First Internet Bancorp (INBK) 2020 Q3 法說會逐字稿

Good day, everyone, and welcome to First Internet Bancorp Earnings Conference Call for the Third Quarter of 2020. (Operator Instructions) Please note, this event is being recorded.

Now I'd like to turn the conference over to Mr. Larry Clark from Financial Profiles, Inc. Please go ahead, Mr. Clark.

Thank you, Nick. Good day, everyone, and thank you for joining us to discuss First Internet Bancorp's financial results for the third quarter of 2020. The company issued its earnings press release yesterday, and it is available on the company's website at www.firstinternetbancorp.com. In addition, the company has included a slide presentation that you can refer to during the call. You can also access these slides on the website.

Joining us today from the management team are Chairman, President and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David will provide a company update and Ken will discuss the financial results. Then we'll open up the call to your questions.

Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Internet Bancorp that involve risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call.

Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

At this time, I'd like to turn the call over to David.

Thank you, Larry, and good afternoon, everyone, and thank you for joining us today. We are very pleased with our third quarter results. Despite the challenges created by the COVID-19 pandemic, we delivered record net income and earnings per share, driven by strong revenue growth, net interest margin expansion and moderate loan growth.

Our significant earnings growth in this low interest rate environment demonstrated the power of our business model and the increasing diversity of our revenue streams. Ongoing favorable deposit repricing opportunities drove our interest costs lower and enabled our fully taxable equivalent net interest margin to expand by 17 basis points this quarter. Additionally, our asset quality metrics remain strong, among the best in the industry, driven not only by our strong credit culture and disciplined approach to underwriting but also by our focus on certain specialty lending lines that target lower-risk asset classes, such as our public finance, single-tenant leasing and healthcare finance businesses.

During the quarter, nonperforming loans and net charge-offs remained low, and we continue to build reserves. We also continue to see a significant reduction in loan deferrals. By quarter end, over 99% of our borrowers who needed payment relief early in the pandemic, had resumed making payments. We are proud to have supported our customers in their time of need and are pleased that nearly all have been able to return to their normal payment schedules in such a short order.

Finally, our record earnings allowed us to further strengthen our capital base, which remains one of our near-term strategic priorities. Our team delivered record quarterly net income of $8.4 million and adjusted net income of $10 million, when excluding a $2.1 million pretax write-down of a legacy commercial, other real estate owned property, more than double our net income from the prior quarter.

Revenue increased 48% to $28.7 million, driven by record performance in our direct-to-consumer mortgage business, which nearly tripled revenue on a linked-quarter basis. Historically, low mortgage rates continue to fuel robust demand in markets across the country and our mortgage banking pipeline remains strong heading into the fourth quarter.

Our SBA business gained additional traction during the quarter as the accelerated build-out of our national SBA platform resulted in increased loan production and higher gain-on-sale revenue. Our near-term pipeline is robust and we look forward to further driving revenue in the quarters to come as we continue to grow this government-guaranteed lending business and the economy adapts to and recovers from the pandemic, and as more small business and entrepreneurs seek financing to grow.

As we have discussed in prior quarters, we are confident there is enormous potential in this space with attractive opportunities on both sides of our balance sheet. Over the last couple of quarters, we capitalized on disruption among some SBA competitors and added sales and operations personnel to our already strong team of professionals. We brought on talent, expertise and depth that will help drive originations well beyond our initial forecast for 2020 and 2021.

Originally, we had envisioned about $60 million of originations for 2020, hitting $100 million annual run rate by the fourth quarter. I'm proud to announce that we have exceeded those expectations. In fact during the third quarter alone, we funded small business obligations totaling almost $58 million and year-to-date, we have funded over $80 million of small business originations. And note that these amounts do not include loans funded under the Paycheck Protection Program. Looking forward, we expect SBA production of between $25 million and $30 million in the fourth quarter and are forecasting originations in excess of $235 million next year, which we expect to translate into gain on sale revenue between $12 million to $14 million for 2021.

I want to take a moment to recognize that less than 2 years ago, our SBA operation was in its infancy. Now we are well on our way to building a leading national platform. The Small Business Administration recently released its list of the most active 7(a) program lenders for its fiscal year ending September 30, 2020, and we placed #40 on the list, with almost $110 million in approved loans. I'm very proud of what we have achieved so far in the small business lending and look forward to becoming a leader in providing financing for the small business and entrepreneurs across the country.

