Earnings Call Transcript - COLB Q1 2021

Operator, Operator

Good morning, and welcome to Umpqua Holdings Corporation's First Quarter 2021 Earnings Call. I will now turn the meeting over to Ron Farnsworth, Chief Financial Officer.

Ronald Farnsworth, CFO

Great. Thank you, Laura. Good morning, and thank you for joining us today on our First Quarter 2021 Earnings Call. With me this morning are Cort O’Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, President of Umpqua Bank; and Frank Namdar, our Chief Credit Officer. After our prepared remarks, we will then take questions. Yesterday afternoon, we issued an earnings release discussing our first quarter 2021 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both of these materials can be found on our website at umpquabank.com in the Investor Relations section. During today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the safe harbor provisions of federal securities law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Page 2 of our earnings conference call presentation as well as the disclosures contained within our SEC filings. Now I will now turn the call over to Cort O’Haver.

Cort O’Haver, CEO

Thank you, Ron. I'll give a brief overview of our performance before handing it over to Ron for the financial details. Frank will then discuss credit, and we'll take your questions afterward. In the first quarter, we reported earnings available to shareholders of $107.7 million, translating to an EPS of $0.49 per share, marking a solid start to our year. Key highlights for the first quarter include notable growth in both customer accounts and our balance sheet. Loan balances increased by $381 million, or 1.8%. This growth included $84 million from organic non-PPP loan balances and a net gain of $297 million in PPP balances. As we indicated in our previous earnings call and at various investor events over the last quarter, we feel optimistic about loan growth for 2021. Total deposit balances rose by $1.3 billion, or 5.1%, during the quarter, with strong growth in noninterest-bearing DDA of $865 million, or 9%, thanks to ongoing customer acquisition and the second round of PPP. Nearly all deposit categories saw growth, except for CDs, which decreased by $374 million, or 13%, as we manage higher-cost deposits. Regarding capital, we informed our shareholders in February about a dividend of $0.21 per share, consistent with our historical payments, and we anticipate announcing the timing of our second quarter dividend soon. With our strong capital levels, we are continually evaluating the best approaches to enhance shareholder returns and have several options at our disposal. While it's too early to share specifics today, we are well positioned to be more proactive in our capital management. Now, I'll give a quick update on our Next Gen 2.0 initiatives, which are progressing well. The growth of our balance sheet is a key focus of Next Gen 2.0, and we are making significant strides. The uncertainties tied to the pandemic created major disruptions, particularly for businesses. Following the strategic transformation initiated with Next Gen 1.0, Umpqua is uniquely positioned to offer a personalized banking experience that helps businesses navigate changes, and we are seeing very encouraging results. We have successfully leveraged the positive brand recognition from our PPP efforts and market disruptions to attract new customers and talent. Our proactive PPP outreach has targeted both new-to-bank customers and those who had negative experiences elsewhere. We have approximately 5,900 customers who obtained their first product from us through a PPP loan, and we have converted over 2,000 of these, or 36%, into full relationships that include additional loan and deposit products. Moreover, we made nearly a dozen strategic hires this year across our middle market, community banking, and commercial real estate teams, and plan to add more positions, with a focus on talent acquisition in the Greater Bay Area, Seattle, Portland, and Southern California. Our human digital technology initiatives are also a vital part of our strategy, with increasing customer engagement through digital channels, including a 35% rise in mobile deposit transactions, a 76% increase in Zelle transactions, and a 16% growth in daily sessions on our mobile banking app year-over-year. Additionally, Go-To enrollments surpassed 80,000 messages, a 49% increase this quarter. An essential element of our human digital strategy is equipping our associates with top-tier tools to enhance customer experiences. A recent example includes using our new loan origination system, nCino, to facilitate the second round of PPP, which improved customer experience and operational efficiency. This technology enabled us to process PPP requests with 75% fewer FTEs compared to the first round and allowed quicker and smoother funding to operating accounts. We look forward to implementing this new system across the bank later this year. On the innovation front, we are actively progressing on our roadmap, introducing integrated receivables, expanding our API offerings, enhancing our commercial card solutions, and upgrading customer accounts to a new online banking experience. Regarding operational excellence, the sale of Umpqua Investments to Steward Partners is set to finalize tomorrow. We view Steward as a strategic partner and anticipate developing referral agreements with them. Earlier this quarter, we announced plans to consolidate 12 store locations by the end of Q2. Including the locations sold last fall, our total Next Gen 2.0 store rationalizations will reach 19. We are on track to achieve our goal of 30 to 50 store consolidations by the end of 2022 and are confident about meeting the upper end of that target. As previously mentioned, to reinvent our workspace for the future, we aim to consolidate back-office space to align with new working trends among our associates and to reduce noninterest expenses. We will share further updates on the timing of those expense reductions as the plans take shape. Finally, this quarter, we’re announcing a change in our segment reporting to better align with how we manage the bank and provide greater transparency into the financial impact of mortgage banking activities. While our mortgage banking team had a successful year in 2020, we didn't want their success to overshadow the strong results from our core bank. To recap, the core banking segment encompasses all lines of business except mortgage banking, while including wholesale, retail, wealth management, as well as the operations, technology, and administrative functions of the bank and holding company. Due to the initiatives from Next Gen 1.0, effectively navigating the pandemic, and the early phases of Umpqua Next Gen 2.0, we are seeing solid financial trends in our core bank, characterized by loan portfolio growth, increased noninterest income, and reduced noninterest expenses. The core bank accounted for 81% of our reported earnings this quarter. The mortgage banking segment includes revenues from the production and sale of residential loans, servicing income, quarterly changes to the MSR asset, and specific related expenses. Revenue and costs associated with residential loans held for investment fall under the core banking segment mentioned earlier. As a key product in our consumer channels, the origination of these portfolio loans can vary, including private bank-originated mortgages and permanent financing from construction to permanent loans. Before I hand it off to Ron, I want to express my enthusiasm about growth opportunities in our markets, the momentum from our banking teams, our capital deployment options, and all the outstanding results we anticipate from our Next Gen 2.0 initiatives. Now, Ron, it's your turn.

