Earnings Call Transcript - FBK Q1 2020

Operator, Operator

Good morning, and welcome to FB Financial Corporation's First Quarter 2020 Earnings Conference Call. Hosting the call today from FB Financial is Chris Holmes, President and Chief Executive Officer. He is joined by Michael Mettee, Interim Chief Financial Officer, and Greg Bowers, Chief Credit Officer. Please note FB Financial's earnings release, supplemental financial information, and this morning's presentation are available on the Investor Relations page of the company's website at www.firstbankonline.com and on the Securities and Exchange Commission's website at www.sec.gov. Today's call is being recorded and will be available for replay on FB Financial's website approximately an hour after the conclusion of the call. During this presentation, FB Financial may make comments that are considered forward-looking statements under federal securities laws. All forward-looking statements carry risks and uncertainties that may cause actual results to differ materially from those implied by such statements. Many factors influencing these outcomes are beyond FB Financial's control or prediction, and listeners are advised not to place undue reliance on forward-looking statements. A more detailed description of these risks is available in FB Financial's periodic and current reports filed with the Securities and Exchange Commission, including the most recent Form 10-K. Except as required by law, FB Financial disclaims any obligation to update or revise any forward-looking statements in this presentation due to new information, future events, or otherwise. Additionally, these remarks may include non-GAAP financial measures as defined by Securities and Exchange Commission Regulation G. A presentation of the most comparable GAAP financial measures and a reconciliation of the non-GAAP measures to GAAP measures can be found in FB Financial's earnings release, supplemental financial information, and this morning's presentation, which are available on the Investor Relations page of the company's website at www.firstbankonline.com and on the Securities and Exchange Commission's website at www.sec.gov.

