Midwestone Financial Group Inc (IOWA) (MOFG) 2020 Q2 法說會逐字稿

Good day. And welcome to the MidWestOne Financial Group's Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this is being recorded.

I would now like to turn the conference over to Charlie Funk, CEO. Please go ahead.

Thank you very much, Sean, and good day to everyone. And thank you so much for joining us on the MidWestOne second quarter earnings call.

We are calling from Iowa City, as we always do, today. And in the room with me is Barry Ray, our Chief Financial Officer; Gary Sims, our Chief Credit Officer; Jim Cantrell, our Treasurer and Chief Investment Officer. And we also welcome Len Devaisher, our new President and Chief Operating Officer to the call today as well.

I will begin by reading the forward-looking statements and just remind you that this release and this call will contain certain forward-looking statements within the meaning of such terms in the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any results, levels of activity, performance or achievements expressed or implied by any forward-looking statement. Forward-looking statements are generally identifiable by the use of words such as believe, expect, anticipate, should, could, would, plans, goals, intend, project, estimate, forecast, and may or similar expressions. Additionally, we undertake no obligation to update any statement in light of new information or future events, except as required under federal securities law.

And with that, I would like to offer a few opening comments and just say, we think this was a good quarter -- second quarter for our company. We recognize there is much uncertainty in the world today, and we expect this to continue for the foreseeable future. We're planning for that in all that we do. So we take this quarter-to-quarter. And again, I thought that there were many positives in the second quarter. I will offer some general comments and then turn it over to Barry Ray and Gary Sims for further comments.

Thanks to PPP and other programs, our assets rose to more than $5.2 billion during the quarter. And as we indicated in the earnings release, we did $345 million roughly in PPP loans. We also recognize that there is significant earnings volatility in our industry, and there's less focus than usual on earnings metrics. But with that said, we're very pleased to report a 13.5% return on tangible equity for the quarter and efficiency ratio, as we calculated, under 55%.

Clearly, our margin, as most margins did, suffered from a mix change as loans paid off, plus we did have excess liquidity created from all of the government programs. Just for your information, we do calculate that the all-in yield on the PPP loans was 1.70% in this quarter. We -- as with many, we expect that forgiveness will occur in the fourth quarter of this year, and we think the fourth quarter will shape up to be a pretty good quarter for net interest margin as we look ahead.

We do believe that we have some more room to lower deposit costs in the third quarter. We started that at the end of July, and we're going to take a further look at that during the month of August. So we do think there's some room to bring deposit costs down further from what they were in the second quarter.

Our loans, ex PPP, were down, as stated in the earnings release. We did have lines of credit that paid down. There were a number of borrowers who would normally carry lines of credit -- line of credit balances at this point in the year that completely paid out. We also had several borrowers that have lots of liquidity on their balance sheet either pay off their loans entirely or pay down their loans substantially, and that contributed to the decline in our loans outstanding during the quarter.

We can't predict payoffs in the third quarter. But I think there's a reasonable pipeline as we enter the second quarter. I would not call it a robust pipeline, but I would call it a reasonable pipeline of new loans as we look forward.

Noninterest income. Very, very pleased with the mortgage results, and most of the mortgage results were driven from our Iowa footprint. Just as a sort of marking the progress we have in mortgage, our volume for the first 6 months of 2020 is 114% higher than it was for the same period in 2019. In the second quarter of 2020, we doubled our production from the first quarter. And the other thing, unlike some of our competitors around our footprint, we have not shut off our business and we're taking all applications as they come, even though close times tend to get a little bit longer due to the volumes.

We're very happy with the wealth management results for the first 6 months of this year. Trust and investment services are both ahead of their budgets, respective budgets for the first 6 months. I think it's fair to say they do face some headwinds, and I would categorize the headwinds that they face primarily as being market volatility as well as just in the COVID age, it's just harder to undertake new business development. But they've hung in there very, very well for the first 6 months, and we're very, very pleased with the results.

If you are familiar with our company, you know that 2/3, roughly 2/3 of our trust assets are located in the Dubuque footprint, and that merger seems to be working very, very well with good client retention and continued growth in fee income.