Ronald Farnsworth, CFO

Okay. Thank you, Cort. And for those on the call, I want to follow along, I'll refer to certain page numbers from our earnings presentation. Page 8 of the slide presentation contains our summary quarterly P&L. I'm going to talk at a higher level on the top of the house items, spend more time on our new segment disclosures and then wrap with CECL and capital. Our GAAP earnings per share for Q1 was $0.49, lower than Q4 as expected due to lower PPP fee recognition, lower seasonal mortgage banking activity and a normalized tax rate, offset by the expected reduction in noninterest expense. Excluding MSR input and CVA fair value adjustments, our adjusted earnings were $0.46 per share this quarter. For the moving parts, net interest income declined due mainly to lower PPP fee recognition, offset partially by lower bond premium amortization and a continued reduction in our cost of funds. We had no provision for loan loss this quarter. And noninterest income reflected a decline in mortgage activity, although not as much as expected a quarter ago. Also, we recorded a fair value gain on the swap derivative as long-term interest rates increased this quarter. Noninterest expense declined to below Q3 2020 levels and our tax rate normalized this quarter as expected, at 24.5%. As for the balance sheet on Slide 9, we are intentionally holding higher levels of interest-bearing cash given the volatile environment, ending the quarter at $2.9 billion, noting the average balance was up 20%. This higher level of cash cost our NIM 4 basis points but gives us significant future optionality for funding loan growth or deleveraging certain liabilities. We increased the bond portfolio 8% as longer-term rates increased during the quarter into similar duration agency investments. And our total available liquidity, including off-balance sheet sources at quarter end was $14 billion, representing 47% of total assets and 55% of total deposits, giving us ample liquidity to fund future loan growth and continue to reduce higher cost deposits and term borrowings. Okay. Now to our refresh segment disclosures on Pages 10 and 11 of the presentation or Pages 15 and 16 of the release. We've simplified our segment disclosures by separating out the core bank from the mortgage banking segment to give investors more transparency on the underlying profitability, trends and some of the more volatile items over the past year, along with reference rates that lead to fair value changes. So now within the core banking segment on Page 10 of the presentation or Page 15 of the release. Net interest income declined sequentially, primarily related to the $9 million decline in PPP fees. Later in the presentation, we have the traditional net interest income and NIM slides, which provide more detail on the moving parts at a consolidated level, but I'll point out, our cost to restrain deposits continues to decline, which we expect will continue over the coming quarters as liabilities reprice lower. I'll talk about CECL and the provision in detail in a few minutes, but you'll see here, we had no provision nor recapture this quarter. 2 lines down is the gain on swap derivatives related to the increase in long-term interest rates this quarter, which is also noted at the bottom of the page. And noninterest income declined sequentially related to a gain on store sales back in Q4. Our focus continues to be on growing commercial fee revenue. And noninterest expense declined $23 million as expected from the fourth quarter. Pretax income for the core banking segment increased 9% this quarter to $115 million, and the tax rate normalized this quarter, resulting in $87 million of net income for the core banking segment. The efficiency ratio on the core is 56%, a few ticks lower than the past few quarters. Turning now to Page 11 of the presentation or Page 16 of the earnings release, we show the mortgage banking segment 5-quarter trends. To start, we had just over $1.6 billion in total held for sale volume this quarter, a change of 8% from Q4. This was better than the 20% decline we expected a quarter ago. The gain on sale margin was 3.82%, in line with previous guidance. These 2 items resulted in the $62.5 million of origination and sale revenue noted towards the top left of the page. Our servicing revenue was stable but did receive higher-than-expected pay down activity earlier in the quarter. For the change in MSR fair value, the passage of time piece remains stable as expected, while the change due to valuation inputs was a loss of $2 million due mainly to the higher pay down activity earlier in the