With regard to credit, our asset quality remains strong, and we are cautiously optimistic about the remainder of 2020 and into next year. Of course, the pandemic continues to create uncertainty. We are monitoring our loan portfolio very closely and working with our clients to help them navigate challenges related to this ongoing public health crisis. This is the right thing for us to do, and it is also good for the bank as we are deepening our connections with existing clients and creating stronger relationships for the long term.

That being said, we are very encouraged by the fact that nearly all of our borrowers we offered loan deferral programs to have resumed making their normal monthly payments. As of October 16, we only had $20.8 million of loan balances remaining on deferral or less than 1% of the total portfolio, a sharp decrease from the $366 million when we spoke to you 3 months ago and down from the peak of $647 million in late May, which was about 22% of the total portfolio. We believe this speaks to the quality of our loan portfolio, particularly our focus on lower-risk asset classes and our disciplined underwriting approach.

As we move into the final months of 2020 and look ahead to 2021, we are confident about our prospects and the strength of the franchise. While the pandemic presented everyone in the banking industry challenges, our digital business model enabled us to serve our customers with minimal interruption and remain focused on our core lines of business as well as earnings growth and profitability.

As always, I'd like to thank the entire First Internet team for their hard work and unwavering dedication to excellent customer service, delivering record revenue and earnings performance during these challenging times. We appreciate their flexibility and cooperation to work remotely over the last several months and we are pleased that as of October 1, we were able to welcome back the vast majority of our employees who had been working remotely through our corporate headquarters in Fishers.

Finally, First Internet was recently recognized for the seventh consecutive year in the Indianapolis Star's Top Workplaces in Central Indiana List, placing in the top 10 in the medium-sized company category. We're proud of the strong culture and workplace environment that we have created.

And with that, I'd like to turn the call over to Ken to discuss our financial results for the quarter.

Thanks, David. As David mentioned, we were very happy with our results for the third quarter, delivering record revenue, net income and earnings per share. We generated these strong results on a relatively flat balance sheet during the quarter, which is consistent with our disciplined balance sheet management strategy. Our business model emphasizes capital efficiency and increasingly diverse revenue streams that drive increased profitability, and our third quarter results reflect solid execution on this plan.

Now let's turn to details of our performance for the quarter. We reported diluted earnings per share of $0.86, more than doubling last quarter's results and up almost 37% over the third quarter of 2019. Excluding the impact of the $2.1 million pretax write-down of legacy other real estate owned, earnings per share were $1.03. Profitability improved significantly with return on average assets of 78 basis points and return on average tangible common equity of 10.83%. Adjusting for the write-down of OREO, return on average assets was 93 basis points and return on average tangible common equity was 12.74%.

Looking at Slide 5, total portfolio loans at the end of the third quarter were $3 billion, an increase of $39.2 million or 1.3% from the second quarter. Commercial loans increased $56.2 million or 2.4% compared with the second quarter, due primarily to production in healthcare finance and construction lending. This growth was partially offset by lower public finance and single-tenant lease financing balances due to portfolio amortization, decreased origination volumes and the sale of single-tenant lease financing loans during the quarter.

Consumer loans decreased $15.3 million or 2.9% compared to the second quarter, due primarily to increased prepayment activity in residential mortgages as well as in the trailers and recreational vehicles portfolios. We sold the portfolio of $12.2 million of single-tenant lease financing loans at an attractive premium during the quarter, which included loans that had properties occupied by tenants in both the quick-service and full-service restaurant industries. We continue to see healthy demand for our loans and are selling many of them to repeat investors. Subsequent to quarter end, we sold a $7.4 million public finance loan at a solid premium, and we expect to continue to sell portfolio loans going forward if this generates fee income and frees up capital that can be used to fund new opportunities across our lines of business.

Moving on to deposits on Slide 6, while overall deposit balances were relatively flat from the end of the second quarter, we saw continued improvement in the composition of the deposit base, with growth in money market balances, interest and noninterest-bearing demand deposits and savings accounts, which was mostly offset by a large decline in CDs and broker deposits. Quarterly money market growth was $117 million and included $87 million in small business deposits.

CDs and brokered deposits were down $138 million as higher-cost CDs ran off the balance sheet and were replaced with much more attractively priced money market accounts and lower rate CDs. This activity drove our cost of interest-bearing deposits 43 basis points lower in the quarter. And we believe that we still have a long runway ahead to reprice deposits lower. Due to the combination of significantly lower money market pricing and the continued CD repricing opportunity, we are forecasting interest expense savings in excess of $22 million next year based on the current deposit pricing environment.

