Origin Bancorp Inc (OBK) 2020 Q2 法說會逐字稿

Good morning, and welcome to the Origin Bancorp, Inc.

Second Quarter 2020 Earnings Conference Call.

Please note this event is being recorded.

I would now like to turn the conference over to Chris Reigelman, Head of Investor Relations.

Please go ahead.

Good morning, and thank you for being with us.

We issued our earnings press release yesterday afternoon, a copy of which is available on our website along with a slide presentation that we will refer to during this presentation.

Please refer to Slide 2 of our slide presentation, which includes our safe harbor statements regarding forward-looking statements and the use of non-GAAP financial measures.

For those joining by phone, please note the slide presentation is available on our website at www.origin.bank.

Please also note that our safe harbor statements are available on Page 5 of our earnings press release filed with the SEC yesterday.

All comments made during today's call are subject to the safe harbor statements in our slide presentation and earnings release.

I'm joined this morning by Origin Bancorp's Chairman, President and CEO, Drake Mills; our Chief Financial Officer, Steve Brolly; President and CEO of Origin Bank, Lance Hall; our Chief Risk Officer, Jim Crotwell; and our Chief Credit and Banking Officer, Preston Moore.

After the presentation, we'll be happy to address any questions you may have.

At this time, I'll turn the call over to you, Drake.

Thank you, Chris, and good morning.

In my 37 years of being part of Origin and running this company for the past 2 decades, I've seen many different cycles throughout my career.

As we continue to live and learn through a period of time that no one expected or predicted, I know that leadership, strategic planning, along with strong talent acquisition is what will lead us through this period of time and not just survive, but end up in a position of strength with an opportunistic attitude.

I can point to multiple strategies that were put in place a couple of years ago that significantly enhanced revenue during the second quarter.

Our community bank mortgage model and our mortgage warehouse strategy are 2 examples of this.

Our community bank mortgage strategy provided a 71.7% increase in revenue compared to the same period in 2018 when we began implementing our new strategy.

Year-over-year, mortgage banking revenue has increased approximately 2.5x with a similar-sized staff.

Our mortgage warehouse strategy positioned the company to take advantage of dislocation in our market to enhance our portfolio with quality relationships while driving strong growth in noninterest bearing balances.

We believe that our ability to execute on our strategies is what makes us unique in the marketplace.

During the last earnings call, I closed my remarks by highlighting 4 strategic areas of focus for our company as we navigate through the rest of 2020.

First and most important is the health and safety of our employees and customers.

This has been at the forefront of our decisions throughout the COVID-19 pandemic, and we continue to balance the health and safety of our people while maintaining a first-rate customer experience.

Our drive-throughs remain open, and our lobbies are serving customers by appointment.

We also have effectively leveraged our technology infrastructure, which has led to an increased usage of our online and mobile banking channels.

These strategies have been successful in managing the health of our employees and customers as well as highlighting the strategic focus we have in partnering with fintech to provide a better-than-peer customer experience with our digital platforms.

Next is our continued commitment to serve our customers and communities.

Throughout the PPP loan process, our bankers did an incredible job of supporting our customers and being responsive to their needs during a critical and challenging time, and they will continue to do so.

Lance will get more into the details of where we currently stand with PPP.

But again, I'm extremely proud of how our bankers have responded.

I'm also proud of the fact that we are standing by one of our core values of corporate and individual commitment to our communities by taking a portion of our PPP loan fees and making contributions to a broad range of local charities, food banks, service organization and educational institutions, including historically black colleges and universities throughout Louisiana, Mississippi and Texas.

Times like these are when our customers and communities need us the most.

Throughout our history, we've been leaders in our communities, and we continue to do that today.

Balance sheet protection is our third strategic area of focus, and we took steps in the second quarter to strengthen our position.

Our results for the 2 first quarters have been impacted by provision expense and increases in allowances for credit loss but our credit quality remains sound, and nonperforming and past due percentage remained stable during the quarter.

We have not experienced credit strain.

I am comfortable with our current portfolio, and we're well positioned to defend our balance sheet.