Our swap income was down in the second quarter. I think we previewed that in the first quarter earnings call. And that's really due to the significant drop in short-term rates that makes the math not work quite as well for us whenever we take the variable side of swaps. Also, we've seen some of our competitors who've been slightly more aggressive than we have with their swap terms and offered for longer period of times than we've been willing to -- than we typically offer. So we would think that swap revenues will continue to be lower as we go forward in time.

On expenses, we continue to focus on the expense line. We recognize that's one of the few levers that we have to pull. And we announced that we -- as we announced in the earnings release, we are closing our Newport, Minnesota office. Our South St. Paul, Minnesota office is 5.5 miles from our Newport location. And as we disclosed in the earnings release, we think we'll save, once this is all flushed through the system, about $360,000 in annual expenses.

If you look at our footprint around the Midwest, I think we have limited opportunities for outright closures because we operate in many communities where we only have 1 office in that community. So it makes it much, much harder for us to think about closing a good deal of offices, but we will continue to look at this as we go forward. We also recognize that we have to continue to focus on noninterest expense control, and we will continue that focus on reducing our noninterest expense into the third quarter of this year.

I want to make just a couple of comments on asset quality. Gary Sims will talk about this more completely when he speaks. We did try to get ahead of the curve in the first quarter with our credit loss expense. And at $4.7 million for this quarter, that's still what we consider about twice our annual -- what would be an annual run rate, or a quarterly run rate, I should say, quarterly run rate. The allowance for credit losses at 1.70% of total loans, ex PPP, we think, is -- puts us in a strong position. And I also note that our nonaccrual loans were down slightly to 1.15% of total loans, and that decreased from 1.28% at the end of the first quarter.

Just a few comments on ag. We always get a lot of questions on ag. And if you look at our watch plus substandard loans as a percentage of total ag loans, it's the best quarter we've had in several years. 18.1% of our ag loans were ready to either watch or substandard at the end of the second quarter. And to give you an idea, in March of 2018, just over 2 years ago, that number was 23.6%. So we've done a nice job of moving to watch and substandard ag loans down as a percentage of ag loans.

Ag loans, as a percentage of our total portfolio, stand at 8.4% at the end of the second quarter. That's down from 9.2% at the end of quarter 1. We expect that to stay the same or go down as we move forward. But I think the most important thing for the outlook for our ag borrowers is the crops in our footprint look very good. Our footprint being mainly Eastern Iowa for -- Eastern and Southeastern Iowa, for ag loans and our crop growers. The government support programs that came from the stimulus program provided a nice boost to our growers. And prices have plateaued. Corn and soybean prices have plateaued at slightly lower levels than they were before COVID-19, but they're off -- well off the lows that we saw during the first outbreaks of COVID-19.

Land prices are basically unchanged from last quarter, which would be down 2% year-over-year and down 13% from the peak. So a little bit weaker, but certainly, they have not fallen precipitously. So overall, I would say that the ag outlook is about the same as it was 3 months ago. And I would think that we're starting to see some stability in the ag sector, although at a lower level than certainly the peak years of 2011, '12 and '13. Still a tough environment, but it's not spiraling down as we sit here today.

As I said, Gary will cover this in more detail when he speaks. We do expect deferrals to be materially lower than what was reported at the end of the first quarter. And when that all flushes through, we think only about 25% of those borrowers will request another 90 days. So we feel very comfortable in our ability to monitor and manage our loan portfolios as we look forward.

A few comments on capital. We think we shored up our regulatory capital in a good way. With our $65 million sub debt issue, it was well received in the marketplace, and we appreciate all those who invested in our company.

We also feel comfortable and confident in the current levels of capital. Ex PPP, tangible common equity stood at 8.35% at quarter end. And we do note that our tangible book value per share increased to $24.74 and was up 5.8% during the quarter.

We also were very pleased to welcome Len Devaisher as our new President and Chief Operating Officer. That chair has been empty for a year, and we appreciate -- I especially appreciate the way that the entire management team stepped forward, came together to keep our company moving forward, and I do think we've moved forward during this time.

So overall, I think it was a good quarter for our company, certainly operating in difficult circumstances. And based on what we see today, we're confident in our ability as well to maintain our dividend on a go-forward basis.

With that, I will turn it over to Barry Ray.

Thank you, Charlie. Unless otherwise noted, my commentary today will be a comparison of the second quarter of 2020 results to the first quarter of 2020.

