Byline Bancorp, Inc. Q2 FY2022 Earnings Call

Good morning and welcome to the Byline Bancorp’s Second Quarter 2022 Earnings Call. My name is Sam and I'll be your conference operator today. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. Please note this conference call is being recorded. At this time, I would like to introduce Brooks Rennie, Head of Investor Relations for Byline Bancorp to begin the conference call.

Thank you, Sam. Good morning everyone and thank you for joining us today for the Byline Bancorp second quarter 2022 earnings call. In accordance with Regulation FD, this call is being recorded and is available via webcast on our Investor Relations website along with our earnings release in the corresponding presentation slides. Management would like to remind everyone that certain statements made on today’s call involve projections or other forward-looking statements regarding future events or the future financial performance of the company. We caution that such statements are subject to certain risks, uncertainties, and other factors that could cause actual results to differ materially from those discussed. The company’s risk factors are disclosed and discussed in its SEC filings. In addition, certain slides contain and we may refer to non-GAAP measures, which are intended to supplement, but not substitute for, the most directly comparable GAAP measures. Reconciliation for these numbers can be found within the appendix of the earnings release. For additional information about risks and uncertainties, please see the forward-looking statements and non-GAAP financial measures disclosures in the earnings release. I would now like to turn the conference call over to Alberto Paracchini, President of Byline Bancorp.

Brooks, thank you, good morning and welcome everyone to review our second quarter earnings call. We appreciate all of you taking the time to listen in. Joining me on the call today are Chairman and CEO Roberto Herencia; our CFO, Lindsay Corby; our Chief Credit Officer, Mark Fucinato; and our Treasurer, Tom Bell. Before we get into the heart of the call this morning, we want to comment on the CFO transition we announced in conjunction with our earnings release yesterday. For that I'd like to pass the call over to our Chairman, Roberto Valencia.

Thank you, Alberto, and good morning to all. I am delighted to announce the appointment of Tom Bell, who is currently our Treasurer to the CFO position. And also Sherylle Olano, who's currently our Corporate Controller to the Chief Accounting Officer position effective August 16th of this year. As you know, Lindsay Corby, who's currently our CFO will be leaving to pursue an attractive opportunity outside of the banking industry with a privately-owned trading firm here in Chicago. We are no doubt sad to see Lindsay leave, but we are comforted by the fact that she's just going across the street. She bleeds Byline and is such a fan of ours and she leaves the finance area in great shape and in excellent hands. Tom Bell has been the Treasurer of Byline since its recapitalization. We have known Tom and worked with Tom, Alberto and myself, since before Byline. So, we know he is not only a logical choice but the best choice. He has over 30 years of banking experience. He started with the Federal Reserve Bank of Chicago and has assumed important roles with other banking organizations. Equally important Sherylle Olano, who's currently the Corporate Controller has been with us since 2014 and she has over 20 years of banking and accounting experience at financial institutions. We spent a considerable amount of time here at Byline in people initiatives, from training to leadership development, to wellness, and succession planning. And in the last several years, this is the third change that we've announced with respect to Executive Officers. And in all of those cases, we have promoted from within, which speaks to the depth of our team and our succession planning process, a hallmark of ours. Pass back to Alberto.