The fourth strategic area of focus is expense management.

On our last call, we told you that expense management was a continued focus of ours and even more so in the current environment.

We continue to evaluate all aspects of our business as well developing plans to reduce expenses in the near and long term.

Steve will discuss the details around expenses later in the presentation.

Now I'll get into the results of the quarter, starting on Slide 3. Total assets increased to $6.6 billion during the quarter, with one of the drivers being over 3,000 companies to which we made PPP loans, totaling approximately $563 million.

Net income for the quarter came in just under $5 million or $0.21 per share diluted EPS.

We had our highest quarter ever in pretax pre-provision income at $27.1 million, which is 44% higher than our first quarter results.

As you can see, our net interest income is up nearly $3.5 million a quarter, driven by PPP mortgage warehouse income.

Our noninterest income is up nearly $7 million for the quarter.

I'll turn it over to Lance to provide more details on our PPP loan process and our COVID-mending response.

Thanks, Drake.

Origin's community banking market model gives us a competitive advantage that our executive market leaders and bankers are incredibly close to our clients.

You saw this manifest itself in our aggressive and quick actions throughout the pandemic in getting loan forbearances to these clients.

Our bankers are actively engaged, proactive and are consistently communicating with our clients about their unique operating and financial situations.

As governments in Texas, Louisiana and Mississippi have opened for more business from Q1 to Q2, our focus has been on supporting our clients and communities through loan forbearances and PPP loans.

As you can see on Slide 5, Origin had just over $1 billion in COVID forbearances outstanding, which represented 21% of our loans held for investment, excluding PPP loans.

We have spent significant time in the past 2 weeks talking directly with each of our clients to understand industry-specific COVID deferral needs.

Our clients are currently indicating significant reductions in the level of forbearances needed over the coming months.

We expect to see our COVID forbearance levels decline to about 8% of loans held for investment over the next several months.

And as you can see where we anticipate our forbearance concentrations to be for the deep dive sectors, Jim will cover later in the presentation.

Looking at PPP results, we have funded $563 million in loans through the end of the second quarter, which has supported over 3,000 companies and 63,000 employees across our communities.

With an average PPP loan size of $185,000, an immediate loan size of $38,000, we feel that this program has been a very strong success in supporting our small business community.

As we move to Slide 6, we highlight our success in continuing to grow core deposits.

Total deposits ended the quarter at $5.37 billion, which was an increase of $816 million or approximately 18% compared to the previous quarter.

While a large portion of this growth was clearly driven by PPP funds, we continue to see a nice increase in organic deposits throughout our markets.

We have specific and meaningful examples around new deposit relationships we have created during the quarter because our execution around PPP when certain competitors could or would not.

As a strategy, we feel we can continue to grow organic deposits while continuing to also reduce deposit costs.

As we think about future loan growth levels, I think it's important to focus on our lift-out strategy that has served us well.

We believe stressed environments provide us with an incredible opportunity to attract talent because of our award-winning corporate culture and community banking market model.

We believe the lift-out strategy is the smarter way to grow our relationships as these bankers have deep insights into our desired prospects.

You will continue to see Origin leverage our culture advantage as we continue to increase the talent level across our markets.

I'll turn it over to Jim to take a deeper dive into our loan portfolio.

Thanks, Lance.

Before we get into the industry deep dive, I briefly want to point out Slide 7, where you can see that our loan portfolio continues to remain well diversified with no significant changes in concentration from what we have previously disclosed.

We continue to monitor industry sectors that may experience a more protracted recovery from the ongoing economic downturn, specifically the sectors of hotels, energy, nonessential retail, restaurants and assisted living.

The list of sectors is not as broad as those in the presentation for the first quarter, which indicates strong asset quality across our portfolio prior to COVID-19.

If you'll turn your attention to Slide 8, you will see that the selected sectors totaled approximately 11.4% of our total loans held for investment, excluding PPP loans at quarter end.

The first segment broken out is our $64 million hotel portfolio, which totals 1.3% of loans held for investment and has historically performed well as evidenced by no nonperforming or past due loans as of quarter end.