Christopher Holmes, CEO

All right. Thank you, Dimitra, and good morning, everybody. We're happy to be joining you. Sorry that we are a day later than intended. We did have a problem with our conference call vendor yesterday where they lost their systems. But we're glad that we were able to get rescheduled, and welcome to everybody, and thank you for joining us. We appreciate, as always, your interest in FB Financial. Were we speaking under other circumstances, my introduction would almost certainly be spent with guidance on our margin following the recent Fed rate cuts, a discussion of our seller mortgage performance, updates on our recently announced Franklin Synergy merger and our recently closed First National Bank of Scottsville acquisition or a discussion on some of our recent personnel changes. However, as I begin this call, I think it's important to remind everyone of our vision and values, and explain how our team has been embodying those over the past 2 months because more than anything, I think our associates, our corporate character and our responses to our customers and communities over the coming quarters were served to drive long-term shareholder value. This great challenge creates the opportunity of a lifetime for our bank to show its true colors and to distinguish ourselves from our competitors in the process. Our vision for FirstBank is to deliver trusted solutions for our customers, provide a great place to work for our associates, to invest in our communities and to provide a superior long-term return for our shareholders. We go about delivering that vision by upholding our values. One team. One bank. Doing the right thing, commitment to excellence, existing for our customers, treating people with respect and enjoying life along the way. March and April have been tumultuous for our customers, associates and communities, beginning with the devastating tornadoes that tore through Nashville and Middle Tennessee in early March. Immediately, our relationship managers checked in with our affected customers and our markets hosted food trucks to provide hot meals for those in need across our affected communities. Those coordinated actions were in addition to a myriad of other individual responses by our associates such as donations to Salvation Army and food banks and other charities. Internally, we banded together as a family. We had an associate who lost nearly all of her world possessions when the tornado was a direct hit on her top floor apartment. Our team responded that morning by making eye appointments so she could get new contacts and glasses, taking her to the mall to get new clothes and essentials, taking her to get a new cell phone and putting her up in housing until she could figure out a longer-term solution. After learning that her pets were missing from the tornado, one of our associates was even able to locate them and facilitate an emotional reunion. Just 2 weeks after the tornado, before any kind of recovery had a chance to take hold, we required most of our associates to work from home and suspended lobby hours in our branches as social distancing became the country's new reality. As a community bank, we've been acutely aware of the financial and psychological strain that the past 2 months have created across our footprint. In turn, our FirstBank family has risen to the challenge of supporting our associates, customers and communities in the extraordinary manner with which I've become accustomed. For our associates' protection, we implemented a work-from-home policy on March 16. Our emergency management committee has been meeting daily since early March, and our board has instituted weekly meetings since March 20. Because it's the right thing to do, we've not cut pay for anyone unable to perform their jobs due to social distancing. I personally provide updates to all of our associates every day to ensure that the team has kept abreast of how the bank is operating in these times, and our marketing team provides a daily company-wide update on how our associates are stepping up for our customers, our coworkers and our communities. By all accounts, our team has adapted to this challenge and morale remained high across the company, maybe even at an all-time high, especially given these challenging circumstances. As we were implementing protective policies for our associates, our relationship managers were moving quickly to get in front of our customers and make sure they knew about the deferral programs that were available to them. We also posted materials on our website alerting customers about the relief programs available to them and encouraging them to ask for help if they needed it. We received fantastic feedback across our customer base as to how quickly we were able to alleviate some of their financial burdens. To date, we've had over 1,400 customers, representing 14% of our loan portfolio, choose to participate in our deferral program, and we're continuing to process those requests as they come in. After the CARES Act, the Paycheck Protection Program and despite our lack of history with SBA lending, we had a group of 10 executives and associates working, in some cases, 20 hours a day to determine how we would implement the program to serve our clients. With their work, we were able to form a team of associates, build a process and begin accepting applications on Saturday, April 4. Since then, we've had associates working relentlessly on our applications approved by the SBA. When it became apparent that the initial round of funding would run out quickly, we asked for an additional 50 associates to work shifts around the clock inputting applications to the SBA platform. We filled that quota within minutes and ended up well oversubscribed. We put out that call at 5:53 p.m. via an email, and within an hour, we had 30 new volunteers in the first of