Thank you, Roberto. And now moving on to the review of our results. As is our practice, I'll start by walking you through the highlights for the quarter before I pass the call over to Lindsay, who will provide you with more detail on our numbers. Turning over to the highlights on slide three of the deck. In summary, we were very pleased with the results for the quarter and the first half of the year. While the outlook for 2022 has changed materially since the start of the year, our businesses have performed well and we've capitalized on opportunities to continue to grow the business. Our clients remain in good financial shape, continue to operate with ample levels of liquidity, and we continue to see good demand for credit to support investment and expansion. That said, economic activity is expected to continue to slow, inflation remains problematic, and higher interest rates create additional challenges for both consumers and businesses. Notwithstanding the strength of our strategy, diversified business model, disciplined expense management came through in our second quarter results, which portrayed another solid quarter of earnings and growth. For the quarter, Byline had net income of $20.3 million or $0.54 per diluted share. This was a bit lower than last quarter, but results include a $4.6 million mark on our servicing asset, which cost us about $0.12 per diluted share. As we discussed back in October during our third quarter earnings call, fair value marks are part of the business, can go up and down in a given quarter, but are not reflective of our operating earnings, which carried over consistently from the first quarter. Our profitability and return metrics were solid across the board. Pre-tax pre-provision revenue was $32 million, which translated into a pre-tax pre-provision ROA of 184 basis points. Return on assets came in at 117 basis points, while ROTC was a healthy 14.1%. Moving on to the balance sheet, assets grew by over $300 million and total assets now exceed $7 billion for the first time. Our performance continues to be positively impacted by strong loan growth, which carried over nicely from last quarter. Loans ex-PPP grew by $405 million or 34% linked quarter annualized, and we crossed over the $5 billion mark on the portfolio. This was the fifth consecutive quarter of solid net loan growth and that at quarter end, reflected portfolio growth of 29% on a year-over-year basis. Results were driven by strong growth across our C&I, leasing, and sponsor businesses, coupled with lower payoffs across the board. Net of loan sales, we originated $443 million in loans, a record level for the company, and up from $325 million last quarter. Line utilization saw another uptick and now stands at 56.2%, which provided a tailwind to additional growth in commercial balances. Our government guaranteed lending business also had another solid quarter of strong loan production with $125 million in closed loans, which as expected was lower than the first quarter. We remain a market leader in this business and as of June 30th, we are the fifth largest 7(a) lender in the U.S. Moving over to the liability side, total deposits stood at $5.4 billion as of quarter end, down 2.6% on a linked quarter basis, but up 5.8% year-over-year. The mix remains strong with DDAs representing 40.5% of total balances. Deposit costs increased eight basis points to 16 basis points for the quarter as we came off the cycle lows and start seeing the impact of higher rates. Revenue for the quarter came in at $75.8 million and was driven by robust net interest income, up 5% from the prior quarter and 6% year-over-year. As we indicated during last quarter's call, we expected to see our margin lag initial rate increases because of floors and the quarterly reset of our SBA portfolio. We saw that this quarter with our margin contracting by five basis points to 3.76%. The decline was also driven by lower PPP fees. Our margin remains strong and our position remains favorable to rising rates. On page eight of the deck, we added additional information for you that shows 99% of floating rate loans are no longer impacted by floor restrictions. Non-interest income came in at $14.2 million, down from the prior quarter, driven largely by the mark we took on our servicing asset. Our efficiency ratio remained in the 55% range and lastly, our deposit per branch increased to $142 million as of quarter end, and reflects the branch consolidations announced in Q4 of last year and completed during the quarter. Asset quality remained relatively stable for the quarter and we remained vigilant and proactive with respect to credit given the uncertainty in the environment. NPLs ex-government guaranteed loans increased by 13 basis points, driven largely by a single borrower that we moved to non-performing status during the quarter. The relationship entails a commercial borrower with multiple pieces of performing and non-performing collateral that were in the process of working out. Given our secured position, we don't anticipate the loss content to be material, if any. NPA showed an uptick as we took in one property into REOs as our part of a loan workout. Charge-off increased from the very low levels experienced last quarter to 24 basis points this quarter and our allowance increase to $62.4 million, largely driven by portfolio growth. Capital levels remained strong with a CET1 ratio of 10.3% and total capital ratio of 13.1% as of quarter end. Our performance and strong capital position allowed us to continue to return capital to stockholders with the repurchase of 232,000 shares of our common stock. This being an addition to our quarterly common dividend of $0.09 cents per share. We believe our balance sheet strength positions as well to continue supporting organic growth and investing in the franchise while returning capital to stockholders. With that, I'd like to turn the call over to Lindsay.

