Mercantile Bank Corp (MBWM) 2020 Q3 法說會逐字稿

Good morning, and welcome to the Mercantile Bank Corporation's Third Quarter 2020 Earnings Results Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tyler Deur from Lambert, Mercantile's Investor Relations firm. Please go ahead.

Thanks, Ily. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the third quarter 2020. I'm Tyler Deur with Lambert IR, Mercantile's Investor Relations firm. And joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, President of Mercantile Bank of Michigan.

We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open up the call to questions. However, before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business.

The company's actual results could differ materially from any forward-looking statements made today due to the factors described in the company's latest Securities and Exchange Commission filings. The company assumes no obligation to update any forward-looking statements made during the call.

If anyone does not already have a copy of the third quarter 2020 press release and presentation deck issued by Mercantile today, you can access it at the company's website, www.mercbank.com.

At this time, I would like to turn the call over to Mercantile President and Chief Executive Officer, Bob Kaminski. Bob?

Thank you, Tyler, and good morning, everyone. On the call this morning, we will provide you with detailed information on the company's performance in the third quarter, amidst the challenging operating environment as well as an update on continued activity specifically related to the pandemic.

First, I again want to recognize the tremendous efforts of our dedicated Mercantile team for their persistent resolve and ongoing ability to navigate the continuous and often unique challenges presented from the pandemic throughout this year.

Our paramount focus has been on the health and safety of our employees, which has created the necessity for flexibility, and our team has consistently risen to the challenge, quite often working remotely and in new environments. These efforts have helped Mercantile deliver strong results while successfully serving our customers and fulfilling their banking needs in a variety of ways.

Mercantile demonstrated continued strength in a number of performance areas for the third quarter, with share earnings of $0.66, which again included a strong provision for loan losses as we continued to build our reserve as a result of pandemic-related issues.

This sustained financial strength allowed us to continue our regular cash dividend program with our Board declaring a fourth quarter cash dividend of $0.28 per share. We are pleased to provide this consistent cash return to our shareholders within this time of uncertainty, and Chuck will provide further updates on the many moving parts in our financial statements during the quarter.

Since the health and safety of our communities is a top priority, our facilities have been updated to incorporate physical and social distancing modifications including our lobbies, which reopened in late June. Our team and clients remain adaptable to alternative methods of banking activity engagement as we continue to closely monitor for developments and revise our plans accordingly. The full time line of COVID-related activities can be viewed on Slide 4 of our presentation.

Our commercial lending team remains focused on the Paycheck Protection Program having successfully originated a significant volume of SBA loans for businesses in our markets. Our team's work on the forgiveness phase of the PPP process continues into the fourth quarter as we assist on recipient clients with gathering and submitting the required information to allow the rendering of a forgiveness determination by the SBA. The efficient efforts of our lending group with PPP have helped to create new relationship opportunities with businesses that face challenges in the application process with the incumbent banks.

Having met the initial stimulus program needs of these clients in the application process, we are now in a position to grow those relationships through discussions about their full banking needs. Our team's diligence and dedication to our communities is illustrated by our timely and responsive assistance to these businesses as they endeavor to take the needed steps for economic recovery and growth.

We also remain focused on meeting the traditional credit needs of our existing clients while strengthening our pipeline and identifying new customer relationships. Ray will provide you with an update on overall portfolio performance and the status of customers receiving assistance through our payment deferral programs, which have largely reverted back to full contractual loan payments. As such, our asset quality remains strong and our focus on sound credit underwriting has led to low levels of past due loans and nonperforming assets.

With the World Series starting tonight, I want to borrow a baseball term to describe for you that our retail mortgage team knocked the cover off the ball in the third quarter as we achieved another record-breaking level of mortgage banking income. The growth of our mortgage lending team in 2020 has allowed their dedicated efforts toward ensuring a strong pipeline, especially during the upcoming months, which reflect normal seasonality. Within a difficult climate, the team has increased market penetration to enhance revenue and achieve strong residential mortgage loan production levels.