As an overview, the company reported net income of $11.7 million or $0.73 per diluted common share compared to a net loss of $2 million or $0.12 per diluted common share in the linked quarter. On a pretax, pre-provision basis, net revenues were $18.9 million for the second quarter of 2020, up 8% from $17.6 million in the first quarter of 2020. The increase in pretax, pre-provision net revenue resulted from a higher net interest income and lower expenses, partially offset by lower fee income.

Credit loss expense of $4.7 million reflected a loan credit loss expense of $6.3 million, partially offset by a $1.6 million reversal of credit loss expense related to off-balance sheet credit exposures.

On the balance sheet, aided by the SBA Paycheck Protection Program activity, average loans grew 6%, and average deposits were up 11%. The company's tangible book value grew 6%.

Returning to earnings components. Net interest income of $38.7 million was up $1.3 million from $37.4 million in the linked quarter as greater average earning asset balances offset a 22 basis point decline in the company's tax equivalent net interest margin. The increase in average earning assets were driven by the origination of SBA PPP loans as well as investment of excess liquidity into debt securities. The decline in the company's margin reflected a full quarter impact from the 150 basis point drop in the federal funds target rate in March of 2020, a shift in earning asset mix to lower-yielding assets and the lack of meaningful term premium on the yield curve, particularly in the overnight to 5-year term, which is most relevant to the company.

Earning asset yields declined 47 basis points. 8 basis points of which was attributable to the SBA PPP loans, which yielded only 2.68%, 7 basis points was attributable to loan purchase discount accretion and 7 basis points of mix.

Total deposit costs declined 23 basis points as we continue to manage our funding costs directionally consistent with asset yields.

Finally, while there remains some uncertainty as to the timing of SBA PPP loan forgiveness, we expect 70% or more of SBA PPP loan fees to be recognized by the fourth quarter of this year, which should otherwise bolster their margin in the near term.

Net PPP loan origination fees totaled about $10.4 million. And during the quarter, we recognized approximately $1.1 million of those fees in spread income.

We recognized credit loss expense of approximately $4.7 million in the second quarter of 2020, down markedly from the $21.7 million in the first quarter. However, that smaller credit loss expense resulted in continued reserve build at June 30, increasing our allowance for credit losses as a percentage of loans held for investment to 1.55% or 1.70%, excluding the SBA PPP loans.

Turning to fee income. Fees were down $1.9 million from the linked quarter as solid mortgage production included in the loan revenue line item was more than offset by reductions in most other line items. Mortgage revenues of $1.7 million were up $855,000 from the linked quarter as mortgage production volumes increased 141% from the linked quarter.

The revenue increase included a $745,000 negative valuation adjustment to the mortgage servicing right in the second quarter of 2020 compared to a $447,000 negative adjustment in the linked quarter.

The decline in other noninterest income was driven by reduced income from our commercial back-to-back swap program. And as noted in our public release, the decline in service charges and fees line item reflected lower customer overdraft experience as well as increased waivers of such fees.

Moving briefly to expenses, the $2 million decline in total noninterest expense resulted primarily from a $1.4 million benefit to compensation and employee benefits from origination costs related to SBA PPP loans. Generally, other expenses were well controlled and down from linked quarter, save for equipment, which was up slightly due to additional purchase of IT equipment to support the company's work-from-home efforts. Our target efficiency ratio remains at less than 60%. And to that end, we continue to evaluate opportunities to improve efficiency, including branch consolidation activities, as discussed in our public release this quarter.

Moving to taxes. The company's effective tax rate for the quarter was 18%, and we expect the tax rate for the year to be 17% to 18%, below the statutory tax rate due primarily to benefits from tax-exempt instruments and tax credits.

I will end my remarks with some commentary on capital. The company's tangible common equity ratio was 7.8% at June 30, down from 8.11% at March 31, 2020. Excluding PPP loans of $327.6 million, the tangible common equity ratio was 8.33%. Our target for this ratio remains 8.5% to 9%, and we expect to return to that range in the coming quarters.

Finally, earlier this week, we announced the completion of the private placement of $65 million of the company's fixed-to-floating subordinated notes. The notes carry an initial fixed rate of 5.75% and are structured to count as Tier 2 Capital at the holding company. That capital bolsters the company's capital levels as we position our balance sheet to weather these uncertain economic times.