several virtual training sessions. All told, over 300 associates have been involved with PPP or approximately 50% of our banking division. Across all portions of the bank, we've banded together as one team to make sure that our customers have been taken care of. For the first round of funding that ran out on April 16, we received approval for over 1,500 applications, representing $267 million and approximately 29,000 employees across our customer base. I checked in last night after the program had reopened and we had gotten an additional 985 loans and $50 million in approvals, and our team is fully caught up at this point and is getting SBA approval responses with a very quick turnaround as applications come in. We view FirstBank as a pillar of our communities and our associates have done well to serve as sources of strength since the world changed. I could spend the entire rest of the call on examples of how our team has made ourselves felt in our communities from providing meals to the frontline workers to donating to food banks and organizing teddy bear scavenger hunts, but I'll only give one of my favorite examples of the impact our associates have on our communities. In one of our community markets, City Hall was forced to close due to COVID contamination. Our market President knew about the issue and immediately offered up one of our recently shuttered branches from an acquisition. The branch is currently being used rent-free by the town to conduct business through the drive-through window, providing a safe way for the community to continue going about its business with City Hall. In short, our associates have been living by our values to deliver on our vision since all this began in March. These are the times that you discover who you're in the bunker with, and I'm extremely proud of the team and the culture that we've built at FirstBank. Due to the way our team treats its customers and communities, I'm confident that we will come through this experience with a stronger position and reputation in the market than we went into it with. And I'm confident that the response will drive long-term shareholder value more than anything we can do over the coming quarters. With that state of the union, we'll move into our current financials. As you can tell, we've restructured our investor presentation a bit this quarter to reflect the shift in priorities of our management team headed into the recession. Those priorities for the foreseeable future are: first, the health and safety of our associates and customers; second, remaining in a strong liquidity position; third, protecting our capital; fourth, keeping our elite financial performer status; and fifth, growth. Notice that growth has moved significantly down that list. I touched on our #1 priority. So now let's talk liquidity. We saw customer deposits build by $440 million over the quarter with customer growth of $230 million and another $210 million from our Kentucky acquisition. At the same time, we had some larger payoffs for the quarter as a few larger borrowers refinanced with nonbank lenders in January and February. So we are currently sitting at an 85% loan-to-deposit ratio. That's our HFI loan-to-deposit ratio. We have $774 million in on-balance-sheet liquidity in the form of cash and unpledged securities, and we have contingent liquidity of $3.4 billion, that's billion with a B, available to us as well. Despite the impact to our margin, we intend to continue to carry much of this excess liquidity. We monitor draws on our lines daily, and we've not seen any heightened drawdowns or concerning activity there. On priority #3, our strong capital ratios indicate plenty of capital headed into this environment, and our capital structure remains simple with the flexibility to act if needed. Our regulatory capital stack consists of common equity, $30 million of trust preferreds and our allowance for credit losses. Our simple balance sheet, limited double leverage ratio and strong investor relationships also give us capital options to take advantage of if needed. We are continuing our dividend at present as we believe our current capital levels and core earnings power support it based on our current forecast. Moving on to credit. I'm happy that we did not loosen our credit standards to chase growth over the past couple of years. As a former colleague used to say, when the tide goes out in times like these, we'll see who's swimming naked; we don't believe that we'll lose our suit. You'll also see that we've provided more insight about what's in our portfolio this quarter. There are a few industries that we view as being potentially vulnerable due to social distancing and the downturn, namely retail, health care, hotels, transportation, leisure activities and restaurants. So we've laid those exposures out in our earnings presentation. I'll let our Chief Credit Officer, Greg Bowers, give some color on those buckets as well as the health of the overall portfolio in a minute, but my message is that we are a community bank. We are going to help our affected customers through these times. Through last Thursday, we've seen $371 million in deferral participations for those industries or 33% of the outstanding balances at March 31. We also have been active in trying to get those customers PPP funding and have gotten around $38 million so far. I'm sure that you noticed, but we also built a large reserve in the first quarter with a new CECL method of provisioning. Our allowance-to-loans HFI ratio increased from 71 basis points at December 31 to 195 basis points at March 31. We use Moody's baseline economic forecast from early April, which assumes unemployment increasing to around 8.7% in the second quarter before slowly coming back down over the next few quarters. We believe that having close to a 2% allowance will provide for the projected loss