As mentioned on the call for the first quarter, we are confident in our hotel portfolio, which had an overall loan-to-value of 41% going into the pandemic.

All of our hotel loans have personal guarantees from strong individuals with cumulative liquidity in excess of $200 million.

On Slide 10, we have a breakdown of our energy credits, which represents 1.3% of our loans held for investment.

As we disclosed in the first quarter, we have no direct exploration or production exposure in our energy portfolio.

Our nonperforming balance in energy services comprised of 1 relationship, has been a long-term work up and has a remaining balance of $2.3 million.

On Slide 11, we provide information on our nonessential retail portfolio.

This segment represents 3.1% of our loans held for investment, with 61% of the sector consisting of loans supported by national credit tenants.

As reported last quarter, the nonperforming loan in this segment represents a single credit that was placed on nonaccrual during the first quarter of this year.

As a result of the significant impact by COVID-19 on this particular property, we charged off $1.6 million during the quarter, $1 million of which was reserved for in the prior quarter.

As to the total portfolio, overall pre-COVID loan to values are low at 56%.

On Slide 12, we have a snapshot of our restaurant sector, which accounts for 2.8% of our loans held for investment.

You can see we have no past due or nonperforming loan balances as of June 30.

Moving to Slide 13, it's assisted living, which currently represents 2.9% of loans held for investment at quarter end with an outstanding balance totaling $140.2 million and a reserve allowance of approximately $4.2 million.

During the quarter, we were successful in selling 1 of our nonperforming loans within this sector of $3.2 million, which resulted in a write-down of $1.8 million, with the loss being fully reserved for in the prior quarter.

In addition, we elected to take additional write-downs totaling $2.5 million, which was also reserved for as of March 31 on 2 nonperforming loans in this sector due to the potential negative impact of COVID-19.

As of June 30, 2020, classified loans within the subsector totaled $11.7 million, representing an increase of $1.5 million.

As mentioned on our last call, we are actively evaluating opportunities to reduce our exposure in the sector.

Slide 14 reflects trends in several of our asset quality ratios.

30 days past dues to loans held for investment, excluding PPP loans, improved to 0.50% at quarter end.

Nonperforming loans reduced 2.63%.

As we continue to assess the impact of the continued economic uncertainty on our portfolio, we saw an increase in the ratio of classified loans to loans held for investment, excluding PPP loans from 1.67% to 2.02%.

While we did experience an increase in the quarter, our current level of classified loans are in line with the levels reflected a year ago.

Charge-offs increased to 58 basis points annualized for the quarter, net of PPP loans, primarily driven by the relationships mentioned previously.

In total, of the $6.6 million in charge-offs during the quarter, $5.5 million were reserved for as of March 31, 2020.

Again, given the economic uncertainties, we elected to take these write downs.

At the bottom of the slide, we have some information on reserve for the quarter.

During the quarter, we built our reserve to approximately $70.5 million, which represents 1.75% of our loan portfolio, net of PPP loans and mortgage warehouse.

The primary drivers in our increased reserve were the downgrades mentioned previously as well as an assumption change within our CECL model, specifically the increase of the reversion period within the ACL model.

Based upon review of forecast provided by Moody's analytics, we adjusted the reversion period from 1 year to 1.5 years, which contemplates that we would return to historical loan loss averages in 2023, with reversion to this level during the second half of 2021 through 2022.

Now I'll turn it over to Steve.

Thanks, Jim.

Starting on Slide 15, you can see trends related to our net interest income and margin.

Our net interest income for the quarter was $46.3 million, an increase of $3.5 million over the linked quarter.

The largest increase in net interest income was a reduction of our deposit cost of over $3.6 million, followed by $3.1 million in PPP loan interest and fees earned during the quarter and also positively impacted by the increase in both yield and volume on our warehouse loans.

We have talked before about our asset sensitivity, and the net interest income results for the quarter were reflective of falling interest rates.

In the bottom right, you could see a NIM waterfall where we see decreased loan yields contribute to a reduction in NIM of 66 basis points, but was partially offset by 37 basis points less than NIM from deposit cost reductions.