quarter. Noninterest expense totaled $42 million for the quarter. Again, this represents a direct held-for-sale origination costs, servicing costs, along with administrative and allocated costs. The direct expense component of this was $31.5 million as noted on the right side of the page, and represented 1.90% of production volume. In prior calls, I talked about a 225 to 250 basis point all-in cost for home lending, but that included the entire group, including the categories I just discussed. To project expense here in the future, this is a good trend level of basis points for the direct origination component. Pretax income for the mortgage banking segment was $27 million, and net income was $20 million, both down 34% from the fourth quarter and within the range of our expectations. It's important to note here, the mortgage banking segment represents only 19% of our pretax income compared to 28% in the fourth quarter and 32% in the third quarter as our core banking growth initiatives take hold. For the near-term outlook on our mortgage segment, assuming no significant change in interest rates, we expect held for sale volumes to decline over the course of the year with best estimates of around $1 billion to $1.1 billion for the next 2 quarters and the mid- $4 billion range for the full year. Gain on sale margins should normalize into the low to mid-3% range later this year. The MSR passage of time should be pretty consistent, and the change due to input should be relatively low, again, assuming no significant change in interest rates. And direct held for sale expense levels and basis points on production should remain fairly consistent with the 5 quarter trend. Okay. I hope this segment discussion was helpful to understanding the moving parts and potential future drivers on profitability. I spent most of my time discussing the segments and note there are several slides later in the presentation on consolidated trends for net interest income margin and expense, but hopefully, this helps give some greater insight into the company. A couple final items before I turn it over to Frank. Let me take your attention forward to Slide 23 on CECL and our allowance for credit loss. As a reminder, our CECL process incorporates a life of loan reasonable and supportable period for the economic forecast for all portfolios with the exception of C&I, which uses a 12-month reasonable and supportable period, reverting gradually to the output mean thereafter. Hence, these forecasts incorporate economic recovery in 2021 and beyond, as most economic forecasts revert to the mean within a 2- to 3-year period. We use the Moody's baseline economic forecast again this quarter, updated in February, instead of moving back to the consensus as we thought a quarter ago due to a closer approximation of the move in long-term interest rates. Overall, the forecast showed improvement in several key areas as the economy reopens. However, Moody's also updated their investor CRE forecast late in the quarter, which included deteriorating forecast related to several investor CRE portfolios, such as hotel, office and retail as compared to the prior quarter CRE forecast. With that update, the recaptures expected earlier in the quarter were reduced, and our model has resulted in an approximately $10 million recapture here in Q1. Given the uncertainty and expectations for more clarity as we progress throughout the year, we overlaid the model result ending with no provision for the quarter. Net charge-offs for Q1 remained low at $17.6 million, much lower than the models from last year suggested. And the majority of net charge-offs this quarter related to small ticket leases that were past due following rolling off their deferral period, which we expected and discussed with you last quarter. The ACL at quarter end was 1.49%, noting this ratio was 1.65%, excluding the government-guaranteed PPP loans. As these are economic forecasts driving the reserve, it will simply take the passage of time to see if net charge-offs follow as modeled. But to date, the models are simply overestimated the actual net charge-offs, given at least a lag of 4 quarters. And lastly, on Slide 21, I want to highlight capital. Noting that all of our regulatory ratios remain in excess of well-capitalized levels, our Tier 1 common ratio was 12.6%, and our total risk-based capital ratio was 15.9%. The bank level total risk-based capital ratio was 14.9%, which is the basis for our calculation of $611 million in excess capital. That is excess over our 12% in-house floor. And with that, I will now turn the call over to Frank Namdar to discuss credit.