content of our portfolio, and we hope that it's substantially less than that. But with the CECL model heavily based on economic forecast, we could have further provisioning if the outlook and the economy continues to decline in the second and third quarters, and we still lack the clarity needed to make the qualitative adjustments to our model. At this point, we're speculating about an unprecedented economic shock, and no one ultimately knows what's going to happen. We're going to continue to prepare for the worst and think that we'll wind up being pleasantly surprised. We had charge-offs of 19 basis points this quarter as we wrote off the remainder of a commercial credit that ran into issues in the fourth quarter. The issue with the borrower came up suddenly late in the quarter before we were able to get a full view of the circumstances. With the time to gain additional information and the change in the economy, we went ahead and wrote down the remainder of 100% this quarter. Of the 24 basis points of annualized charge-off we've had in the past 2 quarters combined, that loan accounted for 17 basis points. As with our CECL build this quarter and the lack of major qualitative adjustments that we made to hold down our allowance for credit losses given the uncertainty of the next few quarters, we acted conservatively by charging the remainder of that loan off this quarter. And as we hope to be pleasantly surprised by the loss content of our aggregate portfolio, we are pleased to already recognize a $700,000 recovery in the second quarter from the charge-off that I just noted above. Our nonperforming loans increased this quarter as approximately $5.5 million of loans previously excluded from this category that have been purchase credit impaired are now reportable as nonperforming loans under CECL. We would consider the slight increase in those ratios as routine, not indicative of any decline in the underlying quality of the portfolio. Moving on to profitability. Our core earnings power, which for comparability, we are viewing in terms of adjusted pretax, pre-provision earnings right now, was $33.4 million for the first quarter, up 8.1% from the fourth quarter of 2019 and 16.8% from the first quarter of 2019. As a percentage of average assets, adjusted pretax, pre-provision earnings was 2.1%, which we believe remains very solid compared to the rest of the industry. As always, we continue to focus on mortgage margin and expense control to drive that profitability forward. We won't be providing guidance on the margin this quarter given the unknowns, the market volatility and the extraordinary number of moving pieces. I'll give you some detail on trends that we see and the actions that we've taken. First, as you're aware, the full impact of the margin of the 150 basis points of rate cuts is not evident in this quarter. Even excluding any noise that the PPP loans will cause this quarter, we would expect to see a further dip in our margin for the second quarter. Of course, our goal is to minimize the trough, and hopefully begin expanding by year-end. We cut rates across our interest-bearing deposit products by about 47% on March 17 and cost of time deposits has come in by around 30 basis points from where they were in mid-March. On our negotiated rate accounts, we'll continue to let our local decision makers make local decisions. We're in frequent discussions with our customer-facing associates about the rate environment and have been asking that they have conversations to bring those rates down as appropriate. On the asset side, I'll remind everyone that we're about 50% fixed, 50% floating in our loan portfolio, and our variable rate portfolio is split evenly between prime and LIBOR based. Roughly 58% of our prime-based loans are at their floors; they should be closer to 100%, unless rates go negative, and we don't think that's going to be the case. About 22% of our LIBOR-based loans are at their floors, so we'll still see some rate reduction on our LIBOR-based portfolio. Now moving to mortgage. Our team had a phenomenal quarter with $8 million of direct contributions. It was a record January and a record February. It would have been a record March as well if we hadn't taken some earnings off the table, the reserve against potential fallout on interest rate locks due to COVID and the disruption of the mortgage supply chain. For the remainder of 2020, we hope to continue to capitalize on a lower rate environment for as long as the market holds as volumes have remained strong through April. We also feel comfortable that our restructured, rightsized mortgage division has the ability to perform well in any environment. We'll also be focusing on expense control for the remainder of 2020 and until the banking industry finds its footing again. This quarter, expenses were primarily up related to the Farmers National Bank of Scottsville acquisition. Excluding Scottsville, we estimate that bank expenses grew by 2.5% over the fourth quarter of 2019. We're scheduled to convert the Scottsville acquisition in May. Following conversion, we expect to begin realizing our 20% cost savings assumptions. So far, on Scottsville, almost the entirety of our conversion prep activities have been occurring remotely and going very smoothly. We believe that this is a testament to the quality of our team and our capabilities and our technology. Also give a brief update on our pending acquisition of Franklin Synergy. We continue to be excited about the core community bank that we're adding in one of the most attractive markets in the country. We believe that we're still on track to close in the third quarter. The strategic reasons for the merger are the same as they were at announcement, and we are eagerly anticipating combining these 2 great banks to continue to create a powerhouse community bank in Middle Tennessee.