PPP loans had an impact on our margin of 6 basis points.

On Slide 16, we report trends of yields and costs.

You can see the impact of falling rates had on our loan yields, declining 63 basis points when excluding PPP loans.

With the focus of reducing deposit costs, we were able to decrease our overall cost of deposits by over 40% during the quarter to 54 basis points.

Our mix of fixed and floating rate loans at quarter end had not changed significantly from the prior quarter.

On Slide 17, I want to go over some of the changes in our noninterest income.

We typically have about 20% of our net revenue from noninterest income.

But this quarter, we performed particularly well in mortgage banking revenue and saw our noninterest income increase by nearly $7 million as a result.

Other changes in noninterest income category included a reduction in insurance commissions quarter-over-quarter, which is expected due to seasonality of the business.

Our insurance revenues this quarter were greater than the same period last year.

Also, swap fee income this quarter was extremely positive for us as our customers were able to take advantage of the low interest rate environment.

Slide 18 covers our noninterest expenses.

As we look at the trend over the past 5 quarters, you can see the progress in our operating leverage, especially in the most current quarter.

While we see improvement in these metrics, our expenses did increase in the current quarter, based on a few factors.

Our mortgage bankers earned $1 million more in commissions due to the high mortgage production during the quarter.

And as Drake mentioned in our earnings call for the first quarter, we took a small portion of our PPP loan fees to pay incentive to bankers who worked around the clock to deliver to our customers.

Lastly, we experienced higher medical insurance expense of approximately $600,000 due to increased claims this quarter.

One of the areas of focus is centered around technology strategy, and the pandemic has given us a stronger focus on this strategy.

Lance and his team are consistently examining how our customers are engaging with us through our online and mobile channels, and we're focused on providing value and building loyalty through those channels as well as looking at ways to enhance our service delivery.

We believe that in the future, we will be able to hold our expenses in line or see reductions from the Q1 2020 and Q4 2019 levels.

Now I'll turn it back over to Drake.

Thank you, Steve.

On Slide 19, as we look at our capital ratios, we remain well capitalized going into the second half of the year.

When we funded the PPP loans, we were able to retain most of the resulting deposits on our balance sheet, and the increase in our average balances caused a reduction in our leverage capital ratio.

As we evaluated a number of factors late in the quarter, we began to use the Federal Reserve's liquidity facility for PPP loans, which we anticipate providing a lift in our leverage capital ratio in the second half of 2020.

Significant temporary increases in our mortgage warehouse lines of credit toward the end of the quarter caused what we believe is a temporary decline in our total risk-based capital ratio.

And we believe our capital ratios will increase throughout the year as we begin to normalize our mortgage warehouse balances.

Considering the unprecedented nature and global challenges in the past several months, I'm pleased with the performance of our company for the quarter.

Historic pretax, pre-provision earnings, historic levels of mortgage production and historically high noninterest income, all because we remain focused on our strategic plan in delivering for our customers and communities.

While there is uncertainty in the markets and what will take place over the next several months, we are putting ourselves in the best position based on what we know today.

That is how we've operated the company for over a century.

I believe in our team and our strategy, and I'm proud that so many of you have chosen to partner with us as we continue to build long-term value.

Thank you for your relationship, and we'll now open it up for questions.

(Operator Instructions) Our first question will come from Matt Olney with Stephens.

I wanted to start on Slide 8, the selected sectors that you guys provided.

I think the overall balance was around $547 million in the second quarter.

I think the same slide a quarter ago was around $1 billion.

So just walk us through how you further refined your focus list on the selected sectors?

And does this imply you're feeling better about credit today than 3 months ago?

Or is this just a statement that you've had more time to work through this over the last 3 months?

Matt, when the pandemic started through the first quarter, we got very aggressive and transparent on areas that we believe could have -- could be impacted through the downturn this health crisis, let's say.

And we included transportation.

We included all health care and a few other areas.

And through the second quarter, we became because of deep dives and a lot of work with individual credits, talking to these clients, actually going out and visit them during this time, we recognize the strength in the transportation portfolio.