Frank Namdar, Chief Credit Officer

Thank you, Ron. I will also be referring to certain page numbers from our earnings presentation for those who want to follow along. We have placed all relevant credit quality information in one section of the presentation starting on Page 23, to display our CECL information normal presentation of credit quality ratios, deferrals and portfolios of interest for a comprehensive view of our credit quality. Slide 24 reflects our credit quality statistics. Our nonperforming assets to total assets decreased 5 basis points to 0.19%. Our annualized net charge-off percentage to average loans and leases decreased 2 basis points to 0.33%. Included in net charge-off number this quarter was $16 million of the previously disclosed pool of FinPac leases with borrowers who elected deferral but were unable to resume regular payments. We expect the FinPac portfolio to return to more historical levels of 3% to 3.5% in the coming quarters. Slide 25 shows the total loan balances that were on deferment at the end of the quarter at 1.4% of the loan book. For deferrals on a portfolio basis, we are reporting 0.3% deferrals in commercial, 1.4% in commercial real estate, 1.4% in FinPac, 0.4% in consumer and 2.9% in residential real estate. We have excluded $166 million in Ginnie Mae repurchases from the deferral numbers as those loans are guaranteed by FHA, VA or USDA role development. On Slides 26 and 27, we continue to highlight the same portfolios of interest, which all continue to perform very well. I would like to again point out that hospitality represents only 2.6% of our portfolio. There are no imminent issues. However, we continue to watch this space very closely. Occupancy levels have increased and are now in excess of 60% on average with our extended stay and limited service properties continuing to perform above this level. As I've stated previously, this portfolio is of low leverage with very strong overall sponsorship to borrowers we have history with. The rest of these portfolios are represented with air transportation at 0.6% with no deferrals, restaurants at 0.5% with only limited deferrals, and finally, gaming at 1.8% of our portfolio with no current deferrals. We remain confident in the quality of our loan book and look forward to future growth.

Cort O’Haver, CEO

Okay. Thanks, Frank and Ron, for your comments. And Laura, we will now turn over to questions.

Operator, Operator

Your first question will come from Jackie Bohlen from KBW.

Jackie Bohlen, Analyst

Cort, I wanted to talk about fees, just to kick us off. Obviously, there's a lot of moving parts there, and thank you for splitting out service charges versus the card revenue; that was helpful. Just as I think about and I'm specifically looking at the composition of other income, commercial product revenue, I know you've got a lot of moving pieces in there, and some of it includes swaps. What needs to happen to rebound to pre-pandemic levels?

Cort O’Haver, CEO

Jackie, let me have Tory answer that since it's near and dear to his heart, and then I'll backfill on Tory's comments.

Torran Nixon, President of Umpqua Bank

Jackie, this is Tory. The pandemic certainly disrupted general activity in some transaction areas, but we are observing a recovery now. For example, one key metric we closely monitor in our middle market and community banking segments is commercial card spending. March marked the highest commercial card spend in the company's history, showing a 17% increase year-over-year, and this is notable considering the lack of travel and entertainment spending that typically contributes significantly to commercial card use. This is just one sign of increased activity; we are also witnessing growth in treasury management and other areas like merchant services. A lot of activity is beginning to unfold in our markets, and I believe we are just a quarter or two away from seeing the full impact of this activity reflected in the bank's profit and loss statements.

Cort O’Haver, CEO

And Jackie, one last thing. As you've heard us talk about balanced growth in the past, we're not just looking for single vertical growth items. In other words, we're looking for customers who borrow, deposit and have an opportunity for us to create fee revenue opportunities for the company. And that's been a big mission around here for the last 3 or 4 years, and you're seeing that activity in the results coming out of commercial banking.

Jackie Bohlen, Analyst

So that 17% growth, is that reflective of customer development that's been taking place over the past year and prior, but maybe we didn't see it because of the pandemic. And now as we normalize, the initial pop could be higher than it otherwise would have because you've got some run rate to make up for. Is that a fair assessment?

Torran Nixon, President of Umpqua Bank

I think so. I think I'd say it a slightly different way. The commercial C&I customer at Umpqua Bank is different today than it was 2 to 3 years ago. It's much higher, much bigger, a lot more activity. And so just the idea of transactions and the economy kind of moving again will absolutely create some opportunity for us in our fee income space, certainly in commercial and community banking.

Jackie Bohlen, Analyst

Okay. And those customers, are any of them part of that 36% that you referenced in terms of converting PPP customers over? Or are these separate customer acquisition efforts?