James Bowers, Chief Credit Officer

Good morning. I'll give my high-level thoughts on the portfolio, and then I'll be available on the question-and-answer section as well. First, looking at the big picture, we are, at our core, a community bank that makes loans to support the economic activities of our communities. In our conversations in the past, we've highlighted our local operating model focused on relationships with our customers. This strategy at its heart means dealing with local people we trust and know to be good operators. Our portfolio reflects that bias. We believe that will help our credit results over the long term and during this pandemic crisis. We believe in conservative underwriting standards with a focus toward cash equity or skin in the game and personal guarantees. We've long focused on keeping hold levels lower rather than higher. We didn't predict the virus, but we knew that things happen and maintaining this discipline would be a good risk management tool. We're trying our best every day to underwrite for the long term through the cycle, not counting on the Greater Fool Theory. Our strategy has always been about in-market lending and I think you'll see that in the numbers in today's presentation. We've never been big on buying in the shared national credits. It doesn't match our strategy of relationship lending. We want to bank the company, the owners and its employees. We don't do that as bankers meaning led by money in our bank. Our shared national credit exposure is less than $75 million and consists of 3 credits, in which we maintain a historical relationship prior to participating in the syndicated credit. None of these shared national credits are in our defined industries of concern. We just wanted to highlight our strategy here. As noted earlier by Chris, we have participated in the PPP program as well as offering short-term deferrals to assist our customers during this unprecedented time. We view this as both a service to our customers as well as part of the process of managing credit risk. The slides that follow highlight our exposures to those industry groups that we view as having the potential to be hardest hit by the virus. I believe you'll see that they are generally a good reflection of what I stated earlier about our strategy: broad diversification, few concentrations, in-market lending and smaller average ticket size. Looking at Slide 12. In our retail exposure, we had 2 buckets: the lessors of retail space and retailers themselves. Touching first on the non-owner-occupied space, we have a mix of property types with no real concentration across our footprint and no major concentrations by tenant. We feel good about the asset quality of the portfolio coming into a recession. Our largest single loan is about $8 million for a fully leased center with approximately a 69% loan-to-value. We have a relatively small ticket size across this portfolio, generally falling into the $2 million to $4 million range. On the owner-occupied in the commercial real estate retail side, you can see that we have a good portion of that book outstanding to auto dealerships with the largest customer in the $20 million range. Otherwise, we're fairly well diversified across this segment with no major concentrations. The 37% of other retailers that you see in the pie chart is all over the board. We have some specialized manufacturers, the largest of which is focused on consumer gift products, we have some building supplies stores and then other smaller retailers. Again, this is the type of granular diversified portfolio that you get when you let community bankers go and serve their communities. Moving on to slide 13. In our health care segment, we do not operate on a national scale, and we tend to avoid private equity-backed startups or other high-risk, high-growth businesses. Our largest investments in health care are in assisted living, nursing homes, and continuing care companies. This is an area where our executive management has significant experience, particularly our Chairman, Mr. Ayers, who has had a distinguished career in the nursing home industry. We have a reasonable presence here, including several assisted living projects, each valued at $10 million or less; a $21 million investment in a continuing care facility; and $11 million lent to a skilled nursing operator. We also have a $28 million loan to a regional not-for-profit health operator. Additionally, we hold various loans to medical and dental practices across our service area, typically with modest average loan sizes, the largest being an $8 million loan to a larger local practice. On Slide 14, you'll see that our hotel portfolio is diversified across our footprint and is focused on high-quality operators and high-quality flags. We have a loan-to-value of about 57% in this book, and we started stepping back from the space, particularly on the construction side, in 2018, when it seemed like things were getting overbuilt. Our focus has not been on downtown Nashville properties with the exception of $112.5 million exposure. Most of the Nashville MSA projects are in places like Brentwood and Green Hills. Our largest single project exposure is $23 million and has a 54% loan-to-value. We do have a concentration with 1 operator in 5 distinct properties, owned by 5 different unique ownership groups. Going into this crisis, we felt very good about our hotel portfolio and still do for the long term. But this industry segment, as you know, has been hit harder than most. Our long-term outlook is largely based upon the quality and strength of our operators, the flags, the locations and our overall lower loan-to-value of the portfolio. It was not uncommon to require our borrowers to inject 35% or more cash equity into the project upfront. We believe that bodes well for their longer-term success and the quality of our credit metrics. Short term, there is no doubt that their businesses will require adjustments and/or capital. Moving to Slide 15. Our trucking exposure consists of truckload operators, equipment lessors to owner/operators and local franchisees of major national trucking companies. There is one larger relationship at the $26 million level, but otherwise, it is fairly spread out across operators and our franchise. And this exposure makes sense for us, given our footprint in the middle of the country where there are several large logistics hubs. Our air exposure is primarily related to multiple owners and/or operators and no commercial airlines. On Slide 16, you'll see that our other leisure book is also scattered across the portfolio with no primary concentration. The largest exposures are highlighted on the slide. Otherwise, it is distributed across various types of customers with a modest average ticket size. In closing with restaurants on Slide 17, we don't have any significant concentration by operators or brands. Our largest customer is a strong local independent operation with roughly $4 million outstanding secured by real estate. The portfolio is widely distributed across our footprint. We do not have our heads in the sand; to the contrary, we're diligently monitoring our portfolio and recognize challenges lie ahead. We are fortunate to enter this recession with solid credit metrics and to be in markets that, pre-virus, were some of the strongest anywhere. We believe they have the resiliency to come out of this equally strong.