And the overall strength in the health portfolio, less assisted living.

So as we continue to work through the second quarter, we saw those trends and our comfort in those areas that they surely weren't, what we would call, a COVID-impacted asset class.

So we remove those and feel very comfortable and confident in that.

Okay.

Got it.

And then in the assisted living book, I believe there were some charge-offs in the second quarter.

The remaining book is, I think, around $140 million.

What color can you give on the existing credit profile of the remaining book?

What's the risk of further downgrades?

Just trying to understand if those credits that were charged off in 2Q have any similarities to the remaining book?

Yes, Matt, this is a point I want to make and be very clear here.

We talked about even in the fourth quarter of '19 and first quarter '20.

Our concerns about assisted living, especially those assisted living credits we have that were developer-run.

Now our assisted living credits that are supported by nursing home operators appear to do better, and the ramp-up periods are quicker.

So what we did was -- and I want to make this point, these charge-offs that we took in the second quarter, 93% of that was reserved in the first quarter.

So these are legacy credits, primarily 4 legacy credits that we decided and use the term clean the slate.

We decided that we were going to get aggressive because 2 of these credits, 1 assisted living credit and 1 retail credit were deals that we had basically ready to close that would have got us at par, and COVID basically impacted both of those deals where they walked off.

So we decided to get very aggressive, had an offer on the assisted living center that was going to close.

So we went ahead and cleaned that off the books, went ahead and took in, I think that was smart thing to do.

The other retail deal was actually a sell-storage center that was going into -- I mean the retail space is going into sell storage.

We decided to go ahead and rightsize that and get it behind us, so we didn't have any further concerns or problems there.

The other 2 credits are assisted living centers that are, again, operated by the developer that we thought the write-down and the loss of the sale impacted the valuation and surely it did on the other 2. So we decided to write those down as we continue to exit this assisted living centers that are developer-run because we do have some deep relationships in our other assisted living centers that are supported by nursing homes and also supported by patient flow out of those nursing homes.

So when we look at the overall portfolio, we feel that we have addressed this appropriately.

We have another credit that we certainly are working out of that we feel at this point, comfortable that we could exit that without significant loss.

So I believe that we have addressed those.

It is important for us to, as I said, clean the slate and put ourselves in a very good position as we look at what COVID impacted -- classes or portfolios might bring in the future.

So this was a very, what I think, confident strong move to make sure that we take care of things.

I understand that it might -- and we don't want it to be an indicator of what we think is coming in the quarters ahead.

We are very aggressive as we classify credits, as we write things down that we take care of these, we put ourselves in a position that they don't linger.

So at this point, we feel comfortable that we're addressing this.

And hopefully, we don't see some further deterioration in our assisted living.

But again, this is an area that we will be exiting.

Okay.

And then the last question for me around the hotel portfolio.

Certainly not a very large book at Origin by any means, but we're hearing some mixed industry data points based on type of property, and you definitely gave us a nice breakdown on Slide 9. But can you give us an update on occupancy levels?

And then specifically, do you -- did the portfolio have any extended, say, properties?

And how do those occupancy levels compare to other parts of the portfolio?

Yes, Matt, our portfolio is, first off, primarily in Louisiana.

It's not an extended state portfolio at all.

It's, I think, brands that are economy and overnight stay.

What's interesting about a hotel portfolio, and this is what I think differentiates us, is that 100% of our hotels have personal guarantees.

Now we have, at this point, a portfolio of $64.04 million.

Out of those personal guarantees, there's partial liquidity in that group of loans of $216 million.

So significant support for those.

We're seeing right now about a mid-40s occupancy level.

And that mid-50s kind of puts us in a position of being able to cove no interest payments and principal payments.

So we continue to work with these.

We have so much confidence in this hotel portfolio because of the strength of the operation and liquidity.

This isn't an area that we have -- I mean every time we do a deep dive, which we just got completed with another one.

We just come out very confident because of the -- not only the ability for them to support, but their attitude and desire to support these properties outside of what we're doing.

Our next question will come from Brady Gailey with KBW.