Thanks, Alberto. Good morning everyone. I'll start with some additional information on our loan and lease portfolio on slide four. Our total loans and leases were $5.2 billion at June 30th, an increase of $357 million or 30% annualized from the end of the prior quarter. Payoffs are relatively flat quarter-over-quarter coming in at $128 million. We believe payoffs will increase in the coming quarters. I'll note that this will be the last quarter we reference PPP loans as the balances and related financial impact are reaching levels that are relatively insignificant to our results on a quarter-over-quarter basis. Furthermore, based on our year-to-date results, we are updating our loan and lease growth guidance for the full year to low to mid-teens, up from high single-digits previously provided. All else being equal, our outlook does imply a slower rate of loan growth in the second half of the year compared with the pace of the first half. Our current pipelines are healthy and we are optimistic about the future of Byline. Turning to slide five, we'll look at our government guaranteed lending business. At June 30th, the on-balance sheet SBA 7(a) exposure was $479 million, flat from the prior quarter with $102 million being guaranteed by the SBA. USDA on-balance sheet exposure was $64 million, nearly flat from the end of the prior quarter, of which $26 million is guaranteed. We continue to see stable trends in this portfolio and as a result, we've decreased our allowance as a percent of the unguaranteed loan balance to 6.6% from 7.4% at the end of the prior quarter. Turning to slide six, total deposits decreased by 2.6% compared with the first quarter. This was primarily due to lower commercial deposits and business accounts as a result of seasonal fluctuations that typically occur at the end of the second quarter due to business needs. Total average deposits increased by 1.6% compared with the first quarter, driven by growth in both average interest-bearing deposits and average non-interest-bearing demand deposits. Total average deposits increased by 7.7% compared with the year-ago period. Our deposit composition and ability to generate core deposits continues to be a strength of our franchise. Commercial deposits represent about half of our total deposits and 76% of non-interest-bearing deposits. During last quarter's call, we mentioned that with rising rates, we would anticipate deposit pricing pressure at some point during the year. In the second quarter, deposit costs were 16 basis points, increasing eight basis points from the cycle low in the prior quarter. Moving on to net interest income and margin on slide seven. Our net interest income was $61.6 million for the quarter, an increase of 4.9% from the prior quarter. This was primarily due to higher average balances of loans and leases, which more than offset the impact of higher interest expense on deposits, reflecting the rising rate environment. Net interest income on a year-over-year basis increased 5.9%, driven by our ability to replace PPP loans with organic loan growth. On a GAAP basis, our net interest margin was $3.76, down five basis points from last quarter, but up from the year-ago period. Accretion income on acquired loans contributed eight basis points to the margin, slightly down from 10 basis points in the last quarter. PPP, interest, and net fee income combined contributed approximately $746,000 to net interest income compared to $2.7 million last quarter. The yield on loans and leases excluding PPP was $4.74, up nine basis points from the first quarter. With all of that said, our margin remained strong both in absolute terms and relative to peers, remaining in the top quartile for banks of our size. The NIM performed as we expected in Q2 and as a result of the rising rate environment, our asset-sensitive profile and organic growth, we believe net interest margin excluding accretion and PPP will begin to expand during the second half of 2022. Moving on to slide eight, we believe our asset-sensitive balance sheet positions as well for rising rates. The asset sensitivity is principally driven by our loan portfolio, of which 56% of loans including PPP are variable rates and nearly all of those with floors are currently priced at or above the floor. We estimate that an instant 100 basis point increase in interest rates will result in an additional 7.8% increase in net interest income, which to reiterate guidance provided last quarter, every 25 basis point increase would result in approximately $4 million to $5 million of additional net interest income on an annualized basis. We believe with SBA loans repricing in July and rate hikes during this quarter, coupled with floating rate portfolio being repriced going forward, positions us well for future margin expansion. Our loan-to-deposit ratio increased at quarter end and is 96% as a result of deposit fluctuations. We believe the ratio will trend back down to the lower 90s as balances return from commercial relationships during the quarter. Turning to non-interest income on slide nine. Non-interest income decreased from the prior quarter, primarily due to a negative $4.6 million loan servicing asset revaluation expense, due to higher discount driven by lower premiums on government guaranteed loan sales. We sold $118 million of government guaranteed loans in the second quarter, an increase of 16% linked quarter. The net average premium continued to be strong at 10% during the quarter, which was as expected lower than the first quarter. Our pipeline for government guaranteed loans remains strong and we continue to anticipate premium pressures next quarter due to negative market conditions resulting from higher interest rates and higher government guaranteed inventory levels in the secondary market. Moving on to non-interest expense trends on slide 10. Our non-interest expense was $43.8 million in the second quarter, a decrease of 2% from $44.6 million in the prior quarter. The decrease was primarily attributed to three factors. First, we saw a decrease of $1.3 million in salaries and employee benefits related to lower payroll taxes and higher deferred salary costs related to loan and lease origination. Second, due to higher reimbursements of legal fees; and third, we saw a decrease in occupancy and equipment expense due to the net effects of our branch consolidation and real estate strategies. We remain focused on expenses and continue to look for opportunities to offset the expense pressures as a result of inflation. We are reaffirming our quarterly non-interest expense guidance to trend between $45 million and $47 million. Turning to slide 11, asset quality continues to remain stable, reflecting our diverse portfolio and disciplined risk culture. Our non-performing assets increased 21 basis points to 54 basis points of total assets in the prior quarter, and net charge-offs were $2.9 million in the second quarter. Total delinquencies were $15.8 million on June 30th, a $13 million or 46% decline linked quarter, reflecting lower commercial loan delinquencies. Our second quarter allowance increased to $62.4 million from $59.5 million at the end of March and represents 121 basis points of total loans. Reserve buildup was driven by an increase in provision, primarily due to growth in the loan portfolio and higher qualitative factors surrounding the macroeconomic environment and rising interest rates. And while we do not see any broad base signs of deterioration in our portfolio today, we believe that the uncertainty in the economy warrants the current level of allowance coverage. Turning to slide 12, we display our strong capital ratios and return of capital. Through the first six months of the year, we returned approximately 47% of our earnings to stockholders through the common stock dividend and our share repurchase program. We believe our capital ratios position us well to pursue both organic and strategic opportunities, while managing our capital through dividends and opportunistically executing on share repurchases. As previously stated, we want to run our total common equity and tangible asset ratio between 8% to 9%. Our TCE ratio at 8.65% gives us the ability to grow our balance sheet while utilizing share repurchases and dividends to return capital as needed. With that, for the last time, Alberto back to you.

