hard to say.

Okay. And then going back to Frank's question on the provision. I just wanted to get a sense for how the Moody's forecasts have evolved in 2Q? And if you have them into July, have the forecasts started to stabilize and become a little bit more consistent? Or have they been as volatile as they were in April and May? Just want to get a sense for how they've been moving.

From my perspective, Matt, they have stabilized. And I would say they stabilized because if you think to -- in March, I think there were some banks that were using like there was one on the 23rd. There was another one on the 27. They were coming out every couple of days, things were so fast and furious. And now for this quarter, I mean, the last model that Moody's developed was -- June 9 was the model that everyone was using for quarter end. And again, I know there is a lot of mid-sized banks that rely on Moody's for their macroeconomic variables. So the fact that they're just slowing down the pace to me implies that you're getting some slightly better lens into the future, although, again, there is still certainly a lot of uncertainty out there.

Understood. And then just last one for me. I know regulatory capital ratios are well in excess of minimums. Tangible common equity, could you just give us some sense of where you're comfortable moving that down to? Or is that even something you're looking at?

Yes. So TCE, I really think this quarter is going to be the low water mark, and we would expect it to climb back from there. And that was really a function of PPP loans, putting those on. I mean, obviously, it's a 0% risk-weighted asset for your regulatory ratios, but the PPP loans impact both TCE and your Tier 1 leverage ratio, unless you're using the PPPLF, which we haven't had to use yet as a funding source because the deposits are still sticking around. So both of those ratios, Tier 1 leverage potentially, tangible common equity here in the short run, we knew would drop as a result of PPP, but because we view that as both the right thing to do in our communities as well as the short-term nature of the program, we are comfortable with that number coming down to 7.4%, and then climbing back towards closer to probably 7%, 8-ish% range by year-end.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Phil Wenger for any further remarks.

Well, thank you all for joining us today, and we hope you'll be able to be with us when we discuss third quarter results in October. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.