So let's talk a little bit about a lift-out strategy that you guys mentioned.

I know you've had a lot of success in Texas with the hold on core franchise.

But as you think about -- M&A is not likely just as an industry, at least, in the near term.

So I think people like the idea of lift-outs.

Is there a geography that you're focusing on?

And then try to help us frame out how big this lift-out strategy could be from here?

Yes.

Brady, this is Lance.

I would say that as a strategy for us, that's worked out well, and we've talked about it in the past, the success we've had across all markets, North Texas, Houston, Mississippi, we're going to continue looking at them.

I mean the way we look at it, we're in the talent acquisition business, and that's a key driver for us.

From a credit perspective, we love the insight of being able to drag over credits versus cold column in the industries.

We had the opportunity to pick up some -- an experienced individual in our Dallas market over the quarter as well as in our Fort Worth market.

We've also done a really good job of improving our mortgage warehouse -- I'm sorry, our mortgage MLO talent as we've added a lot of talent in North Texas and North Louisiana and Mississippi.

We're going to continue to focus on that.

And we think that our culture is a strong attractor.

The way that we sort of build our business through our geographic model is an advantage for us.

Going all the way back to '08, '09, we thrived during a downtime or a stressed environment because of our ability to attract bankers.

And we think that's going to be the case here again.

All right.

That's helpful.

And then if you look at the first half of the year, the provision level has been running around $20 million a quarter, and reserves have been built aggressively.

How do you think about the need for additional provisioning and additional reserve building for the back half of the year?

Brady, this is Drake.

We spend a tremendous amount of time, I think, when we started midpoint first quarter, we started projecting based on portfolio growth, the strength of the portfolio.

We did some early projections.

And I would say that, at this point, due to the significant uncertainty surrounding the pandemic, we feel the major change moving forward will be in key factors in duration of pandemic, which could push our ICL to a range of, let's say, 2%, which would be consistent with our first quarter projections.

But I want to make a point, we don't feel or expect core credit trends to be a driver in our increase moving forward.

Okay.

And then finally for me, I mean if you look at the net interest margin, excluding the noise from PPP, it's down to about 315 in the second quarter.

Again, excluding PPP, how do you think the margin will trend here?

Do you think it will be stable at that 315 level?

Or do you think there could be some more downside?

No.

And again, you can imagine the work that goes on internally where we are today.

And our model is driven by strong C&I, we'll continue driving that model.

So Steve and Chase and our team has done a lot of work, so I'm going to turn that over to Steve and let him address NIM trends.

Brady, we expect NIM in the third quarter and fourth quarter to be flat to a couple basis points decrease.

I want to give you a little range there.

And I want to add to that, Brady, that there are some scenarios that we see 2 basis points up and down, but primarily, we're projecting it flat.

Our next question will come from Brad Milsaps with Piper Sandler.

Drake, I wanted to maybe dive into some of the mortgage performance a little bit more.

I know you guys have been working hard to make some change in that group.

But just kind of curious if you had maybe production or loan sales this quarter versus what you did a year ago?

And then maybe the change in the gain on loan sale margin.

Just trying to get a sense of how much of this quarter's performance is because of all the refi that's going on and what part of it is maybe more permanent at a new higher run rate from some of the changes that you've made?

Yes and again, the strategy we put in place 2.5 years ago and really about running 2 years ago was put us in a position because had we not done that, we wouldn't be in a position to take advantage of the marketplace.

I want to -- but we're running at this point with strong pipelines and strong origination, about 50-50 origination to refi.

So our markets -- and this isn't just DFW in Houston.

I mean our -- shockingly, our North Louisiana market is really booming from an origination standpoint.

Mississippi is doing very well.

So we expect similar activity as we can see through the third quarter from a pipeline and what we're projecting is a decent fourth quarter.

So Steve, give him a little numbers around sale.

Sure.

So loans originated, I'm going to go back to the fourth quarter of '19, about $145 million; first quarter, $110 million; this past quarter, $258 million.

So you can see the vast improvement in loans originated.