Our team put forth a tremendous effort to ensure the entire loan origination process, from receipt of an application to closing, is completed in a structured and timely manner. Ray and Chuck will have more detail on mortgage production in their comments.

Turning to our operations. With the ongoing investment and deployment of technology as alternative delivery channels, which has only been accelerated by the current environment, an evolution in the way banking is done appears to be at hand. Mercantile has been able to reduce its number of locations from 53 to what will be 37, once our recently announced optimization in our branch network is completed later this year.

Our current footprint can be viewed on Slide 3. We continue to engage our customers so we can take a holistic approach to their needs and understand how patterns and preferences of interaction with us are evolving, especially in view of the realities brought about by COVID-19.

We consistently aim to reevaluate our interactions across the board, conforming to industry best practices while seeking to break new ground across a number of important areas. As we look back on the past 2 quarters that were so heavily impacted by the pandemic, the health and safety of our people has been paramount. This focus on our people has reinforced our commitment to pursuing best practices in environmental, social and governance, with particular emphasis on the social component as we work to meet the needs of our stakeholders.

Our Board of Directors, which includes recently introduced members with diverse business experience, our management team and our staff remain committed to fulfilling the ever-changing roles as reliable and dedicated community partners and leaders.

In addition, we continue to build our internal diversity, equity and inclusion programs and have facilitated ongoing meetings featuring guest speakers we have brought in virtually to provide forums for our employees. Our goal with these programs is to help our team members' process and address the issues that have been brought to light in our country and our communities in 2020 regarding racial justice and diversity, equity and inclusion.

We have had ongoing discussion groups within our organization where staff are able to listen and learn about others and provide an opportunity for introspection. We are fervently committed to maintaining these sound corporate practices built on integrity and trust while working to diligently cultivate and strengthen our critical relationships with our diverse communities, our employees, our customers and our shareholders. Together, we have built an incredible foundation that positions us well to sustain and build on these efforts for our continued success.

Those are my introductory remarks. I'll now turn it over to Ray.

Thanks, Bob.

Our loan portfolio increased $17 million in the third quarter of 2020, which consisted of a $37 million increase in commercial loans and a $20 million decrease in retail loans, primarily mortgage loans held for sale. The professional manner in which our team administered the origination of over 2,100 PPP loans earlier this year has continued to yield opportunity to grow our base of commercial relationships. Additionally, our construction pipeline remains solid with $99 million of commitments in commercial construction and development loans, which we expect to fund over the next 12 to 18 months.

Asset quality remains strong as nonperforming assets totaled just $4.6 million or 0.11% of total assets at September 30, 2020. This breakdown can be found in the financial portion of our presentation on Slide 22. Additionally, accruing commercial past due loans at quarter end are nominal in dollar terms, totaling just $213,000, representing 6 borrowers. Overall, past due information can be found on Slides 11 and 12.

During the quarter, we undertook a review of the risk ratings associated with the loan portfolio, resulting in a provision for loan losses of $3.2 million, reflecting adjustments to the risk ratings of 159 specific credits, these are those relationships moved to the watch list.

In contrast, in the prior quarter, the provision expense of $7.6 million is generated entirely through qualitative factors. These actions bring the allowance for losses to total loans to 1.27% when excluding the impact of PPP loans. Payment deferrals at the peak of the program in mid-July impacted 738 borrowers, represented $719 million in exposure. Presently, as of October 19, extensions are in place beyond September 30 for 8 borrowers, representing $12 million of exposure, as seen on Slide 6. The current modest deferral numbers when combined with our expectations for brokerage future requests and our strong past due performance are positive indicators.

The risk rating process depicts a portfolio of strong characteristics reflecting strength similar to that of the precrisis economy as seen in Slide 10. Maintaining accurate risk ratings will remain a key focus in the upcoming quarters as our borrowers continue to report results impacted by the pandemic.

We continue to monitor the financial condition and performance of credits, particularly in the following segments: auto dealerships, hotels and lodging, assisted living, restaurants and movie theaters. Some of these individual segments account for more than 5.1% of commercial loans. The composition of these segments can be seen on Slide 9.