Turning to net interest income and net interest margin on Slide 7 and 8, net interest income and net interest margin on both a GAAP and a fully taxable equivalent basis showed strong improvement compared to last quarter, with lower deposit costs driving the increase. Interest income from the loan portfolio was relatively stable as higher average loan balances offset a modest decline in overall loan yields.

As you can see from the net interest margin bridge on Slide 8, the securities portfolio had the largest negative impact on margin during the quarter as continued declines in short-term rate indices impacted variable-rate securities, and increased prepayment speeds resulted in accelerated premium amortization, which affected yields on mortgage-backed securities.

With regard to the impact of elevated cash balances on net interest margin, you will see on the roll forward that cash only negatively impacted the quarterly change by 1 basis point. However, we, like many other banks, have experienced excess liquidity for several quarters now. In terms of how these balances are truly impacting margin, when we adjust for a more normalized level of cash, we estimate that excess cash is negatively affecting margins by about 13 basis points. We are pleased to have reached an inflection point in our net interest margin and expect the upward trend to continue next quarter and throughout 2021.

Turning to noninterest income on Slide 9, noninterest income for the third quarter of 2020 was $12.5 million, more than double the level generated in the second quarter. The increase was driven primarily by the record revenue from mortgage banking activities and increased gain on sale of loans, which was due mainly to a higher amount of SBA 7(a) guaranteed loan sales in the quarter as well as the sale of the single-tenant lease financing loans that I mentioned earlier. Mortgage banking revenue benefited from strong mandatory LOC activity and higher margins as well as increased best efforts revenue on sold production. While we expect mortgage revenue to remain strong in the fourth quarter, we are not forecasting it to be at the record level we generated in the third quarter.

In regards to small business lending activities, the strong third quarter origination activity David mentioned earlier, translated into about 100% growth in SBA gain on sale revenue from the prior quarter. Additionally, as a significant portion of the third quarter originations occurred in September, we currently have $35 million of guaranteed SBA 7(a) balances pending sale into the secondary market, which we expect to close early in the fourth quarter. These pending sales, coupled with new origination and sale activity should drive increased fee revenue from this line of business in the fourth quarter.

Looking forward into 2021, we are conservatively forecasting lower mortgage revenue as compared to 2020 performance thus far. However, it is still expected to be very strong on a historical basis. That being said, in comparison to 2020's level of noninterest income, we expect that gap to be filled by a continued strong increase in SBA gain-on-sale revenue.

With respect to noninterest expenses shown on Slide 10, the increase to $16.4 million was mainly the result of 2 factors: one, a $2.1 million write-down of 2 legacy OREO commercial properties; and two, higher salaries and employee benefits. These items were partially offset by lower other expenses and consulting and professional fees. The higher salaries and benefits were due primarily to incentive compensation for SBA business development officers and mortgage loan officers due to increased origination volumes and increased headcount in small business lending.

Now let's turn to asset quality on Slide 11. The allowance for loan losses increased $2.5 million or 10% to $26.9 million, resulting in an increase in the allowance to total loans to 89 basis points or 91 basis points excluding PPP loans, up 7 basis points from the linked quarter. As growth in the loan portfolio was modest during the quarter, the increase in the allowance was driven primarily by further modifications to qualitative factors in our allowance model to reflect the ongoing economic uncertainty related to the COVID-19 pandemic, as well as changes in portfolio composition.

Nonperforming loans increased by $1.6 million compared to the linked quarter as 2 single-tenant lease financing loans with balances of $2.5 million in the aggregate were placed on nonaccrual status, partially offset by a $700,000 loan previously on nonaccrual that paid down in full and other smaller-balance, nonaccrual loans that were charged off in the third quarter. We placed the 2 single-tenant loans on nonaccrual because the properties are currently vacant. However, both borrowers are still current on their mortgage payments and are working to get the properties re-leased.

Net charge-offs of $100,000 were recognized during this quarter, resulting in net charge-offs to average loans of 1 basis point as compared to 12 basis points in the prior quarter. We recognized a loan loss provision of $2.5 million for the third quarter, consistent with the second quarter. The provision for the third quarter was driven primarily by the continued reserve build in the allowance for loan losses, as mentioned earlier.

While we continue to build our reserves out of an abundance of caution in this ongoing uncertain environment related to the pandemic, we also continue to feel very good about our asset quality and credit performance to date.