Thank you, Lindsay. Moving on to slide 13, we were very pleased with our results for the quarter, in particular our ability to adapt to the changing rate and economic environment. Loan growth exceeded expectations, net interest income growth was strong, and expenses were balanced for both near-term efficiency and long-term investment. Looking ahead, there is uncertainty in the environment given higher inflation, higher rates, and geopolitical disruptions. Regardless, we believe our balance sheet, diversified business model, disciplined expense management, and focused execution of our strategy will continue to provide the foundation for our success. In closing, pipelines remain healthy and we're in a strong position heading into the back half of 2022. We're optimistic about our ability to continue to grow the franchise while creating additional value for our stockholders. I'd like to thank our employees for their hard work and unwavering dedication to our clients and business. With that, operator, let's open the call up for questions.

Thank you. Our first question comes from the line of Terry McEvoy from Stephens. Terry, your line is now open, please go ahead.

Hi. Thanks. Good morning, everyone. And first off, Lindsay, enjoyed working with you since the IPO and you will be missed. And Tom, congrats, look forward to working with you more. Maybe just start with a question. Lindsay, just when you think about your margin outlook, could you help us understand how you kind of internally are looking at the composition of your deposits in terms of any sort of mix shift from non-interest bearing to interest bearing? And you provided some comments on loan growth, what do you think deposit balances do from here over the remainder of the year?