We recorded noninterest income during the third quarter of $13.3 million, up $6.6 million or nearly 100% since the prior year quarters. As can be seen on Slide 15, this improved level of noninterest income was largely driven by a 228% increase in mortgage banking income, reflecting the success of ongoing strategic initiatives designed to increase market share, a higher level of refinance activity stemming from historically low rates and increased share in the purchase market and an increased percentage of loans sold.

For the third quarter of 2020 purchase mortgage loans originated were up 50% over the comparable quarter in the prior year, while refinance activity increased 103% as seen in Slide 18. October applications and backlog suggests that refinance opportunities will persist in the near future and purchase applications are at seasonally high levels. Continuing to enhance mortgage banking income to increase market share, including an increased share in the purchase market, remains a priority. We will continue to hire proven mortgage loan originators as we are able.

Noninterest income from payroll services grew 8.7% despite high levels of unemployment during the quarter relative to the prior year comparable quarter. Service charges on accounts decreased 4.2%, primarily due to larger balances offsetting charges. Credit and debit card income increased by approximately 5.7% as activity within the accounts began to recover for reduced activity during the pandemic. The year-to-date activity is approximately equal to last year despite the pandemic-induced reduction in activity.

That concludes my comments. I will now turn the call over to Chuck.

Thank you, Ray.

As noted on Slide 13, this morning, we announced net income of $10.7 million or $0.66 per diluted share for the third quarter of 2020 compared with net income of $12.6 million or $0.77 per diluted share for the third quarter of 2019. Net income for the first 9 months of 2020 totaled $30.1 million or $1.85 per diluted share compared to $36.1 million or $2.20 per diluted share for the first 9 months of 2019.

Proceeds from bank-owned life insurance claims and a gain on the sale of a former branch facility increased net income in the first 9 months of 2019 by $3.1 million or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased $0.16 or 8% during the first 9 months of 2020 compared to the respective prior year period.

The lower levels of net income during the third quarter and first 9 months of 2020 compared to the respective 2019 periods resulted from higher provision expense and overhead costs, along with lower net interest income, which more than offset increased fee income.

Turning to Slide 14. Interest income on loans declined in the 2020 periods compared to the 2019 periods primarily due to FOMC rate cuts aggregating 225 basis points since the beginning of the third quarter of 2019 with 150 basis points of those cuts occurring in the first quarter of 2020.

Interest income on securities during the 2020 periods benefited from accelerated discount accretion from called U.S. government agency bonds totaling $0.3 million during the third quarter and $3.0 million during the first 9 months of 2020.

In total, interest income declined $4.7 million during the third quarter of 2020 compared to the third quarter of 2019 and was down $8.1 million during the first 9 months of 2020 compared to the first 9 months of 2019.

Interest expense declined in all categories during the 2020 periods compared to the 2019 periods, reflecting the declining interest rate environment. In total, interest expense declined $2.6 million during the third quarter of 2020 compared to the third quarter of 2019 and was down $5.1 million during the first 9 months of 2020 compared to the first 9 months of 2019.

Net interest income declined $2.1 million during the third quarter of 2020 compared to the third quarter of 2019 and was down $3.0 million during the first 9 months of 2020 compared to the first 9 months of 2019.

Provision expense increased significantly in the 2020 periods compared to the 2019 periods, primarily reflecting the coronavirus pandemic and its impact on the economic environment. Provision expense totaled $3.2 million during the third quarter of 2020 and $11.6 million during the first 9 months of 2020 compared to $0.7 million and $2.5 million during the respective 2019 periods.

The relatively large provision expense recorded during the third quarter of 2020 was primarily associated with the commercial loan risk rating adjustments Ray mentioned earlier, while the large provision expense recorded during the second quarter of 2020 was primarily comprised of the allocation associated with the newly created COVID-19 pandemic environmental factor and an increased allocation related to the existing economic conditions, environmental factor. The COVID-19 factor was added to address the unique challenges and economic uncertainties resulting from the pandemic and its potential impact on the collectability of loan portfolio.