Torran Nixon, President of Umpqua Bank

That would be minimal in that. So that's not really represented at all. This is just traditional growth in our middle market segment over the last 2 to 2.5 years. It's just a different looking customer today than it was a couple years ago.

Jackie Bohlen, Analyst

Okay. And then I guess my follow-up question, and then I'll step back, which is what kind of growth are you seeing from the new relationships with PPP? I mean you've got a pretty good conversion rate going there?

Torran Nixon, President of Umpqua Bank

Yes. So this is Tory again. So I think as Cort mentioned, we had about 6,000 or so loans, PPP loans, that we made to non-Umpqua bank customers, roughly 2,000 of those we have since turned into full-fledged relationships with the bank. They vary in size from companies that have $100 million or $200 million of revenue to a small, small company in our community, so kind of across the spectrum. To date, most of our activity to bring them into the bank has been deposit generation and certainly getting them set up on TM and commercial card and integrated payments and all those things that we talk about. And it's really occurred over the last 3 to 4 months. The way I look at it is we have another 4,000 to go. So there's a lot of opportunity for us just in that book. But I think Cort also mentioned that we're taking a very aggressive stance on prospecting and kind of highlighting and promoting the brand of Umpqua Bank and what we've done, what we continue to do in our communities to attract talent, new bankers and attract new customers.

Operator, Operator

Your next question will come from the line of Jared Shaw from Wells Fargo Securities.

Jared Shaw, Analyst

I guess looking at the loan growth outlook, but specifically, C&I, how much do you really have to burn or how much do the customers really have to burn through all that liquidity on the balance sheet before they come back into a net borrower position or start seeing growth? Or I guess, how should we be thinking about that dynamic between needing to see a higher loan-to-deposit ratio before loans start really increasing?

Torran Nixon, President of Umpqua Bank

Jared, this is Tory Nixon again. I appreciate your question. You're absolutely correct that businesses and the bank have a lot of liquidity. The primary focus for them is how to utilize that liquidity effectively. We closely monitor utilization rates in lines of credit within our middle market and community banking segments. Over the past year, these rates have dropped from the low 40s to the low 30s, indicating that companies are not using their debt to finance operations. This trend will need to shift in the next 3 to 6 to 9 months. Regarding our loan growth and pipeline, during our last call, I mentioned that we had a pipeline that matched pre-pandemic levels at about $3 billion. I'm pleased to report that we've increased that figure to $3.5 billion this quarter. Most of our loan pipeline consists of new prospects for the bank, and this represents the highest loan pipeline I've encountered in my five years with the company. We are optimistic about the activity from our team and our outlook on loan growth moving forward.

Jared Shaw, Analyst

Okay. And then is there any plan in sort of conjunction with the Next Gen 2.0 and some of the closures of branch space? What's the hiring plan to go out? And is there a plan to target new relationship managers or grow the commercial lending personnel base?

Torran Nixon, President of Umpqua Bank

Absolutely. We began this initiative about 2.5 to 3 years ago and continue to pursue it. We've brought on several individuals in our middle market division. Some of these hires were made to replace team members as we upgraded our talent to better serve larger and more complex companies. Additionally, many new hires are focused on markets where we see significant growth potential. We're very optimistic about our major metropolitan markets in relation to core middle market business. We are consistently seeking talent and have a pipeline in place that we aim to expand. We will keep moving forward with this effort.

Jared Shaw, Analyst

Okay. And then just finally for me. Maybe, Ron, you're talking about the opportunity to roll off some higher cost funds and maturities. What's the maturity schedule for time deposits and potentially, I guess, borrowings look like over the next 12 months?

Ronald Farnsworth, CFO

Yes. The majority of the time deposits will have a tail within 12 months and then borrowing is the same. So I think there'll be quite a bit opportunity for continued reduction in those two helping support the NIM.

Operator, Operator

Your next question will come from the line of Matthew Clark from Piper Sandler.

Matthew Clark, Analyst

Maybe just start on the margin outlook and trying to get a sense for maybe we're near a trough level just given the opportunity to remix some excess liquidity. Can you just give us the kind of weighted average rate on new loans and securities, so we can try to get a sense for where that margin is headed?

Torran Nixon, President of Umpqua Bank

Yes, Matt, this is Tory again. Interest rates on new originations are, depending on the line of business, between the low 3s to low 4s. It's been fairly consistent over the last couple of quarters, so we haven't seen any change there on new originations.

Ronald Farnsworth, CFO

And Matt, this is Ron. On the bond side, the upper 1s, maybe to 2, depending on the day and/or the generations in the 10-year. And I'd say, overall, for near-term outlook, we expect the margin to be relatively stable at this level and then longer term would be benefiting from deploying that excess liquidity back into loans, increasing that loan-to-deposit ratio. But for near term, pretty stable.