Sure Terry. Yes, great question on the margin. Yes, I would say that when we look at the margin, given the higher interest rates, we do think that you'll start to see some shift into higher-yielding deposit products, in particular, money market and time deposits. So, when we look at our betas and what we're seeing going forward, we're currently modeling about 40% for interest-bearing deposit betas during the second half of the year Terry. So, that's kind of to give you a little bit of color there. And then in terms of your second part of the question around the deposit growth, yes, we continue to remain focused on deposits. We really managed the balance sheet looking at the average deposit balances, Terry. So, we did see a slight increase quarter-over-quarter in terms of average balances and we'll continue to watch that here as we go forward. We've seen a great pace of loan growth and we obviously are very active in the market, making sure when we get a lending relationship that we get the deposit relationship with it as well. So, trying to offset as much as we can with core funding and we have plenty of liquidity and availability to pull other levers as needed.

Thanks for that. And then as a follow-up, you were active on the branch closure side, which has helped the expenses. I'm just wondering have you noticed any impact on those customers where the branches were closed and the deposit balances and relationships there?

Sure, in terms of the branch closures, we do monitor that pretty closely, Terry. You tend to see a little bit of runoff in terms of the higher yielding deposits, particularly in time deposits, but nothing outside of the ordinary of what we've seen in the past and has met our expectations in terms of what's happened there. So, good performance. Our retail team does a great job in terms of reaching out to customers and making sure that their needs are taken care of and help with the transition given the closures. So, nothing out of the ordinary and has been in line with what we've seen in the past.

And then just some clarity of the page eight when you said, was it the loan-to-deposit ratio is 96%? And Lindsay I wasn't quite following you on, you expect that to go lower, I couldn't quite understand the reason why that was going to drift lower?

Sure. So, there were fluctuations right at the very end of the quarter with some of our commercial customers. And we do anticipate that we'll be going back lower into the lower 90s here as time goes on, and those deposits come back into the bank. So, there's just some seasonal fluctuations that occurred at the very end of the quarter, Terry, and we do anticipate that it'll trend back down.

Okay, thanks for clearing that up. And thanks for all the help with the questions. Thanks.

Sure. Absolutely. Thanks Terry.

Our next question comes from the line of Ben Gerlinger of Hovde Group. Ben, your line is now open, please go ahead.

Thanks guys. Solid loan growth this quarter, I was curious how you guys are approaching the growth for the latter half of the year, was there anything pulled forward with that? Is the goal really managed NII growth versus hold the margin? And I get that you're going to get a lift from rates, it's just kind of how you balance those three?

Yes, Ben, that’s a great question. It really begins with the opportunities we see in the market. Our main focus is on growing our business, establishing new relationships, and continuing to support our customers. This is our top priority, even before considering net interest income or margin changes. Regarding growth, I know you've raised concerns in previous calls about our loan growth guidance, and you’ve pointed out that we have missed the mark a bit. However, we believe, as Lindsay mentioned, that loan growth this year will surpass that guidance. From this point onward, we expect to see growth in the mid-single-digit to high single-digit range for the rest of the year. We anticipate some payoff activity throughout the year that hasn’t been reflected yet. Nevertheless, we acknowledge that in recent quarters our growth rates have exceeded that expectation. That’s the message we wanted to share, Ben.

Got you. Okay. And then just from a 10,000 foot view, in terms of the clients that you're banking, us there seemingly any pressure points that are building to the surface here? It seems as though the headline of a recession is selling newspapers, but from a boots on the ground perspective, it doesn't seem like there's a lot of pressure points that weren't already known, whether it be wage inflation or commodity pricing or anything like that. Is there anything that we're missing that would be driving stronger loan growth, but could eventually turn into theoretical credit issues down the road?