We elected to postpone the adoption of CECL as permitted by the CARES Act. However, we are running our CECL model concurrently with our incurred loss model. Based on preliminary results, we do not believe a loan loss reserve balance determined by the CECL model is materially different than the loan loss reserve balance as determined by our incurred loss model as of September 30, 2020, similar to the results at the end of the first quarter and second quarter.

Continuing on Slide 15. Fee income increased in the 2020 periods compared to the 2019 periods, primarily reflecting significantly higher mortgage banking income. Excluding bank owned life insurance claims on the gain on the sale of a former branch facility during the first 9 months of 2019, fee income during the first 9 months of 2020 increased $14.4 million or 88% when compared to the first 9 months of 2019.

Reflecting increased refinance and purchase activity, along with the successful implementation of several strategic initiatives over the past couple of years, mortgage banking income was substantially higher during the 2020 periods compared to the 2019 periods. Third quarter 2020 mortgage banking income was $6.6 million higher than the third quarter of 2019, and income during the first 9 months of 2020 was $14.5 million higher than the first 9 months of 2019.

Credit and debit card income returned to pre-COVID levels during the third quarter, reflecting a recovery in transaction volume for the second quarter. While not quite returning to pre-COVID levels, service charge on account income during the third quarter was much improved from the second quarter, in large part reflecting higher transaction levels from our business customers.

Continuing on Slide 16. Overhead costs increased in the 2020 periods compared to the 2019 periods, primarily reflecting higher compensation costs and the expansion of our main office back in 2019.

Salary and benefit costs were up $3.1 million or 22% during the third quarter of 2020 when compared to the third quarter of 2019. Mortgage banking-related compensation costs were up $1.3 million, while the bonus accrual increased $1.2 million. The bonus accrual recorded during the third quarter equated to 3 quarters worth of accrual as no bonus accruals were recorded during the first and second quarters due to the economic environment.

Salary and benefit costs were up $4.4 million or 11% during the first 9 months of 2020 when compared to the first 9 months of 2019. Mortgage-related -- mortgage banking-related compensation costs were up $3.7 million, while the bonus accruals were essentially the same.

Occupancy, furniture and equipment costs were up a combined $0.6 million during the third quarter of 2020 when compared to the third quarter of 2019 and up a combined $1.5 million during the first 9 months of 2020 when compared to the first 9 months of 2019, in large part reflecting the fall of 2019 completion of our main office expansion.

We expect fourth quarter overhead costs to be similar to that of the third quarter. Included in the fourth quarter will be a $1.5 million write-down on branches that we are scheduled to close this quarter and being offset by a much lower bonus accrual as there's no catch up involved in the fourth quarter.

Continuing on Slide 17. Our net interest margin was 2.86% during the third quarter of 2020, down 31 basis points from the second quarter of 2020 and down 85 basis points when compared to the third quarter of 2019. But it -- but within the guidance we have provided in the previous call.

The yield on earning assets declined 40 basis points during the third quarter of 2020 when compared to the second quarter of 2020, while the cost of funds declined 9 basis points during the same period. In comparing the third quarter of 2020 with the third quarter of 2019, yield on earning assets declined 128 basis points while the cost of funds declined 43 basis points.

The yield on loans was down 15 basis points during the third quarter of 2020 compared to the second quarter of '20 -- the second quarter of 2020 and down 103 basis points when compared to the third quarter of 2019, in large part reflecting the FOMC's aggregate 225 basis point reduction in targeted Federal funds rate mentioned earlier.

We are recording the origination fees and direct origination costs of PPP loans equated to a $15 million net increase to interest income on commercial loans using a level yield method. Third quarter 2020 net accretion totaled $3.0 million. Assuming no forgiveness transactions, we expect to record net accretion of $2.5 million during the fourth quarter of 2020; and $2.1 million, $1.6 million, $1.2 million and $0.8 million during the first, second, third and fourth quarters of 2021, respectively, with the remainder during the first half of 2022.