And in the pipeline, December, our pipeline was $68 million; March, it was $165 million; and in June, it was $168 million.

So the pipeline is slightly bigger than it was last quarter.

So with that pipeline, we feel that we're going to have a really good third quarter.

Almost as good as the second quarter, but definitely higher than historical numbers.

And on the gain on sale, there are 2 things.

One, with a little bit more refinanced, you typically get a little bit better gain on sale, but we also had a very good sit down, make sure that we're getting as much money as we can on these.

And we just wanted to make sure we just had a concentrated effort this quarter.

So going forward, we think the gain on sale will be pretty good.

If we go back to historical purchase versus refi, that may go down a little bit, again, because any time you have a refi business, you're going to have a better annual sale.

Great.

That's helpful.

And Drake, just to follow up on the forbearance discussion.

You noted in your comments and in the deck that you expect deferrals to come down from 21% down to 8%.

Can you kind of talk through what gives you some confidence around that?

I know some -- I think almost all are making some form of payment.

Just any additional color there on what kind of gives you the confidence that you'll see that improvement here over the near term?

Well, I think it goes back to the relationship and management relationship.

We -- each one of our forbearance is our relationship managers, and portfolio managers have been in discussion with them.

We took a -- we got aggressive.

And I want to make this point early on, and we were there to support our customers.

Well, as the investor climate looked at those as potential losses moving forward, we decided to have very good conversations with our customers.

I believe this 8% in that range is conservative based on what we know today in those conversations.

But we will make a point that 70% of that 21% forbearance level made payments during that first 90 days.

And we just feel very confident that, that number at 8% is very conservative, but I will make this point with a resurgence and being in the position we're in from an economic standpoint with uncertainty, we are still going to be here to help these customers get through this period of time.

So I mean we -- and I'm not saying that say, "Hey, we know there's an increase" But we're going to do what we have to do, and we're going to be here for the customers and not necessarily just look at a percentage of forbearances.

Got it.

That's helpful.

And then maybe just final question for Steve.

Can you remind us how much you have left to recognize in PPP fees over the balance of the program?

We do.

As of the end of June, with $14.5 million net fees remaining.

(Operator Instructions) Our next question will come from Kevin Fitzsimmons with D.A. Davidson.

Just a quick follow-up to Brad's question on the PPP fees.

What's your best guess on timing?

I know you have to wait until the SBA actually puts a platform out there for the forgiveness process to work, but are you visualizing assuming it happens mid to later fourth quarter that you would recognize the lion's share of the remaining PPP fees coming through the margin in fourth quarter?

Or does that bleed into first quarter '21?

2/3 of our PPP portfolio is less than $150,000.

So I would say at that point, there's no expectations on our part that anything is going to happen in the third quarter or in the fourth quarter.

That's why we've taken the position.

So these PPP loans lesser to our customers.

And we are not going to potentially sell these, especially service and release at this point with the thought that 2/3 of our portfolio could be forgiven under $150,000.

So we would think at that point, 2/3 of those fees would -- well, that's not going to be accurate because the large ones had larger fees.

I think that's fair.

I think the lion's share of those would be brought into income after the forgiveness of those.

I totally agree.

And one thing I'm going to have to add is you really have to look at the SBA procedures.

If they turn around tomorrow and give us full procedures, we'll work on it.

And then we will have the forgiveness as soon as possible.

But if it continues to drag and they come out with changes and revisions, I could see some in to the first quarter of next year.

But that's not because we're not ready.

It's only because of the procedures from SBA.

Right.

And my understanding is even if they come out with the procedures, they have 60 days or so to process it and they're in total control about the timing, correct?

Correct.

And that's why it's difficult for us to say whether it's going to be the fourth quarter or the first.

If it was totally up to us and our customers, I would say, the fourth quarter.

But we have to give that timing and also the timing at the back end.

So just to be conservative, I would say the vast majority will be in the first quarter.

But if we could get them quicker, we would.

Okay.

Just a quick follow-up.

Drake, in your initial comments, you had mentioned on focus on expenses.

And obviously, this quarter, it's a bit of a byproduct of the success in mortgage that you have some of the incentive comp from that.