Matthew Clark, Analyst

Okay. Great. And maybe just shifting gears to capital. I think you guys were revisiting the buyback last quarter were in the process of looking at it and seeking maybe approval. I guess can you give us an update on where that stands and what your appetite looks like?

Cort O’Haver, CEO

With the amount of excess capital we have, we are evaluating all our capital opportunities, and I'll address your specific question shortly, including whether there is a chance to find smaller opportunities where we can increase a fee category or leverage our loan expertise. This remains our primary objective with the excess capital available. We are being very opportunistic in this regard. Regarding a buyback, it requires regulatory approval following our impairment from last year, and we expect to have more information on that soon.

Matthew Clark, Analyst

Okay. And then your commentary around small fee generators or asset generators, any desire to do whole bank M&A to the extent your multiple can afford it?

Cort O’Haver, CEO

Yes. We've always been opportunistic in our approach. For the past three or four years, our primary focus has been on improving profitability, and we've demonstrated success in that area. Currently, we are looking for opportunities that align with our core strategy of becoming the preferred business bank, specifically those that allow for quick execution and integration. We view this as vital to our success.

Matthew Clark, Analyst

Okay. And last one, just a housekeeping one. Ron, do you happen to have the remaining net PPP fees left with round 2?

Ronald Farnsworth, CFO

Yes, I do. The total PPP fees to be recognized are approximately $44.5 million. Round 1 will account for about $12.7 million, while round 2 will be around $31.7 million. Therefore, the majority will come from round 2, but we anticipate that forgiveness will continue throughout the year.

Operator, Operator

Your next question will come from the line of Michael Young from Truist Securities.

Michael Young, Analyst

I wanted to begin with the segment breakout. I appreciate the additional disclosure and insights provided; I find them helpful. I just want to clarify my understanding. It appears that if we adjust for PPP fees and provisions, the bank reflects the true value of the stock, and the mortgage business may seem low-cost or free for investors. However, is there any information available about previous years when mortgage volume was lower and the mortgage business was often unprofitable?

Ronald Farnsworth, CFO

Michael, this is Ron. I wouldn't say the mortgage business is losing money. Anytime that occurred might have been related to a significant downdraft in interest rates and so you had an MSR fair value charge that wasn't quickly followed by an increase in volume. We actually didn't experience that last year. Q1 of last year, you'll see in the mortgage segment did show that MSR hit, but then obviously, record earnings over the following 2, 3 quarters. But absent MSR fluctuations now, the profitability remains just at lower levels.

Michael Young, Analyst

Okay. And then, I guess, the valuation on the bank is pretty reasonable. It seems like the plan is to kind of march that forward. I didn't know if there was any additional color you could give, maybe Ron, at this point, now that there are some more defined, I guess, portions of the expense savings and timing around kind of an expense guide, maybe into quarter 2 or at the end of the year, as you've done in the past with Next Gen 1?

Ronald Farnsworth, CFO

Yes. Great question. And you're right. I mean the goal with the segment change and we talked about these moving parts every quarter for the last several years, but actually seeing them on paper helps just from a transparency standpoint. So that was most definitely the goal to see the underlying profitability and value trends of the core bank versus that of mortgage. On Page 3 of the presentation that we do lay out on the right side, those Next Gen 2.0 initiatives. And I'll point out here in Q2, we'll see reduction in expense related to the sale of Umpqua Investments. We've got additional store consolidations here in Q2. We might also see some excess disposal costs related to lease exits, Q2, Q3, but then that facility-side save will start kicking in later in Q4. That's really the more back office type stuff. So we'll start seeing here pretty quick.

Michael Young, Analyst

Okay. And then maybe one last one, if I can. I don't know if this is for Cort or Tory. But just sort of curious about the reopening in your markets more broadly in customer activity. Saw some loan growth this quarter, but just the outlook as we move through kind of the summer and reopening and just thoughts high level there.

Torran Nixon, President of Umpqua Bank

Michael, it's Tory. As I said earlier, I think that we're certainly impressed by our ability to continue to prospect and continue to work with our customers virtually over the past year. Obviously, as the world starts and begins to open up, there is some pent-up demand for activity. And our folks are just chomping at the bit to get out and visit with customers and meet with prospects and to get back into the growth part for the company. I mean we're really excited about the momentum that we've built over the past year, how we kind of stood up for our communities and what our real potential and opportunity in the company is. So our loan pipeline is significant. Our activity throughout the company, I think, is very significant, and we're excited to see what we can accomplish over the next several quarters.