The yield on securities during the third quarter of 2020 and the first 9 months of 2020 benefited from accelerated discount accretion on called U.S. government agency bonds. Accelerated discount accretion totaled $0.3 million during the third quarter of 2020, positively impacting the quarter's net interest margin by 3 basis points. Accelerated discount accretion totaled $3.0 million during the first 9 months of 2020, positively impacting the period's net interest margin by 11 basis points.

Negatively impacting our net interest margin during the 2020 period and especially the second and third quarters of 2020, with a significant volume of excess on balance sheet liquidity depicted by low-yielding deposits with the Federal Reserve Bank of Chicago and a correspondent bank. The excess funds are primarily a product of federal government stimulus programs as well as lower business and consumer investing and spending.

Overnight deposits averaged $450 million during the third quarter of 2020 and $280 million during the first 9 months of 2020 compared to our typical average balance of $50 million to $75 million.

We expect a level of overnight deposits to stay at elevated levels for the remainder of 2020 and well into 2021. This excess liquidity lowered our net interest margin during the third quarter of 2020 by about 30 basis points.

The cost of funds has also been on a declining trend, primarily reflecting the falling of interest rate environment. But in terms of magnitude and scale, not to the degree of experience and/or yield on loans. We currently expect our fourth quarter net interest margin to be in a range of 2.75% to 2.80%. Again, that assumes no forgiveness of PPP loans.

As noted on Slides 18, 19 and 20 is our mortgage banking income. Mortgage loan originations increased substantially during 2020 periods and especially during the second and third quarters of 2020, in large part reflecting significant refinance activity stemming from the decreased interest rate environment, coupled with the ongoing success of the strategic initiatives that were designed to expand market penetration, enhance gain in activities and operate more efficiently.

Mortgage loan originations totaled $237 million during the third quarter of 2020 compared to $133 million during the third quarter of 2019, an increase of almost 80%. Mortgage loan originations totaled $646 million during the first 9 months of 2020 compared to $258 million during the first 9 months of 2019, an increase of about 150%. About 61% of the mortgage volume during the third quarter of 2020 consisted of refinance applications compared to about 53% during the third quarter of 2019.

Approximately 81% of the mortgage loan originations during the third quarter of 2020 have been or will be sold on a secondary market, up slightly from the 79% during the third quarter of last year.

Continuing on Slides 21 and 20 -- 22, standard quality metrics of the loan portfolio remained very strong with continued those levels of nonperforming loans and loan charge offs. Nonperforming loans as a percent of average loans equaled only 12 basis points at September 30, 2020.

The balance of other real estate owned was about $500,000 at quarter end. Gross loan charge-offs totaled only $125,000 during the third quarter of 2020, while recoveries of prior period loan charge-offs totaled $250,000.

The resulting net loan recoveries of $125,000 equated to 2 basis points of average total loans annualized. Additions to nonperforming assets totaled $1.6 million during the third quarter of 2020 with a net increase of $1.2 million recorded in nonperforming assets during the quarter.

Over the past 12 months, the balance of our loan loss reserve has increased by over $11 million or about 45% with the coverage ratio, excluding PPP loans, growing from 88 basis points to 1.27%.

Capital is shown on Slide 23. We remain in a strong and well-capitalized regulatory capital position. The Tier 1 leverage capital ratio was 9.8% and the total risk-based capital ratio was 13.8% as of quarter end. The total risk-based capital ratio was over $126 million above the minimum threshold to be categorized as well capitalized.

There was no share repurchase activity during the third quarter of 2020. As in late March, we elected to temporarily see share repurchase activity to preserve capital for lending and other purposes due to the uncertainty surrounding the COVID-19 pandemic. We currently have about $10 million available in our repurchase plan.

On Slide 24 and to conclude my remarks are some comments on the 2021. Due to the high degree of uncertainty that currently exists, we will not be providing earnings performance guidance as we have done on past conference calls. However, we are able to offer key considerations that should be factored into any earnings forecast of our company. Clearly, economic conditions, asset quality, PPP forgiveness activity and mortgage banking operations are expected to have the most impact on our operating results for the remainder of this year and into 2021.