And with that, I will hand it off to Gary Sims for credit.

Thanks, Barry, and good afternoon, or good morning, depending upon where you are at today.

I wanted to just take a minute and focus my comments on 3 areas of detail, all of which are outlined in the supplemental financial disclosures, provide a bit more color to what we've provided to you in those documents.

The first thing I wanted to kind of walk through was our enhanced credit monitoring. And what we -- as we finished the first quarter and identified what we believe could be our possible vulnerable industries within our portfolio, the 6 vulnerable industries that we identified at the end of the first quarter, we undertook an effort to build upon our existing monitoring processes and create some enhanced monitoring appropriate for the current economic position that we find ourselves in.

So what we did was we identified all of those loans in the vulnerable industries greater than $1 million, and we also identified our top 30 relationships. So we focused on higher risk, and then we focused on higher exposure for those 2 categories. And we put together a monitoring process for those 2 categories that we completed at the end of the second quarter, which really took a deep dive into all of those relationships and gave us the ability to clearly understand where those relationships were and where we believe they were going over the course of the current economic cycle.

And to give you an idea of just the penetration, when we combine that with our existing monitoring processes associated with our watch and worse credits, when we combine all those efforts, we took a, I would consider it to be a deep dive into $1.04 billion of our portfolio, which represented 29% of our portfolio.

So I wanted to share with you kind of what the key takeaways from our efforts in the second quarter were. First of all, we experienced migration in the portfolio. We expected that. We -- based on our identification of vulnerable industries, we expected to start seeing some of those credits migrating to pass to watch, watch to substandard. And that was identified in the supplemental information as well. Primarily, within that migration, you saw 3 of the vulnerable industry categories migrating, hotels, restaurants and retail. And it's not to say that within the vulnerable industries, we won't see additional migration from other industries. It's just that those categories had the most immediate negative impact from the pandemic.

The second thing that we experienced from our due diligence was the nonperforming assets were relatively stable for the quarter. That was also expected as we looked at our migration trends. We didn't expect a lot of migration to nonperforming this quarter, and it turned out that was the case.

Another deliverable that was possibly not as expected was that we identified 2 categories within vulnerable that, based on our analysis of our customers, we feel like that they're not going to be materially more vulnerable than our average portfolio over the course of the cycle. And those categories were senior living and our QSR, or quick-service restaurant portion of our restaurant portfolio. As a result of what we actually saw from our customers' performance, we did remove those 2 categories from our vulnerable industries calculations. And so what you saw, as a result, was our vulnerable industries that, we are identifying, represent 14% of our portfolio on a go-forward basis.

And then -- and then the last thing I wanted to point out in terms of what we found was our deep dive into our portfolio gave us the ability to provide significantly more detail around each one of those vulnerable categories as is outlined from Pages, I believe, Pages 9 through 13. A lot more detail for you to dive into and understand what those portfolios look like and how we believe they'll perform over the course of the cycle.

Last thing I did want to point out about this enhanced level of credit monitoring is we do expect this to continue for the foreseeable future as we manage through this cycle. We expect to be doing this enhanced monitoring through the cycle.

So the second thing I wanted to share with everyone was kind of our experience with deferrals, and Charlie had alluded to it earlier. As we finished up the second quarter, for the most part, the first round of deferrals that we have rounded were put in place. And that represented 13% of our total portfolio, 14.5% ex PPP. Based on what we're seeing and what we're talking about with customers right now because, for the most part, that first round is starting to roll off, and we are seeing customers go back into repayment mode, but we're also seeing customers ask for a second round. Based on what we're hearing from our customers, we -- as Charlie alluded to, we expect, compared to the 13% of total portfolio, 14.5% ex PPP, we expect 3% to 5% to be the range of second round of deferrals of total portfolio.

And then the last thing that I'll highlight there was our vulnerable industries are -- were heavy users of our deferral program, as you would expect, and even more specifically, hotel and retail CRE were heavy users of the program. So it served the purpose that it was intended to serve, no question.

And then the last thing I wanted to touch on briefly was the PPP program. As we said earlier, PPP, roughly $345 million in PPP loans over the course of the program. As Barry mentioned, I'll emphasize it as well. Based on the conversations that we're having with our customers, and we're having conversations with all of the major users of the PPP program, we expect a very high percentage of forgiveness as a result of their utilization of the PPP program and then enhancements in the PPP program over the course of the past few months.