With respect to liquidity and capital, as shown on Slide 12, our overall capital levels remain healthy, both at the company and bank levels. With the solid earnings performance for the quarter, our tangible common equity to tangible assets ratio increased to 7.24% from 7.01% in the second quarter. Additionally, tangible book value per share increased to $31.98, up from $30.92 in the second quarter.

In terms of our outlook for the fourth quarter and into 2021, we believe we are extremely well positioned for the lower interest rate environment, and there are a few items I want to reiterate and summarize for you.

As mentioned earlier, we are forecasting in excess of $22 million in interest expense savings next year from deposit repricing. When you combine that with stabilized asset yields, which should improve in future periods due to a better asset mix, we are expecting significant growth in net interest income and expansion in net interest margin for 2021. We also expect to maintain a stronger level of noninterest income going forward. As David mentioned earlier, we are forecasting $12 million to $14 million of gain on sale revenue from SBA loan sales next year, which will be supplemented by gains on portfolio loan sales as well as increased servicing revenue as our managed SBA portfolio grows. When combined with a solid outlook for mortgage production, we feel very confident in our ability to increase noninterest income from historical levels.

We continue to remain cautiously optimistic regarding the impact of the pandemic on the credit quality of the loan portfolio. While we remain vigilant in our monitoring and underwriting procedures, we do not see elevated credit losses on the horizon at this point. With the forecasted revenue growth, we see a clear pathway to net interest margin expansion and a return on average assets approaching 1% and higher on a quarterly basis in 2021. And finally, with increased profitability and modest balance sheet growth expectations, we are forecasting increased capital levels with tangible common equity to tangible assets in the range of 8.5% by the fourth quarter of 2021.

With that, I will turn it back to the operator so we can take your questions. Nick?

(Operator Instructions) First question comes from Michael Perito, KBW.

I wanted to ask a quick clarification question on the mortgage outlook. I understand it's probably a little hard to put an exact number out there. But Ken, I mean, is it fair to say that the revenue production in the fourth quarter will be down materially from the third quarter, but still up materially from where kind of the first half run rate was? I mean, I know it's kind of broad, but do you think that's kind of a fair way to capture based on the pipeline you see today?

Yes, Mike, I think that's a good way to summarize it. I think we -- obviously, it was extremely strong, well above any prior performance we've had in the past. But we still feel good about, given where interest rate markets are, refinance purchase activity, that it should remain at a higher level than kind of prior run rates, if you will.

So I mean, will it be down from [9.6]? Yes. But it's probably going to be in the range of, call it, somewhere, $5 million to $6 million.

There is a little seasonality, Mike. Obviously, December -- kind of that Thanksgiving to December, things roll on the new home side of things, it won't have, obviously, any impact on the refi. But yes, Ken's pretty comfortable, we're pretty comfortable with that $5 million to $6 million number for the quarter.

And as we think about next year, I felt like maybe there were a couple of things you guys were doing on your end over the last 12 to 18 months with that platform. And it seems like based on the third quarter here that it's ready to go. And that -- obviously, there's a lot of volume and demand. So as we think about next year, I mean, certainly, it's not going to be $22 million, $23 million, but is it like a mid- to high teens revenue type opportunity for you guys, you think? Or will the environmental drop off be more severe than that?

I'd probably put it in the mid-teens. We're not overly zealous, I guess, we're not anticipating anywhere near what we had this year. But I'd say -- put it in mid-teen, $14 million, $15 million is kind of what we're using internally.

Okay. Very helpful. And then similarly, on the NIM counts, I was wondering if you could maybe kind of translate that interest expense savings comment to a more -- a little bit more on the margin. And I guess, maybe the easier way to ask the question is if you just look at the curve and where rates are today, and you assume that that's kind of the environment going forward, once all your liabilities reprice, I guess two-part question: One, can you give me a little more color on what kind of incremental loan yields are doing here? And then the follow-up to that being, where does the NIM settle in this environment once you've worked through all the liability repricing opportunities that you have?

Yes. I think on the loan side, I think we've probably seen things kind of flatten out. I will say, as we kind of look forward, we do see the opportunity just from an overall earning asset perspective to continue to redeploy excess cash as well as cash flows from securities into, say, other lower-yielding assets into higher yield and loan production. So we do expect kind of overall yields on earning assets to trend upward into 2021.