We separate what we observe based on our clients' performance and the performance of the loan portfolio as we assess loans, evaluate relationships, and renew loans continuously. Generally, at the end of the quarter, our clients are financially stable with good liquidity levels, especially compared to pre-pandemic times. However, the outlook is crucial. We are in a high-inflation environment, and many of our customers have managed to pass on increased input costs to their end customers to maintain their margins. The question remains about how long they can continue to do this. We're uncertain about the answers and will have to monitor how our clients perform in a situation where we all anticipate an economic slowdown due to the Fed's rate hikes aimed at alleviating inflation pressures.

Got you. All right. Well, that's helpful color and I also like to echo Terry's point, it's been great working with you, Lindsay and congrats to everyone who's taking the new seats. We look forward to working with everybody going forward.

Thanks Ben. Appreciate it.

Our next question comes from the line of Nathan Race of Piper Sandler. Nathan, your line is now open, please go ahead.

Hi, everyone. Good morning.

Good morning Nate.

Good morning Nate.

Going back to Terry's last question in terms of the dynamics with deposit flows, sounds like you'll have some deposit growth in the third quarter. And I'm just curious if the step-up in funding costs that we saw here in 2Q, if that's kind of a good proxy to use going forward with deposit costs accelerating upwards and maybe that's offset by just less wholesale funding on the balance sheet with that kind of deposit replacement after the increase in wholesale that we saw in the second quarter?

Sure, that's a great question. Regarding costs, they did increase quarter-over-quarter, which I mentioned last quarter. I believe we will continue to see deposit costs rise, driven by our loan-to-deposit ratio and competitive market pressures. We are monitoring the situation closely. Competitors have been slow to adjust, but with the recent rate hike, I expect them to increase deposit rates soon. This change may occur faster in the third quarter compared to the second quarter. The fluctuations in borrowings at the end of the last quarter were influenced by our commercial base situation, which was slightly elevated. As rates continue to rise, we should expect an increase in borrowing costs as well. All these factors will be significant as we head into the third quarter and beyond.

Yes, Nate, the only other thing I would add is I think it's important to keep in context, kind of, the starting points for this, because when looking at some of our peers and other institutions' reporting numbers, and we hear about comparisons, well, this bank that saw this, this bank saw that, and certainly that's part and parcel to what you guys do. But I think it's important to keep in context, kind of, what the starting point and ending points are likely to be because you could have a relatively lower sensitivity, but your starting point is much higher, therefore, you're going to end up, on an absolute basis, still with higher costs. And when we think about our business, we were coming up cycle lows of deposit costs around eight basis points. So, we're not really that concerned about seeing an uptick of eight basis points or something like that. Rates are higher, the Fed has moved, obviously, very aggressively, 225 basis points so far year-to-date, when we were expecting maybe at the beginning of the year, at this point, we'd be seeing 50 basis points. So, we're pretty, pretty happy with eight basis point sensitivity relative to 225 basis points movement in rates. Just some context.

Got it. That's very helpful. Thank you. Changing gears and just kind of thinking about the SBA premiums going forward. Is the magnitude of the step down that we saw here in 2Q is that reasonable to expect in 3Q with the Fed raising rates by a similar degree, at least thus far here in the third quarter? or does that kind of pace of decline slow from here to some degree?

That's a great question. I wish I had a crystal ball for a perfect answer, but we are seeing pressures. We believe we are close to reaching a bottom, although we can't be certain. However, it seems likely that you'll experience a bit more pressure. We have the capability to hold loans on our balance sheet if needed, so if premiums fall to a point where it makes more sense to hold the loan, we can do that. We anticipate pressures will continue, but we believe there will be some improvement by the end of the year in terms of premiums as inventory moves through and market conditions stabilize.

Got it, makes sense. And just kind of one broader question on just the loan growth and kind of overall organic balance sheet growth prospects in here. Obviously, there was a larger M&A integration that occurred recently in Chicago. So, just curious, kind of, how you guys are thinking about share gain opportunities at this point? Are you guys seeing opportunities to add talent? Or do you feel like the opportunity to grow market share is feasible with the existing team in place?