Michael Mettee, CFO

Thank you, Greg. I know that we have covered a lot so far. So I'll give some brief color on margin and mortgage and then be happy to answer any questions after our prepared remarks. First, on the margins, our cost of interest-bearing deposits for the month of March was 1.14% compared to 1.25% for the quarter. The cost of our non-time interest-bearing deposits for the month of March was 79 basis points versus 93 basis points for the quarter. And the vast majority of our non-time interest-bearing accounts that we were able to reprice essentially have been repriced. We have seen these costs come in by about 30 basis points since those actions were taken in mid-March. On the time deposit side, our cost for the month of March was 1.91%. We have over $650 million coming due over the remaining 3 quarters of 2020, approximately $175 million in the second quarter, approximately $270 million in the third quarter, and approximately $215 million in the fourth quarter. Those are coming due with an average cost of 1.94%. With rates where they are now, we're hopeful to pick up significant costs on the deposits as they mature. On the asset side, our contractual loan yield for the month of March was 5.03%, and the contractual yield on our loan portfolio, excluding PPP loans, is approximately 4.9% right now. Interest-bearing cash is earning 25 to 35 basis points right now as opposed to the 1.51% that we reported for the quarter, and our investment portfolio is yielding around 2.6% as compared to the 2.81% that we reported for the quarter. On mortgage, no additional color on outlook, but I would like to highlight the hedging activity on our mortgage servicing rights. We were able to offset approximately $15 million in value reduction of our mortgage servicing rights asset during Q1 through our hedging strategy, which is designed to mitigate changes due to rate movement and expected prepayments. We do not hedge fair value to cash, which accounted for approximately $4.7 million of the mortgage servicing rights fair value change for the quarter.

Christopher Holmes, CEO

All right. Thank you, Michael. Now that we're through the quarter, let me touch briefly on our personnel announcements from Friday before I wrap up and open it up for questions. As you're aware at this point, James Gordon is following the path of many great Tennesseans, and he is heading down to Texas. James has been an integral part of our operations. He is a personal friend, and he's been a great teammate for the last 4 years. We're going to miss him and we wish him well. That said, James has helped us develop some great bench strength in finance and accounting. We have faith in Michael and the rest of the team that we'll lean on as we conduct the search for James' replacement. I was also very happy to promote some of our market executives in that announcement. Travis Edmondson, our new Chief Banking Officer, has been a great young talent that we picked up in the transaction with Clayton, and I feel very confident in his leadership and his ability to handle that role. Nathan Hunter has 45 years of banking experience and is a great talent, and we look forward to his shepherding our East region going forward. Brent Ball, another great young talent from the Clayton transaction, will take over Knoxville from Nathan. Jim Mosby will take over as our Nashville region President. Jim has been a star member of our team for some time now, and we're excited to see him operate in this expanded role. Finally, to conclude, a lot happened this quarter. I'm extremely proud of our associates for the manner in which they've taken care of our customers so far. We are a community bank and we differentiate ourselves with customer service and quick local decision making. I think we've done very well with that so far and I have no doubt we'll continue to serve and support our customers and communities going forward. I'm proud of the way our associates have handled this adversity and our management team for getting everything up and running so quickly that they would hardly miss a beat operationally as the world has changed. From a liquidity, capital and credit perspective, I'm confident in the strength of our balance sheet. I believe that we are well positioned to weather this storm and come out on the other side, ready to take advantage of all the opportunities that this disruption is going to create. I'm confident that we're going to keep our position as an elite financial performer.

Operator, Operator

Our first question comes from the line of Stephen Scouten with Piper Sandler.

Stephen Scouten, Analyst

Thanks for all the detail in the presentation, it's very helpful. I'm curious, maybe first off, I didn't see any breakout of what the manufactured housing portfolio is currently? And curious if you could give us an update on that portfolio and kind of how you're thinking about that in this term loan?

Christopher Holmes, CEO

Yes, certainly. We included some general information about the manufactured housing portfolio. It's important to note that we view this portfolio in two distinct parts: one is manufactured housing retail and the other is manufactured housing communities. The communities segment is the larger part of the portfolio and those loans are more similar to commercial and industrial loans. The retail portfolio, which is smaller, is approximately $180 million, and consists of loans to individuals purchasing the units. Greg, I’ll let you provide insights on the performance characteristics.