In closing, while uncertainties remain that may impact Mercantile's financial condition and operating performance in future periods, we note that we entered this stressed environment with strong asset quality and a solid capital position. We are pleased with our third quarter operating results and financial condition as of September 30, 2020, and believe we are well positioned to navigate through the unprecedented environment created by the coronavirus pandemic and other events.

Those are my prepared remarks. I'll now turn the call back over to Bob.

Thank you, Chuck.

That now concludes management's prepared comments and we'll open the call to the Q&A.

(Operator Instructions)

Our first question today comes from Brendan Nosal with Piper Sandler.

Just want to start off on the margin here, and thanks for all the puts and takes that you guys offered in your prepared remarks. Just thinking back to the last quarter's call, I believe that you said the expectation for the margin with a normal level of liquidity and no PPP forgiveness was about 3.10% to 3.15%.

Just curious if this is a decent expectation once liquidity does eventually roll off to a more typical level. Or is there more pressure from that figure from what you've got previously?

Yes, Brendan, I think there might have been some miscommunication because the numbers you just quoted excluded the excess liquidity. So that was the difference between what we actually reported and that calculation.

So one of the things that we see on the balance sheet during the third quarter was everything pretty much was steady from where it was at the end of the second quarter. So -- and part of that was our excess liquidity position, we ended the second quarter soon thereafter with about $450 million on deposit with the Fed and a correspondent bank. And it was pretty much that average throughout the quarter and that's pretty much where we're at right now. So a lot of stabilization there, which is good. But certainly, a tremendous amount of excellence liquidity that we certainly don't need.

Clearly, we would like the -- our borrowers and our depositors to start using those funds. If anything, from a macro standpoint, to make sure that the economy continues to recover. But it appears that we're in a state of steadiness and at least so far here in the 3 weeks into the fourth quarter, we haven't seen any change in our balance sheet structure.

So in looking at our margin for the fourth quarter compared to where it came in, in the third quarter, but we are expecting some slippage there, the 2 main items there -- or 3 main items, I guess, certainly, the bigger one would be the reduction in PPP loan fees that we're going to record. Again, we're using the level yield method, so that goes down over time and I gave you those numbers.

We did have -- one of the things we don't really budget for are any prepayment fees. We typically get those every quarter, but those are very difficult to predict. So we really don't predict those. And then the -- our methodology of trying to manage interest rate risk with our bond portfolio, whereby we buy heavily discounted bonds during periods of rising interest rates.

A vast majority of those bonds have now been called, so we don't really expect much of that to take place in future quarters, including the fourth quarter. So those are the 3 primary items that get us from a margin over in the mid-2.80s to maybe mid-2.70s.

Got it. That's perfect. And totally understood that the first figure I quoted excludes any impact from excess liquidity. Perfect.

Just one more from me. Hoping you can offer a little bit more color on the credit downgrades that drove the provision this quarter. Just kind of any [probable] thoughts on industry concentrations or characteristics, et cetera.

And then as you look ahead, are there any more credits that are on your shortlist or -- for more downgrades? Or do this quarter's action pretty much true-up their risk ratings to what the environment is today?

So this is Ray. Your last question, definitely, as we made these downgrades, we feel like it completed the job. We tried to even look ahead and say, "Are there any in the fourth quarter that could potentially give us issues?" And we downgraded those as well.

So we feel like based on all the information that we have today, we completed that job. And also looked hard at all the credits that had requested and experienced deferrals in their payments and went through those very carefully, about 45% of those showed no change in risk rating.

We downgraded about 40% of those one match and the balance, which was a relatively small number, about another 14%, another match. So we feel like all the information that's available to evaluate our credits have been take into account. And we've downgraded everyone that we see having some small issues now or anticipate having issues in the next quarter.