And then the last thing I'll emphasize there. I mean, what we're -- and Charlie alluded to it in his comments, relative to the usage of the PPP and the deposits that we've had on hand as a result, what we're experiencing from our customers is that many of our customers, the PPP program will make a very material difference in how they are able to survive and thrive through this pandemic cycle. So we were active participants, and we're big proponents of the program as it played out.

So with that, that's the sum of my comments, and I believe I need to...

Yes. I'll take that. Just one clarification in my comments. I had mentioned the overall yield on the PPP. The all-in yield on the PPP loans was 1.70%. It was actually 2.68%. I think I got the wrong number in my comments, and I apologize for that. 2.68% all-in yield on PPP.

And with that, Sean, we will send it back to you.

(Operator Instructions) Our first question today will come from Brendan Nosal with Piper Sandler.

Just want to start off on the reserve. So I guess you did this pretty in-depth review of your entire -- or most of your portfolio this quarter. And as you said, there was some negative migration as expected, but the provision was still relatively low in comparison to the first quarter, still built the reserve, but at a much lower level.

So just based on what you can see at this point, do you expect to keep building the reserve throughout the second half of the year? Or are you pretty happy with the 1 70 level you're at today?

I'll start, Brendan. This is Gary, and I'll start to answer the question. If I miss any highlights, I'll ask Charlie or Barry to add in as well.

What you've seen from our reserve and the provisions that have gotten us to where we're at is, in the first quarter, based on the expected migration we saw in our portfolio over the course of time, and even more specifically, in the second quarter, we did put together a pretty significant provision, which materially bolstered our reserve as we finished up the first quarter. As the quarter really played out the way we believed it would, that allowed us to moderate the level of provision that we were putting in place for the second quarter. And as we provided more than our net charge-offs, that created the reserve build that you alluded to.

What we -- I mean, what we anticipate happening in this quarter and on a go-forward basis is we'll continue to monitor that migration and match it up against our belief about where the portfolio is going. CECL has given us very good tools with which to manage that reserve. But at the end of the day, it is management's responsibility to estimate the reserve based on what they're seeing in the portfolio.

So if I had to venture an estimation right now, I believe that for the third quarter, we'll continue to moderately build reserve until such time as we actually start seeing the losses that we've been building towards.

That's super helpful to hear your thoughts on that. Just one more for me. Just on the goodwill or the potential for a goodwill impairment that you've alluded to in the pre-release, is that review complete? Or is it still ongoing?

The review is complete.

Got it. Perfect. And then if I can just sneak one more in there. Just curious for your thoughts on how the core NIM behaves from here once you factor in kind of the sub debt issuance, perhaps offset by the flex that you still have on the funding side. Just the core margin kind of the rest of the year?

Yes. Brendan, this is Jim Cantrell. It is a difficult thing to forecast. We've had some discussions internally about the margin. I do think you're right. The sub debt will provide a little bit of drag on the margin going forward. That came on the books here right at the beginning of the third quarter.

Aside from that, and absent any -- well let me back up and recognize. There will be noise in the NIM from the PPP program and from any shift in mix. I think in the second quarter, our core NIM, absent the mix change in the PPP loans and the purchase accounting adjustment, is pretty flat. The rates on our deposits came down pretty comparably with our rates on earning assets. But the mix shift and those low-yielding PPPs really caused some narrowing. We do think that the fourth quarter for the NIM, because of the PPP, is going to be significantly improved if we get the forgiveness that we expect in the fourth quarter.

So all that is to say there's going to be a lot of noise.

The core of it, I think, is going to be for pretty flat to maybe some pressure on the NIM as we move forward.

Brendan, this is Barry. I'll clarify on the goodwill when I complete. We -- management's completed their review. I would say it's 99.9% complete. Our auditors would have us tell you that their review is not complete until we file our 10-Q. But right now, all indications are that the review is 99.9% complete.

And the next question today will come from Jeff Rulis with D.A. Davidson.