In terms of that deposit savings, and that's really going to be a larger driver of NIM performance -- I mean, I think we feel pretty comfortable sitting here today that fourth quarter NIM will be kind of in the range of 1.9% to 2%. And as we look forward into 2021, we continue to see incremental improvements in NIM over the course of the year. So you're kind of in that, call it, low 2s to [2.10, 2.20-ish] range earlier in the year and in fourth quarter, closer to that [2.3%, 2.4%] range. But that deposit, that $22 million of deposit repricing savings over the course of the year is very powerful when it drops down to the bottom line.

And obviously, that's -- those are pretty significant improvement, right, on the margins. So can you just maybe walk me through the risk? Like what could happen that could dampen that upward trajectory over the next few quarters here?

I mean, I think right now, if the curve, which doesn't seem like...

Short of rates going up, obviously.

Yes. And if we -- short rates going up is probably the biggest risk on the deposit side. I mean, the good thing about the deposit piece of it is it's really just math, if you think about it. I mean, we have almost $1 billion of CDs that are kind of 2-plus-percent maturing over the course of the next couple of months -- or excuse me, the next 12 months, that our new CDs are coming on in the range of 50 basis points today.

Not all of those CDs are being renewed. Some are just rolling off. Some are renewing at a much lower rate. But when you combine that with just really resetting the entire cost of the money market base, you go back to think about it, at the beginning of the year, our money market rates were 1.9%. And today, we're paying 60 basis points on consumer and 50 basis points on small business and commercial, and we have even other more institutional accounts, higher balance that we're paying a much lower rate on. So when you translate that into a full year of savings, it's a large contribution to that $22 million.

Got it. Okay. And then last question for me, and I'll step back and let some others jump in. But just, David, I mean, I think over the last 6 months, the banking industry has been exposed to a lot of, I think themes that were kind of simmering and then got accelerated around digital banking. And I feel like one thing historically that has been difficult for the purely digital bank is to really kind of cultivate customer relationships that weren't very, very price-sensitive. And I guess, just kind of a broad strategic question here, but do you feel that foundation shifting at all? And are you more optimistic going forward here that with customer preferences really starting to tilt digital, that you guys will be able to drive more kind of sticky relationships overall, whether lending or deposit base than maybe you were historically? Or do you think that it's too early to tell?

Michael, I'd tell you, the -- in our view, our relationships with, particularly the retail customer has been very sticky from day 1. We do attract them with rates, but once we've got them, they've stayed with us for many, many, many years.

I would tell you that last probably 6 to 9 months when the COVID crisis hit, there's got to be millions of consumers and individual small businesses all across the country that would have never gone to a digital platform, have they not been forced to do that by the COVID virus. So it's twofold. One, we have millions of clients out there that now are comfortable with the platform and when they're traditional banks, they start to do a little shopping and look or the branches -- I'm on a call every other week with a lot of CEOs here in Indiana; for the last 3 months, they've been very worried about how to get branches opened safely for both their customers and their staff, and we've been going about business and opening accounts left and right.

So I think, yes, there's been a monumental shift in our business opportunity. We're spending virtually nothing on the marketing side of things. And as Ken said, in the last quarter -- third quarter over second quarter, we picked up $117 million in money market, with almost $87 million of that coming from the small business community. I don't know if you've caught it yet, Newsweek released yesterday, they rated their annual survey on banks, and they rated our small business checking account as the best in America. So I think the SBA small business opportunity, as I said earlier, really helps both sides of our balance sheet from the asset generation and earnings as well as the deposit side. And I see nothing to slow that down.

Next question is from George Sutton of Craig-Hallum.

Great results. By the way, congrats on the Newsweek, that's impressive. Talk about burying the lead deep in the Q&A, though. So on that note, though, the -- when we talk about the SBA strength that you're seeing and the disruption that you're seeing from competitors and your ability to bring new salespeople in, what is the pitch to them? What is unique about your offering and your capabilities? And how much of that is digitally driven?

It's two factors, George. It's the fact -- the digital platform is huge for everybody. They love the focus. And quite honestly, the play of my entrepreneurial background and not being a banker, has been phenomenally attractive in bringing the BDOs on board because it's the understanding of the way we operate and think about small business. And then it also rings very true to the small business community, with that checking account product that we have out there now, the services we have bundled around that. It's just a -- it's a rock-solid platform.