Yes, Brendan, this is Bob. Just to amplify that, we had a definite plan as we went through the summer months. Our intention when the pandemic first started and the severest of the economic shutdowns was occurring, that we weren't just going to have a knee-jerk reaction and downgrade the portfolio without some empirical data from our clients and financial statements and do it in a very systematic way. That occurred during the summer into the fall. And as Ray indicated, concluded looking into the third quarter and we feel really good about where we stand.

Working with our clients, knowing exactly where they are in terms of their economic recovery and any challenges that remain ahead for them. But to underscore, we felt really good about the status of the portfolio and the reserve and the associated grade with those particular credits.

(Operator Instructions)

Our next question today comes from Damon DelMonte with KBW.

So first question, just wanted to clarify, Chuck, on your comments regarding expenses. You said you expected fourth quarter to be similar to the third quarter. And then you also noted that there would be about $1.5 million of a write-down on the branch closures that are taking effect here in the fourth quarter. Does that -- is that $1.5 million included in that outlook for a relatively flat quarter-over-quarter basis? Or is that excluding it?

So that includes it, Damon. So when we -- so on an overall basis, we expect the cost to be flat. Included in that is the $1.5 million in write-down that we'll be recording throughout the quarter as the branches close. But as I also mentioned, with the bonus accrual, we did not accrue anything in the first and second quarter because of obviously the pandemic.

As we work our way through the year and we see our performance and as we talk with our compensation committee, we are in the process of formally formulating bonus plans. And based on those discussions in our calculations, we needed to not only accrue for the third quarter, but we needed to catch up for the first and second quarter. So on an overall basis, those 2 items, so a lower bonus calculation in the fourth quarter compared to the third kind of offsets the $1.5 million expected in write-downs on the branches.

Got you. Okay. So -- well, just to make sure I'm [fair in] this. So then something like around 20 -- a little bit over $25 million then is reasonable?

No, it would be the same as the third quarter, Damon.

Oh, it would be the same. Okay. Okay. It's interesting that they offset perfectly. Okay.

And then I guess with respect to the PPP forgiveness process, what are your thoughts and what are you guys hearing on timing of this? Do you think -- we're kind of well into the fourth quarter here. Do you think we're going to see much forgiveness in the fourth quarter? Or do you think everything is going to kind of be -- with the election coming up next month and whatever ensues after that, do you think this is all going to kind of be put on hold until we get into 2021?

Yes. This is Ray. It's very hard to predict how that process is going to go. We stand ready to act on whatever guidance and actionable items we get from the SBA and those have been somewhat sparse to date. How those will roll out for the remainder of the quarter, very hard to predict.

But the bottom line is we'll be ready as soon as practical, as soon as that information is available to us. We have the mechanisms in place electronically to deal with that information. We also have people in place to deal with the information. So we are ready and waiting.

We've actually started the submission process, working with our clients, providing them with the tools, as Ray said, to be able to make those submissions for the forgiveness. Some customers are still working through that process with their financial advisers on their accounting side and their legal side to make sure the documentation is in order.

But through our electronic portal, we've now started the submissions to the government. Have not received any responses yet, but we understand that they've got a lot that they're trying to work through on their end from the SBA standpoint.

So as Ray said, we're ready, we're very transparent with our clients and available to assist the process towards its conclusion for each client.

One of -- this is Chuck. And I'll just add my two cents. One of the things that the entire bank industry has been waiting on is the expedited process that we're all hoping with the trade groups trying to get $150,000 and lower. It appears that it would be at a $50,000 lower clip. And while the SBA has provided some guidelines, they have not yet opened their portals up to accepting those specific applications that represents about 45%. So loans under $50,000 represents about 45% in the number of loans out of the 2,100 that we originated under PPP.

Right. Okay. Okay. Great. And then -- so to make sure I'm reading this correctly, your loan deferrals are now down to like 43 basis points of loans, only $12 million. Correct?

Correct.

Okay. So how do we think about provision going forward? It sounds like this quarter, you adjusted the ratings on some and you kind of built up some additional reserving as a result of those indicators. Do you think you go back to a similar level in the fourth quarter? Or do you think you can even go lower than that in the fourth quarter, kind of after any major macro changes?