Gary, I appreciate the color on the credit detail. That was informational. I guess beyond the deferrals, I did want to clarify the -- so if you're at 14.5% of loans, ex PPP, quarter end, I wanted to -- your statement about when you get to the second round of deferrals, you expect there was a 3% to 5% number. Does that equate to the -- you expect 14.5% on deferral to fall to 3.5% when all is said and done? Maybe I...

Right.

Yes.

That's correct. The 14.5% to fall to 3% to 5% of the portfolio for that second round of deferrals.

Okay. Great. And the majority are on 90-day? Or I mean, how -- I guess, how far are you through that? [There was that]...

Yes. Sorry, I didn't mean to interrupt. Yes, the program, as we formulated it and put forward was we offered an initial 90-day, for the most part, an initial 90-day deferral opportunity. And then we have followed up with a second 90-day deferral opportunity for those who have asked for it.

As a second round has been requested from customers, and as we've noted, our expectations is it is materially less usage in the second round, we are asking more -- we're contemplating more about what that second round means for the credit risk profile of the customer asking for that deferral. So it's being incorporated into our thought processes around risk profile.

Yes. Makes sense. Maybe just a question on the fee income side. Obviously, kind of service charges and maybe swaps less so, but a little bit of customer behavior and the mortgage. I think Charlie referenced, is still going strong into the quarter. I guess, maybe we don't get back to the ceiling on service charges immediately, but just thoughts on how the fee income line transitions through the back half of the year would be helpful, either specific or broadly speaking.

I'll start off, Jeff. I think that -- yes, I think as we articulated last quarter, we thought that the $10-plus million that we had was a high watermark. I think that I would say that probably $8.3 million to $8.5 million per quarter of a fee income run rate is what we would expect.

I would also just add to that, Jeff, that yes, customers, it appears, are keeping larger balances. And therefore, we don't have as much NSF income, which is understandable in light of the current circumstances. If government stimulus programs don't come through, you might see that some of the deposits start to run down, you might see a little bit more of that activity. I personally think you might see a little bit of uptick in the service charges, but I don't know that it will return to prior levels anytime soon. But that's just a guess.

Okay. And maybe a last one, Charlie. Just you discussed the goodwill, but the -- any further thoughts on the dividend? I think you've got certainly more clarity or the deep dive on the credit side. You've shored up with kind of a sub debt issuance a bit. But you do have a little higher payout ratio. I'm just interested in the conversation about, is that -- I imagine it continues to be monitored, but thoughts on the dividend.

Yes. So we've started running stress tests in the February, March time frame. And we clearly think that based on what we see now, the dividend is secure, and we're committed to the payout. If circumstances change, we're certainly -- we will certainly review that. And that's probably the best guidance I can offer you right now. As we look at things right now, it's a secure dividend.

And the next question will come from Terry McEvoy with Stephens.

I had a question, I guess, at Slide 6, the enhanced credit monitoring. It sounds like in the second quarter, you look at your 30 largest loan relationships, $16 million to $35 million in size. Any of the vulnerable industries fall into the -- your 30 largest loans? And then just broadly speaking, were there any downgrades, upgrades or any actions as it relate to those larger credits?

Yes. This is Gary. I'll start to answer that question as well. There is overlap between our vulnerable industries and our top 30. Within our top 30, we do have 2 hotel relationships. And we also had -- from our original vulnerable list, we had several senior living relationships and then we had 1 quick-service restaurant relationship. So there is overlap between the 2. And as a point of clarification, because we will continue our quarterly review of those large relationships, each one of those will stay in the mix.

As we look at that top 30 list, the 2 hotel relationships in that top 30 -- top 30 list were downgraded to watch. None of the rest of the top 30, either in the vulnerable or outside vulnerable, were downgraded as a result of that review.

And then just as a follow-up question. I thought it was interesting earlier, and I can't remember who said it, but the quarterly provision of $4.7 million, I think it was mentioned as being kind of 2x the normal quarterly run rate. And I guess my question is, was that a pre-CECL comment? Or what was behind that statement? Because so much has changed this year as it relates to reserving and provision, and I just want to make sure I understand where that statement was coming from.

That's a good question. And to clarify that, I was the one that made the statement, and I was referring to what we budgeted going into the year, which we would consider normal times. And so we used roughly $2 million as a normal provision. But clearly, we're in different times now, and we're reserving appropriately.

(Operator Instructions) The next question will come from Damon DelMonte with KBW.