And what happened, a lot of our peers, particularly those in the SBA world, went chasing after the PPP program, thinking they could get in and out in 60 to 90 days. Well, it's a drug on forever. A lot of them have strained their capital base. They're really not in a position to make loans today. So we had plenty of capacity and just the whole story, the platform, the structure of the bank itself and just being ready to go and take advantage of the shakeup in the market has helped tremendously. As Ken said, we had a bang-up into the third quarter and we've got a pipeline in excess of $100 million out there right now.

A little bit of the same question on the mortgage side. Obviously, the market itself has been strong. But I'm wondering if there's something that you've been doing uniquely that has been a further accelerant to the strength there.

Yes, kind of the same game: about 18 months ago, we made a pretty major investment into the mortgage back office and structure of the product, increased our efficiencies tremendously. This past quarter, I mean, we have definitely pressured our employees and put them through the ringer over the last 90 days with the volume that has come through here. But we did almost a year's worth of volume traditionally in 90 days. And we're able to do that because we made a little over $1 million investment in a new platform about 18 months ago that really create a much better experience for both the customer and our staff.

So they worked extremely hard. Got to give them all the accolades in the world. They've done one bang up job, but the platform and the changes we've made, made it very simplistic for the customers to come back. A lot of the business, I would tell you, in the last 90 days, we spent virtually nothing on marketing and advertising to bring in leads for the mortgage. They're either finding us straight up on the web or they're customers that we've had in the past, that because of the low rates are in a position to refi and come back again and they're telling their friends. Probably 30% to 40% of the activity we've had over the last 6 months have either been prior customers or folks that referred people to us that haven't cost us a dime in marketing expense.

Great. Just one other question relative to the $12 million to $14 million assumption for a gain on sale next year. What is the -- what's being assumed in that? What's the risk, if any, to those expectations? Is it rate-driven? Is it loan demand-driven? Is it -- is that currently in your production? Just curious how those numbers were derived.

The numbers are based on getting roughly $230 million in total originations next year. And sitting on a $100 million pipeline now that has grown month-to-month over the summer from -- when we were sitting here back at the end of the first quarter, we had a pipeline of about $25 million to $30 million. It's now in excess of $100 million and growing by the day.

Right now, the SBA product particularly because of some of the economic situations is just -- it's the best game in town for a lot of small businesses, traditional banks, C&I programs have tightened up. I'm a true believer that the SBA guarantee does not make a bad loan good, but it takes somebody that might be a little bit on the cusp and gives them the edge of a start-up or a new business. And for every company that's in trouble across America today due to COVID, there's 2 that are absolutely hitting it out of the park.

Give you an example, we had a gentleman that was -- been in the liquor business for the last 5 years, making a specialty whiskey. He applied for $150,000 loan to modify one of his manufacturing lines from alcohol for whiskey to alcohol for hand sanitizers. The man's made more money in the last 6 months than he has the last 5 years, and we're finding opportunities like that all across the country and the SBA is a perfect fit and a perfect product for those companies.

Next question is from Nathan Race, Piper Jaffray.

(inaudible) to continue the margin discussion. Curious within that context for the expansion that you alluded to, Ken, what you're anticipating in terms of deposit flows. I think there was the expectation that there'd be some outflows here in the third quarter. It doesn't seem like that happened, and you guys are out standing alone relative to peers within that dynamic. So just kind of curious how you guys are thinking about deposit runoff within that guidance you provided for expansion going forward in the margin?

Yes, it's interesting. It's the -- I think that we continue to, what we believe, aggressively reprice deposits lower and yet we continue to grow money market balances and certain segments of the CD base, particularly consumers and small business, renewal rates kind of remain in the 75% to 80%. We have seen some very stronger runoff in what we call the institutional CDs and the institutional deposits, trust companies and credit unions, public funds of that nature that are kind of more, call them, professional investors, for lack of a better term.

But I think we were probably over the course of the year, expecting some deposit, more deposit runoff than what really happened. And I think that some of that's probably just a factor of the interest rate environment and most -- a lot of other banks out there are reducing rates as well.

I think as we kind of look forward into 2021, I think we're forecasting that we may have some probably modest deposit growth, kind of low/mid-single digit. But I think we do expect some, what we call, maybe folks to have small businesses or consumers, who have been hoarding cash for lack of a better term, with the uncertainty of the pandemic -- and this kind of assumes we return to some sense of normalcy -- those depositors will put some cash to work and reduce balances. But at the same time, I think we feel comfortable in our ability to continue to grow that. So there'll probably be a bit of an offset there. But we're not -- I think as we look forward into 2021, I mean, the composition of the deposit base should remain fairly stable and not a lot of growth.