Yes. Damon, I mean it's an interesting perspective that you're putting on it and we're looking at it ourselves. Really, there's -- and we kind of did that with the second and third quarter. There's really 2 key drivers, right? There's the environmentals and then there's the specific downgrades. We hit the environmentals really hard in the second quarter, obviously, created, as we mentioned, the COVID-19 factor.

Our economic factor is as low as it can go. The COVID factor could theoretically have additional downgrade to it, which would cause some additional provision. And that is a reminder that factor was designed to be the "we don't know what's going to happen" factor.

And so far, obviously, we look at our asset quality and we're certainly pleased with the performance so far. And -- but we're -- it appears that we're far away from being out of the woods yet. So that factor, we'll certainly continue to take a look at. The other factors that we haven't touched yet, which are the traditional factors that the regulators gave us years and years ago, trends in past due, changes in collateral values, those types of things, things are holding up pretty steady, so far.

But clearly, at the end of this fourth quarter here and going forward, of course, we'll continue to look at those and change those if need be. I think Ray and Bob already kind of did a really good job of explaining what we did with the downgrades in the third quarter.

So kind of putting all that together, as we sit here today and see what's going on, we feel really good about where our reserve is, but we're certainly going to continue to look at all those factors. And if we need to downgrade loans, we'll downgrade loans, if we need to change some factors, environmental factors, we'll do that. But all things being equal, we're pretty comfortable with where we're at currently.

(Operator Instructions)

And it looks like we have a follow-up question from Damon DelMonte with KBW.

With regards to capital, can you give a little perspective on where the shares are trading today and the possible use of capital to do a buyback or even look to raise some additional sub debt to kind of bolster regulatory ratios to maybe facilitate buyback down the road? Kind of what are your thoughts around that?

I think there are tugs and pulls in all different directions, Damon, that you kind of alluded to, with many banks, many companies issuing some sub debt. And some other banks thinking about [differing their toll in the water back with buybacks]. But I think as we continue to consult with our Board and look at our numbers, we're taking the "steady as she goes" approach.

I think as Chuck indicated in his comments, that the buybacks, we've -- we're sitting on the sidelines right now, but we'll continue to evaluate that and make sure that the stock price being what it is, that we don't miss any opportunities that we might otherwise take.

So it's kind of a balancing act to make sure that we're good stewards of our capital and position us for whatever may come down the pipe in 2021 in terms of economic challenges or opportunities to deploy that capital. We want to make sure that we're well positioned to be able to handle whatever that can be thrown at us and take advantage of opportunities in the same manner.

So I think we continue to evaluate that from quarter-to-quarter and look at see where we stand. But for right now, we're quite comfortable where we're at.

Got it. Okay. That's good. And then I guess just last question. Just quickly on mortgage banking. Can you just give a quick update on your pipelines here in the fourth quarter and kind of how you think that shapes up for the actual fourth quarter result?

Yes. Typically, in the fourth quarter, there's a seasonal decline in the mortgage business. And as we observe our pipeline over the very recent past, they have not shown any of those classic signs of a seasonal decline. So it will -- it may very well come towards the very end of the year. But in the next month or 2, we expect it to hold up at similar levels to what we've experienced in the last month or so.

And anecdotally, Damon, still, when you look at houses that they pop on the market, considering that we're almost in November, just from my neck of the woods in the Kent County area of Grand Rapids, the houses are on the market very long before they're snatched up and purchased by a prospective new homeowner.

So yes, the market continues strong, as Ray alluded to and it's going to be interesting winter months. But I think because of the fact that the spring season was pushed back because of the shutdowns of the pandemic, I think it could create some interesting volume opportunities for us as we go through the winter of 2020 and 2021.

This concludes our question-and-answer session, and I would like to turn the call back over to Bob Kaminski for any closing remarks.

Thank you, operator. And thank you very much for your interest in our company. We hope that you and your families stay safe and healthy. And we look forward to speaking with you again at the conclusion of the fourth quarter come January.

This call is now concluded. Thanks again.

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