This one relates to the outlook for expenses. Barry, could you just kind of go over your thoughts again on what a normalized expense base will be kind of when you factor in the deferred expenses from the PPP loan originations?

Will do, Damon. Yes, in the deferred PPP loan origination benefit, that's really a onetime benefit this quarter. And so I would say, our -- I would say our quarterly expense run rate, Damon, probably somewhere $29 million to $30 million.

Got it. Okay. And then, Charlie, you -- I think you had mentioned that there was some decent pipeline activity for loan growth. You didn't characterize it as robust, but you said there was definitely some activity. Could you just talk a little bit about that? Is that from existing customers? Have you guys been able to win new relationships from the PPP lending program? Were you able to bring over new customers through that? Just a little background on what you're seeing with the pipeline.

A little bit of both. There's a little bit of transition on PPP. I would say that most of the pipelines that we've seen have been existing customers. And we have a number of existing customers who are still doing pretty well and they're running their businesses, and they seem to be doing quite well financially. In Denver, we've got -- we hired a new banker earlier this year, and he sourced some relationships. And I still think there's a lot of potential in Denver. We obviously have to be careful during these economic times. But in Denver, there's still some transition from some of the larger competitors that may not handle the PPP process very well. And so our Denver group actually is -- I had a conversation with them a couple of weeks ago, and they're still very confident that they can make their budget numbers, and it's just because they're finding opportunities that appear to be good opportunities. So a little bit of both, but especially in Denver, I think we've been able to find some new opportunities.

Got it. Okay. That's helpful. All my other questions have been asked and answered.

Thank you, Damon.

And the next question will come from Brian Martin with Janney Montgomery.

Just maybe two for me. Maybe one for Jim. Just going back to the margin, I guess, for -- I guess a minute, Jim. I guess your thoughts on the mix change or Charlie's comments about the mix change and kind of the volatility. I mean, I guess if the loan pipelines aren't super robust at this point, I guess, is your expectation that, that mix -- we're seeing this quarter based on trends really doesn't change in the near term? Or I guess, are you expecting that any significant change? Or should we just kind of continue to think about it the way it is today?

Yes. Well thanks, Brian. I'll give you my best answer and because you're asking about the future. I think we've seen a big -- the biggest part of the shift mix, I suspect, has already happened. That's my gut tells me. Having said -- so we've increased the investment portfolio several hundred million dollars relative to the loan book. What is, I think, going to offset that a little bit is we're going to get some -- we think we're going to get some PPP loan forgiveness in the fourth quarter. And my suspicion is that the PPP loans will be forgiven at a faster rate than the corresponding deposits that were attached to those loans will run out of the bank. That's my gut. That's my guess. And so we'll get some additional income because we'll release some fees upon forgiveness. But the result may be that the balance sheet could possibly become even a little more skewed towards investments. But that's -- how much of that will happen, I don't know. That's very much an unknown at this point.

Okay. Perfect. I appreciate it, Jim. And maybe just one for Gary, I guess, on the -- when you look at these vulnerable industries, can you just talk a little bit about the consistency of what's in the CRE retail bucket? I mean, that seems to be the biggest one out there. And just kind of -- I don't know if you can offer kind of where the reserves are on that portfolio today. Or just any more -- a little bit more detail on just that portfolio and how you're thinking about it today.

Sure. And I don't have a specific breakout of the reserve specifically tied to the CRE retail. It's part of the improved commercial real estate category in the CECL detail there. So it's a subset of that particular category.

What we're seeing in the CRE retail is, it's actually held up to date pretty well. And as we talk to our customers, we think the dynamic that's happening there is many of their customers, small business, dominated by small business customers, have benefited from the PPP program such that they've been able to, on balance, stay relatively current on their rents. So we haven't seen just wholesale rent abatements necessary. But what we see in the future is probably 2 quarters into the future, 3 quarters into the future, we're going to see those small businesses struggling more than they have over the past quarter. And then rents will be challenged to be collected, and we'll start to see deterioration in that particular space into the future. Does that help in terms of additional color there?

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Yes. No, I think it does. And it just sounds like it's more continued monitoring and more issues potentially down the road as opposed to near term here. Okay. That's all I had, guys. Other stuff was answered.

Thank you, Brian.

Thanks, Brian.

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