Okay. Got it. So kind of a static deposit portfolio is embedded in that guidance, the interest expense savings, if I'm hearing you right?

Correct.

Okay, cool. Great. And then kind of changing gears and looking at the left side of the balance sheet, healthcare finance growth was pretty impressive in the quarter. And I imagine there's still a good pipeline along those lines, just given the disruption that exists within that asset class. So just curious to know how the yields or the weight average rate on those on that production kind of compares to the portfolio yield at around [3.88%] in the third quarter and just kind of the outlook for loan growth on balance sheet into 2021 as well.

On the health care finance portfolio, that production generally is coming in around 4% on average. So it's -- we've probably seen loan yields drift lower in loans as obviously we're in the new interest rate environment and new production comes on at a lower rate. But it's kind of in that 4%. Sometimes we'll get more, maybe a little bit less at other times. But it's pretty much in line with the rest of the new production we have. And that was just to my point earlier about trying -- as we kind of have the ability to put some cash to work and redeploy cash flows from the securities portfolio -- obviously those are 2 lower-yielding asset classes -- and put cash to work, whether it's in new construction lending, which has relatively stronger yields and healthcare finance as well. As -- and we continue to fund new loans in single-tenant as well. Pipelines are starting to improve there, and obviously our C&I teams are out working hard as well and yields on what they're doing are above 4% as well.

Okay. Got it. That's helpful. And then changing gears a little bit, thinking about the expense run rate, if we take out the OREO write-down in the quarter and based on the mortgage banking guidance that you provided for the fourth quarter, how should we kind of be thinking about the overall operating expense run rate for the fourth quarter?

Fourth quarter should be relatively consistent with kind of that adjusted number for the -- for this past quarter, for the third quarter. Might tick up a little bit because we continue to add talent in SBA, especially kind of on the credit administration side. So we'll kind of have a full quarter baked in of expense there. But it should probably be relatively consistent with that -- with the third quarter's activity.

Okay. So about 15.5% or so, give or take?

14.5%. Yes.

Okay. Got it. And then just lastly for me, just a housekeeping question on the tax rate going forward. Any thoughts along those lines?

Well, obviously, as you folks all saw, our tax rate jumped up here in this quarter. Obviously, we had much -- a larger proportion of revenue coming from taxable sources, mortgage and SBA. And I think as we kind of look forward, I mean, if you think about the revenue mix this quarter, even though we expect SBA to continue to grow and into '21, mortgage, as David talked about a little bit earlier, mortgage, our forecast is conservatively pulled back from what we expect this year to be when we get to the end of the year.

But that revenue mix will probably stay the same with the SBA making up the difference there on mortgage. So I think probably the days of the tax rate less than 10% are probably past. So we're probably somewhere in a -- on a 12% to 13% basis, I think is probably a good estimate, looking forward into 2021.

Congrats on the great quarter.

The next question is from John Rodis of Janney.

Nice quarter. Ken, I just wanted to make sure I heard you right. So you said as far as ROA, you can -- you guys feel like you can do a 1% or sort of in the 1% area for 2021? Or do you think you hit that in the back half of the year?

I think what we -- earlier in the year, we're probably getting close to that. We're probably, call it, the high 80s to low 90s. But I think definitely in the back half of the year, right now as we look at it, we're -- we should be north of 1%, probably not terribly far north of it, but we should be kind of, I don't know, call it, [105, 110] in the back half of the year.

So -- and that assumes, based on the prior question, just a tax rate of 12% to 13%?

Correct. Yes.

Okay. So assuming a relatively stable balance sheet, and this is sort of simple math, but then we're talking about earnings for a full year with a $4 handle on them, $4. Am I missing something there?

You're spot on, my man.

It's simple math, but it's back of the envelope. So I just wanted to make sure. Okay.

Your envelope back is my envelope, John.

Just asking -- Ken, just asking the -- for next year, the expense question. With a 1 ROA, what sort of efficiency ratio -- do you think it's sort of mid- 50s to high 50s to 6 -- call it, 55% to 60%?

It's going to -- it's a low 50s.

Okay. And based on your balance-sheet strategy, originating and selling loans, there's no reason to think you guys need to raise any more capital or anything like that in this environment, correct?

No, that's correct. No.