Cort O’Haver, CEO

Michael, it's Cort. So let me add on. We operate in five states, with the majority of our business in three states that took a proactive approach to the pandemic, closing early in many communities we serve. Specifically, here in Portland, we are still operating at a very modest level compared to pre-COVID. As Tory mentioned, we are seeing a notable enthusiasm from both consumer and commercial customers eager to get back to business. We have shown some loan growth, which ties back to Jared's question about when cash will be redeployed into businesses and when they will start borrowing. We're beginning to see more activity, and in some communities, we are over 50% operational. The reason for this comment is that we have done well in the economies we serve, and they have not yet reached their full potential. We are very optimistic about, as Tory pointed out, the pipelines for bringing in new customers and witnessing some cash coming off the balance sheets of businesses, along with commercial loans reaching low 40s to 50% utilization. We feel we are in an excellent position unless there's a pandemic like COVID-27, which I wouldn't wish on anyone and don't believe will happen. We are very enthusiastic.

Operator, Operator

Our next question will come from the line of Steven Alexopoulos from JPMorgan.

Steven Alexopoulos, Analyst

I wanted to start on the mortgage side and appreciate the new disclosures; they are actually very helpful. First, on the gain on sale margin, maybe for Ron, just given the recent dip in the 10-year we've seen this quarter, have gain on sale margins held in there? I hear the longer-term guidance, but I'm just wondering if near term, they might hold in pretty steady with where they were in 1Q.

Ronald Farnsworth, CFO

It has. And that's more related to the fair value change on lock pipeline over time with the pull-throughs. But yes, I'd say so here near term. Over the longer term, later this year, we do expect it to continue to glide lower, as we discussed previously, but it was good to see that high 3 range still in Q1.

Steven Alexopoulos, Analyst

Okay. And then if we look at the efficiency ratio on the new disclosures, too, it's crept up every quarter, at least what you're calling out. Ron, how do you think about a normalized efficiency ratio for the segment?

Ronald Farnsworth, CFO

For the mortgage segment specifically? I would estimate it to be in the upper 60s to 70s range, primarily driven by the gain on sale margin in the low to mid-3s and the direct cost of originations being between 1.9% and 2%. However, it's important to note that this represents a smaller portion of our overall pretax income when it occurs.

Steven Alexopoulos, Analyst

Yes. Yes. Okay. That's helpful. And then on all of the store consolidations that you've had, can you talk about deposit retention trends? Number one. And number two, I know digital transactions are up a ton. But what feedback are you getting from your customers on all of the branches that you've closed? Do they even care about branches anymore?

Cort O’Haver, CEO

Yes, it's Cort. First of all, our transactions and traffic have decreased by over 30% compared to last year. To answer your last question, it's unclear whether customers don't care or have just trained themselves not to care since we're not seeing the traffic. With the consolidations this year, there's been less noise overall. Our normal customer turnover has been minimal, close to zero, and when we combine stores and reach out to customers, we've actually seen our combined balances increase. We may lose some customers, and to be honest, we can't please everyone. However, due to our efforts in managing these consolidations, customer feedback has generally been positive. While I can't say anyone is thrilled about closing retail locations, the store experience we are known for seems less important now compared to a strong digital presence. This shift is why we’ve made significant investments over the past three years, and we will continue to consolidate our stores, aiming to be more aggressive on the announced 30 to 50 closures by the end of the year. We see opportunities now that we didn't notice two quarters ago.

Torran Nixon, President of Umpqua Bank

Steve, this is Tory. I'll just add one piece into that, which would be our Go-To platform. Our customer base on Go-To is now over 84,000, and it continues to grow. That's a significant part of our store consolidation. These customers still have a connection to the company through Go-To, and it's serving us very well, as Cort mentioned.

Steven Alexopoulos, Analyst

Tory, I'm curious on Umpqua Bank to go, are you finding that customers are engaging more frequently with the bank given that feature? Or is it the same frequency, just a different format?

Torran Nixon, President of Umpqua Bank

It depends; it's generally more frequent. The usage of the app is evolving over time. Much of it is service-related, which makes sense. I may need to accomplish something, but I either prefer not to visit a physical store or there's no store nearby. I can meet my consumer banking needs through the app, which is how the majority of people use it. Once you try it, like I do and others here as well, you'll find it's a fantastic app. It's very useful, and you get excited about being able to send a text message and get things done that you need. I believe our customers truly appreciate it.