Nate, as you know, we're always looking for opportunities to add talented bankers to Byline. We think we have a great platform serving local businesses here in Chicago. And we think our platform for bankers looking to have access to not only products, services, capabilities, sophistication on the credit side, but also really being in a position to serve clients well. We are above anybody else when it comes to offering that. So, we're constantly looking for that and we're constantly looking to continue to grow relationships in the market. So, I think the short answer to your question is yes, to both of the both of the questions.

Okay, great. Lindsay, it's been great working with you over the years. Best of luck at your next endeavor and look forward to hopefully staying in touch.

Sounds good. Thanks, Nate. Appreciate everything.

Our next question comes from the line of Damon DelMonte from KBW. Damon, your line is now open, please proceed with your question.

Hi, thanks and good morning, everyone. Lindsay, it was a short experience. I only picked up coverage not too long ago, but I know our roots go way back. So, congrats and best of luck and Tom, I look forward to getting to know you and working with you as well. So, with that being said, just wanted to ask a couple of quick questions here, a lot of good things have been asked and answered already. But on the expense side, the recommitment to that $45 million to $47 million range, you kind of attribute that to just some of these one-time items this quarter that go away, and you kind of go back to a normalized run rate? Is that kind of how you think about that?

That's spot on.

Okay. All right. Great. And then as far as the little bit of uptick in non-performing loans this quarter, can you just give us a bit more detail on what drove that and kind of, where they stand in the resolution process?

Yes, Damon, this is part of our routine operations. We have relationships that we monitor, some on an ongoing basis. This specific situation involves an entrepreneur who owns various types of properties. We had been keeping an eye on this relationship for some time, moving from watch to special mention. One of the properties in the collateral pool is currently facing challenges. We are well-secured as it's a pool of multiple collateral pieces, and we are simply being proactive. We believe the issues with this property justify classifying the entire relationship as a non-performing loan, and we will be working on resolving the loan as part of our normal business practices. This is real estate secured, and we feel confident about our collateral. As we mentioned, we do not expect any material loss, if any at all.

Got it. That's great color. Thank you. And then I guess, lastly, is the technical question on the tax rate, what would be a good effective tax rate to model for the back half of the year?

Sure. Assuming no tax rate increase, I'd say same guidance of 25% to 27%.

Okay, perfect. Great. And congrats again, Lindsay.

Thanks, Dan. Appreciate it.

Our next question comes from Brian Martin from Janney. Brian, your line is now open, please go ahead.

Hey, good morning, everyone.

Good morning Brian.

Hey Brian.

Good morning. I wanted to ask about the reserves; it seems you increased them slightly this quarter amidst discussions about a potential recession. How do you plan to address this moving forward? Additionally, within your portfolio, are there specific areas where you are monitoring more closely or feeling more concern? What do you see as the biggest risks in the portfolio in light of the current macroeconomic challenges?

Yes, regarding the first part of your question, Brian, we believe that our reserve is adequate as of the end of the period. Just to remind you, we are still using the incurred loss model for our reserves, and we will transition to CECL at the end of this year. From that perspective, the reserve reflects the significant growth in our portfolio, along with certain qualitative adjustments to account for the uncertainties in the economic environment.

Okay. And is there any areas that you guys are more concerned with today when you look at the portfolio, kind of, where the greater risk in the portfolio is today? Can you give any kind of color on that or just how you're thinking about?

Yes, I think we don't have anything specific to report, but we've been focused on monitoring how businesses will respond as we move beyond the stimulus measures introduced during the pandemic. We've been continuously reviewing our portfolio and customers as part of our regular practice. Although we don't have any current indicators of concern, we are actively looking for signs of potential credit weakness, especially as the economy is expected to slow down. While we can't provide any specifics yet, we are committed to identifying any signs of weakness in our portfolio as quickly as possible.

Got it. Thank you, Alberto, that's helpful. There's a lot of discussion about the premiums on the SBA side. Can you talk about opportunities to increase volume there? Also, can you discuss possible changes in the mix as you look ahead, considering the anticipated roadmap regarding the premiums? Any context on that would be appreciated.