Okay, thank you, guys; nice quarter.

(Operator Instructions) The next question comes from Lance Gad of Gad Foundation.

Great quarter. I was wondering if you could give us some color on the $2.1 million OREO -- legacy OREO write-off? I think you mentioned there were -- it was more than one loan, but I'd like to -- I'd like full color. What was the amount? What happened? Any color you could give us?

Yes, Lance, the -- it was actually 1 loan, 2 properties. They were student housing at University of Southern Illinois in Carbondale. We put it into OREO almost 8 years ago. And quite honestly, with the COVID drop in enrollment at the university, drop in funding from the State of Illinois, there's some question whether -- there was a question, I don't know that it's still out there, the university was even going to go forward or be consolidated into another school -- that we've had it on the books for 8 years and just decided it was time to get it off. So we wrote it down, and we are looking -- we had a national broker, listed it for 6 months. We got 1 nibble in 6 months that did not pan out, and they specialize in student housing. So we just figured it was time to make it go away.

What was the gross amount before the $2.1 million?

The loan initially started at $5 million. We took a charge, a time back. We've recovered a little bit from the gentlemen who owned the property. So it originally started at $5 million and the remaining balance on it was $2.1 million.

Oh, and you took the whole -- you took a write-off off the whole thing?

Correct. It's off the balance sheet in total.

Yes. Just to clarify, we wrote part of it down 3 years ago.

Right.

We didn't -- we wrote a piece -- we wrote a portion of it down, yes, I think it was the fourth quarter of 2017 or 2018. And so we recognized that back then. And there was a case -- there was some fraud involved on the lender side with that deal originally.

Is it occupied at all?

We have a very nominal number of students in 1 building, 1 building has been mothballed for probably about a year. And once COVID hit, the dormitory was predominantly foreign exchange students. And with a combination of COVID and current practices out of D.C., limiting foreign students coming into the U.S., that number dropped off precipitously at the beginning of the year. So those 2 factors, on top of everything else, that's why we decided it was time to make it go away.

Well, let me know if you take an offer of book value for it, okay?

We'll do, sir.

We have a follow-up question next from John Rodis of Janney.

Ken, just one other question, just on provisioning. You guys were $2.5 million this quarter, sort of in line with the second quarter. How should we think about provisioning going forward into next year, just based on your outlook, based on what you see as far as credit and you said you don't really see much in the way of charge-offs at this time?

Yes. I think right now, we probably feel like fourth quarter's provision won't be at that $2.5 million level. If you look at the charge-off history, the nonperforming loan history, I think we feel pretty good about that. I mean, I think we'll continue to build the reserve, just probably not at the same pace.

So you're probably -- look, I mean, looking at a reserve lower than $2.5 million. And I guess, if you want to look forward into 2021, our forecast on that provision is somewhat lower as well than what we have for year-to-date here.

Okay. And again, as far as CECL goes for you guys, that's not until 2023, correct?

Yes, CECL is first quarter of '23.

Okay. So as we look -- well, okay. So as we look out to -- I mean, assuming the balance sheet is still relatively flat, sort of the current level annualized around that ballpark sort of makes sense?

Well, right now, we're doing about $2.5 million. I'd probably reel it back down to -- historically, we were in that $750,000 to $1 million. I'd say, as Ken stated, we'll continue to build a little bit. I'd plug in, if you want to plug a number for next year, I'd look at about $1.5 million a quarter unless something changes in the dynamics of the economy. But probably back to something in the line of $1.5 million. We want to continue to build it a little bit. And as we said, the asset base should stay relatively stable. So that should allow us to cover anything coming in that's on the horizon and continue to build the outstanding a little bit.

But obviously, David, I mean, there's still a lot of unknowns out there, but I guess that just goes to how good you feel about your current borrowers and stuff, what you know today.

Yes, exactly. You're exactly right, John. Unless there's a full-scale shutdown again, what's starting to happen in spots across the country. But if there's a nationwide shutdown, kind of all bets are off. Shy of that, I think we're in really, really good shape.

This concludes our question-and-answer session. Now I'd like to turn the conference over to Mr. Becker for closing remarks.

Okay, I'd like to say, it was a good run this quarter. I'd like to thank all of you for joining our call today. I think we ran a little longer than we normally do. We appreciate you hanging with us. We hope everyone remains healthy and safe during these challenging times. Have a great day. Thank you for your time.

This concludes the conference. Thank you for attending. You may now disconnect.