Steven Alexopoulos, Analyst

I could say that customers would like it. Is it more cost-effective for you to actually engage with customers that way to solve these service issues?

Cort O’Haver, CEO

It's Cort. Even though we have occasional surges from customers experiencing issues, typically, you don't interact with your Go-To application on a daily basis. While it might seem that managing 80,000 texts over time would require many Umpqua Bank associates, you can actually handle hundreds and thousands of accounts because usage tends to come in bursts. There may be times when specific customers have issues leading to a spike in communications, but generally, the volume returns to negligible or zero. This makes it highly scalable. We actually find it to be more scalable than our store experience since customers use it when they truly need assistance, rather than for routine tasks like visiting a store to perform simple transactions. We're still analyzing this data, and we might share more insights in a future call, but we believe it to be significantly more scalable.

Operator, Operator

Our next question will come from the line of Jeff Rulis from D.A. Davidson.

Jeffrey Rulis, Analyst

Just wanted to circle back on the expenses just to fine-tune where we are on sort of the progress on Next Gen. Ron, I think you mentioned, obviously, the sale of Umpqua Investments and the consolidation in the second quarter are going to be kind of lumpy. And I guess at the midpoint of this year's projected of $23 million, $24 million, call it, kind of how much was in the Q1 run rate? And if you could kind of give us a progress of that throughout the year, it sounds like there's some exit disposal costs that will offset that. But just a little more refined than kind of what we've captured and how you see it captured throughout the year?

Ronald Farnsworth, CFO

Yes. You bet. There was a couple million dollars in Q1 just based off of the facility exits we had late in the year, but you're right. We'll see 2 of the 3 months in Q2 related to the Umpqua Investment save, a little bit of a tail on store consolidations in Q2. We might also see some excess disposal costs related to lease exits, Q2, Q3, but then that facility-side save will start kicking in later in Q4. That's really the more back-office type stuff. So we'll start seeing here pretty quick.

Jeffrey Rulis, Analyst

Sure. Okay. But I mean if you look at for 50% of the 39 to 56, certainly that target, you say on track, that's by the end of the year, we're still there.

Ronald Farnsworth, CFO

Yes.

Jeffrey Rulis, Analyst

I wanted to clarify the net charge-off composition within FinPac. You have done well to identify that group of leases that you anticipated, but can we expect a return to historical levels in the second quarter? It seems largely resolved now, and the remainder of the portfolio doesn't appear to be generating significant losses either, but I just wanted to confirm that I understood correctly.

Ronald Farnsworth, CFO

You did. Yes, you did. I do expect the FinPac number to drop down to more long-term averages here in the second half of this year. And at least at this point, we don't see it on the bank impact side. And again, that gets back to the CECL commentary I had earlier. It's been a continuing trend over the last 4 quarters at least. We haven't seen the charge offs.

Operator, Operator

Your next question will come from Andrew Terrell from Stephens.

Robert Terrell, Analyst

Ron, I appreciate the guidance on the direct home lending expenses. I did want to ask, though, just on the indirect mortgage expense. It generally averaged about $5 million a quarter, but it stepped up to about $10 million this quarter. Was there something unusual in that number? And should the $10 million kind of step back down to the $5 million run rate or so?

Ronald Farnsworth, CFO

I'd say it was probably more a function of allocations internally around portfolio production. But I'd say it should be pretty stable with the last couple quarters, looking out over the balance of the year. There's nothing within the servicing or administrative areas of our mortgage segment that we expect to see significant increase or decrease. Majority of the Next Gen 2.0 saves are related to the core banking segment.

Robert Terrell, Analyst

Okay. And then I just wanted to ask you, we've seen a couple of bigger MSR sales across the industry this quarter. I know there might have been some for Umpqua on the table pre-pandemic. Is there any appetite to exit any of the MSR moving forward?

Ronald Farnsworth, CFO

At this point, no. We're pretty comfortable with where we're at with it. Obviously, the valuations are much reduced from where we were a year-plus back and a great connection with customers and look to see continued profitability within the mortgage segment.

Operator, Operator

As I’m not seeing any further questions from the phone line at this time, please continue with your closing remarks.

Ronald Farnsworth, CFO

Okay. Thank you, Laura, and I want to thank everyone for their interest in Umpqua Holdings and attendance on the call today. This will conclude the call. Goodbye.

Operator, Operator

Thank you, sir. Thank you so much for presenters. And again, thank you, everyone, for participating. This concludes today's conference. You may now disconnect. Stay safe, and have a lovely day.