James Bowers, Chief Credit Officer

Yes. Thanks, Chris. Yes, that's right. That manufactured housing piece of it is something we picked up with the Clayton acquisition. It's run by Kevin Kimzey; he does a great job. The portfolio has continued to perform well. To date, past dues are hanging in there as past dues are across the board. So it's always something that we're going to pay attention to. But right now, that has worked out well. The deferrals within that group are similar to the deferrals that you would see on the mortgage portfolio. We acknowledged that in relation to the energy sector, there is some exposure in the oil and gas-dependent area. We have considered this, and it is just one of the categories we will monitor alongside almost every other portfolio segment we manage.

Christopher Holmes, CEO

I will say, interestingly, we monitor it daily in terms of past dues, and week over week, the past dues were actually less in the latest week than they were in the previous week. As we've been engaging with people, affordable housing is always in demand, and perhaps it's even in a little more demand right now. We're maintaining contact with the borrowers, and so far, that portfolio has performed well. Clayton, who manages it, experienced it through the last downturn, so they have some experience with it. Most of us at the table right now didn't have that experience. There is a lot of communication, and frankly, so far, it has been better than expected as things have turned out.

Stephen Scouten, Analyst

That's great. That's helpful. I'm curious about the update on the pending FSB acquisition. In the last two quarters, they've incurred losses while trying to sell off some of their riskier credit portfolio. They mentioned in their release that there's been a slowdown in their ability to sell those loans. Could you clarify how that transaction will work with the $400 million, along with the loans they are still attempting to sell? Additionally, what is your potential exposure in the structure of that transaction?

Christopher Holmes, CEO

Yes, I understand, Stephen, thank you. I have a couple of general comments. As you mentioned, the financial landscape has changed significantly since we announced the transaction with Franklin Synergy, which was unexpected. However, when considering their transaction, there are many variables at play. This includes credit repayment expectations, interest rate fluctuations, liquidity considerations, and factors related to both the loan portfolio and the investment portfolio as well as fixed assets. As we assess the situation and consider changes, it's important to remember that we have also established an exchange ratio. Therefore, the tangible book value aspect appears to be a neutral transaction for us. I'm uncertain about the exact impact on EPS accretion. If the marks increase, some of that might slightly decrease. However, overall, it seems to remain positive. The $430 million portfolio, which I would describe as a legacy SNC leverage lending portfolio that we announced during the transaction, is something we will not pursue going forward. They announced that they wouldn't be pursuing that in the future. They have been working to reduce it, and it's a bit easier for us to manage because of our size compared to them, as it is performing well and generating earnings. It has decreased to about $400 million, with some fluctuations bringing it back up to around $408 million. Looking ahead, the landscape has changed, and while this could impact our immediate plans, it won’t affect our long-term strategy. We won't sell high-quality performing loans at significant discounts just because we have stated our intent to sell them. As we proceed, we will be cautious, aiming to maximize profitability and minimize risk.

James Bowers, Chief Credit Officer

When we initially announced the transaction, it appeared that it wouldn’t be very challenging to dispose of most of the portfolio at close to par. While that's not impossible now, the situation has certainly changed, prompting us to reevaluate that strategy. I think, too, as well, we stay in contact with their management. They're continuing to do a great job, serving their community and managing the bank in these times, maybe I'll reference their participation in the PPP program as well. They did also indicate satisfactory overall asset quality, but have seen some challenges in that institutional portfolio like you talked about.

Stephen Scouten, Analyst

That makes sense. It's a great summary you've provided. You may take on more of the remaining $408 million at close than expected. That being said, you will probably also increase the market that occurs. Is that a fair summary?

James Bowers, Chief Credit Officer

Yes. Yes, that's fair.

Stephen Scouten, Analyst

Okay. Great. And then one last thing. You guys gave some great detail on the PPP program. I haven't seen from others in terms of your expected fees on a net basis. And I'm wondering if you could give some color into what's driving that kind of 65% net of these direct costs and originations. Is that kind of accrual accounting? Or is that true incremental costs that are related to the PPP program over time and other things? Just give us some idea of what we can expect relative to the gross fees.