But are there anything that you could tell us at this point that initiatives or things you're looking at to more permanently take down the expense run rate that you guys are taking an early look at or starting to implement?

Yes.

Let me turn that over to Lance.

He has been kind of the ring leader in driving the bank from an expense reduction standpoint.

Lance?

Yes, thanks.

Obviously, with our asset sensitivity being mindful and smart about expense control and reduction is critical for us.

So yes, we have multiple initiatives going on or starting with really digging into vendor contracts and finding opportunities, looking really closely at all of our leased real estate and the opportunities we may have there and then working through all of our expense structure and the analysis on ATMs, analysis on branch profitability.

It's all undergoing right now.

And we feel like we have some strong opportunities.

Okay.

Great.

And just a very quick point of clarification.

The waterfall that you show on the NIM change, with 66 bps on loan yields.

Is that really entirely the effective low rates on your fixed and variable rate loans?

Or is that also reflecting the mix, the excess liquidity, the impact of that?

A lot of banks have talked about that impact of excess liquidity.

That is not excess liquidity.

That is really the decrease in the rates over our fixed and floating loans.

Okay.

So I assume that the guidance of the margin being roughly stable going forward, ex PPP really implies that the progression of reducing deposit cost is really starting to catch up with that.

What's probably going to be an ongoing effect of as loans continue to reprice downward?

Yes.

And that's a strategy that we have in place that we potentially see our ability to drive down total cost of funds to historical level as we saw several years ago.

And that's going to be the challenge that we drive this next couple of quarters to get to that point.

I think it's extremely important that we manage that and are successful with that deposit reduction, expense reduction.

Your next question will come from Matt Olney with Stephens.

Just wanted to go back to the outlook for operating expenses.

And Steve, you know there were some unusual items in 2Q as far as some of the payouts for the PPP work, the mortgage payouts, health care.

And I think you mentioned -- I want to make sure I got that right that you said that the third quarter operating expenses would be more in line with the 4Q or 1Q '20 levels, I guess it would be closer to around $30 million, $36 million, $37 million range.

Am I interpreting that right, Steve?

Absolutely.

However, if we do have another really good quarter for mortgage, then the mortgage commissions will also increase.

But if you look at Q1 at $36.1 million, that would be the base.

And without any mortgage -- increased mortgage commissions, it may be $36.3 million, $36.5 million.

We don't see a drastic increase at all in there.

Okay.

Understood.

And then circling back on the allowance levels.

I believe, Drake, you mentioned the possibility that the allowance, the ACL ratio moves towards that 2% level.

There's obviously lots of noise around PPP and warehouse.

So does that 2% commentary -- is that compared to the 1.33% that was reported allowance in 2Q, whether the 1.75% that excludes PPP and excludes mortgage warehouse.

Matt, thank you for that clarification.

It excludes PPP and mortgage warehouse.

We're at 1.76%, 1.77% now.

We see that continued potential build to what we think would be adequate based on the position we're in today and the data that we have would be adequate.

Okay.

And then just the last question.

Thinking about loan balances in the near term, it seems like you've got some nice tailwinds that will continue for a more months, whether it's PPP or mortgage warehouse but at some point, those will start to pay down.

And my guess is it's the fourth quarter.

So am I interpreting that right that these loan balances could remain elevated in 3Q, but then move lower at some point in 4Q and into 1Q?

Is that your assumption as well?

That is right on target.

This concludes our question-and-answer session.

I would like to turn the conference back over to Drake Mills for any closing remarks.

Well, I want to thank everybody, and a couple of points.

I mean historically, our organization thrives in crisis situation.

And I think we are in an opportunistic position to really build relationships and take advantage of dislocation.

I'm very comfortable in our current position.

I'm very comfortable with our balance sheet, confident in our leadership team and our ability to navigate through this health crisis.

I'm extremely pleased with the commitment of our people and the strength of our culture to lead our customers and communities through this crisis and sincerely thank you for your support and your partnership.

And I truly appreciate your participation and interest today.

Thank you for attending.

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.