Sure. So, the gain on sale is a function of volumes and premiums, right. So, I did state in my prepared remarks that the pipelines are healthy. I said, Brian, the biggest piece there is if the premiums get to a level that we prefer to hold the loans, we have that ability. So, our team has shown a great track record of being able to produce and the volumes have come. Again, we're coming off of an all-time high year last year. So, just keep in mind that 2021, and in particular, September 30th of 2021 was the peak and that was the end of the subsidy. So, that was really an outsized quarter for us, and frankly, an outsized year. So, the team continues to work hard and staying the course in terms of production and pipelines remain full right now. So, we'll keep an eye on it and keep you posted here as we go forward.

Okay. Lindsay, can you provide any specifics on how low the range could go before you might consider adding more to the balance sheet? Reflecting on the past, was there a time when you were adding to the balance sheet at certain levels?

Sure. So, I mean, at the end of the day, it's a loan-by-loan basis, Brian. But I'd say when you look at the premium and you go back a while, I'd say when you looked at when the government shut down and we had to stop, you saw our gain on sale go to a lower level and then also, in the first quarter when COVID hit, you saw premiums go down. Those are, kind of, a good floor to, kind of, look at in terms of premiums going back. But I'd say that's really the better spot when it hovers down into those ranges. I'd say that's really where we think about okay, does this make more sense? And we'll run the math on each loan and see what the earn back is and figure out are we better off to sell it or hold it. So, we do think that things will improve. We think this is temporary, but we do think that there will be improvement and we can hold them a little longer and sell them later if need be.

Brian, the math is straightforward. We don’t have a black box; we simply look at the carry we can earn on the loan over approximately three and a half to four years, which is typically the life of these assets. We take the present value of that and compare it to the premiums we can receive from selling the loans in the market, and that's essentially the big picture math.

Yes, that's helpful. I appreciate all the information and it's been great working with you, Lindsay. I wish you the best of luck, and hopefully, we can stay in touch. Also, congratulations Tom.

Great. Thanks Brian.

Thank you.

We next have a follow-up question from Nathan Race from Piper Sandler. Nathan, your line is now open, please go ahead.

Thank you for the follow-up. My question was somewhat addressed in the previous discussion, but I am curious about what you are observing regarding SBA credit quality. I understand that SBA loans represent a significant portion of the charge-offs in the second quarter. It seems that investors are paying more attention to this asset class, especially as 7(a) borrowers are affected by recent rate changes from the Fed. Are you considering tightening your underwriting criteria going forward, and do you believe this will impact future volumes?

Mark, would you like to say?

We are closely monitoring the rate increase for our customers, and the credit quality in that segment is currently quite stable. We are observing some upgrades and downgrades, along with a few charge-offs. Overall, the situation appears to be in good shape at the moment. However, we are maintaining vigilance and regularly assessing the impact of rates, particularly as we approach the third quarter. I expect to see some deterioration in that portfolio during this time.

Okay, great. And I was remiss early not to congratulate Tom and Maria, as well.

Thank you, Nate.

Thank you, guys.

Thanks Nate.

Thank you.

Thank you for your question today. I will now turn the call back over to Mr. Alberto Paracchini for any closing remarks.

Great. Thank you, Sam. In closing, and before we close for the day here, I want to acknowledge and thank my colleague and good friend Lindsay Corby for being a great partner during the 20 earning calls that we've hosted over the last five years. It's been an honor and a privilege to have worked closely with her for the last nine years. On behalf of the company and all of us at Byline, we want to thank her for her commitment, her leadership, hard work, and the contribution she has made over that time. We'll certainly miss her, but we want to wish her nothing but the very best that she embarked on a new journey and look forward to having her as a commercial customer soon. I would also like to welcome Tom to the floor and we look forward to working with him going forward in his new role. That concludes the call for today. Thank you for your time this morning and your interest in Byline and we look forward to talking to you again next quarter. thank you.

This concludes today's call. Thank you for joining. You may now disconnect your lines.