Christopher Holmes, CEO

Yes, the short answer is that we have some technology partners that we are compensating. To elaborate, when we began this process, it was important to note that we are not a traditional SBA lender, much like many banks. Consequently, we were all trying to find solutions quickly. We utilized various sources for assistance. Ultimately, Jack Henry has been a key vendor for us with whom we've worked extensively. They provided support with both the application and submission processes to the SBA. We are collaborating with two different vendors to assist us, one for the application and another for the submission. We took some time at the beginning, and as you may recall, we didn’t start accepting applications until the Saturday before the program launched on Friday. This resulted in a slightly delayed start. During that time, there was a lot of anxiety and eagerness to join the program, but we didn’t have a fully reliable process initially. In fact, we had to implement a plan B on Saturday due to an issue with a different solution. Despite this, we managed to get the process running smoothly. In round 2, which commenced on Monday, we processed approvals for 900 applications, totaling $50 million in loans within just 2 days. The process has been refined and is now functioning very well. Interestingly, in the first round, the average loan amount was approximately $175,000, while in this round, the average loan balance has dropped to $51,000, indicating that we are reaching smaller customers.

Operator, Operator

Our next question comes from the line of Tyler Stafford with Stephens.

Tyler Stafford, Analyst

I wanted to start on one of Stephen's earlier questions just around the manufactured housing portfolio. So the $180 million of retail, how much is the community piece of it? And then you said the deferrals, there are similar to what you've seen in mortgage, but I don't think you guys disclosed what the actual deferrals are on mortgage. So could you quantify that a little bit for us?

James Bowers, Chief Credit Officer

Yes. Thank you, Tyler. This is Greg. The manufactured housing community portfolio is approximately $220 million to $230 million. When I mentioned deferrals, the actual figure is around 6.7%, which relates back to my earlier reference about the MBA regarding just single-family homes in general, and that was my point.

Tyler Stafford, Analyst

Okay. That’s helpful. Could you provide some insight into the hotel portfolio's pre-COVID performance? Specifically, what were the loan-to-value ratios and debt service coverage figures around December 31, 2019? Chris mentioned that you usually secure 35% cash in those deals. On a weighted average basis, what would those LTVs and debt coverage figures look like for that portfolio at the end of the year?

James Bowers, Chief Credit Officer

This is Greg. So debt service coverage on things like that, we've got in excess of 1.25, 1.30, is what you would see. What we were emphasizing was on the construction projects. You see 35% or more cash equity going into the projects. All of these were doing well. The exception to that is one that you've seen on our list for a long time, and frankly, it's been there probably since 2010. It's our largest nonaccrual, and it has fluctuated over time. It has consistently remained in nonaccrual status. Its performance varies, sometimes improving and sometimes deteriorating, but we have solid collateral support for it due to the real estate involved. Additionally, we have some extra collateral beyond the specific facility. However, it has been in this situation for a long time.

Tyler Stafford, Analyst

Understood. Okay. Just thinking about the reserve for a moment, I appreciate completely that the final marks on FSB aren't obviously complete. But if we can kind of maybe put aside the macro kind of Moody's related changes for a moment, is there any preliminary range you can help us think about for a combined ACL ratio at close for the 2 companies?

Christopher Holmes, CEO

Yes, we haven't reached that point yet, Tyler. Michael, feel free to add. We've considered it, but it's still too early for us to provide any insights. CECL is relatively new, and we are still in the process of fully understanding it ourselves. Unfortunately, we don’t have the information to share at this time. With the various dynamics in the economy and the ongoing changes with CECL, we would let you know if we could, but we just don’t have it yet.

Tyler Stafford, Analyst

Fair enough. That's totally fine.

Christopher Holmes, CEO

Michael, do you have anything to add?

Michael Mettee, CFO

Yes. I mean I would echo those comments, and I would expect it's probably likely higher than ours.

Operator, Operator

Our next question comes from the line of Stuart Lotz with KBW.

Stuart Lotz, Analyst

I guess most of my questions have been answered. I appreciate all the color on the credit book. Maybe turning to expenses and a question for Michael. I think the run rate this quarter came in a couple of million higher than we were looking at. Kind of how are you guys thinking about a 2Q run rate with a full quarter of Scottsville in there as well as your kind of target expense cuts? Just trying to get a better picture of what we can expect before layering on FSB?

Michael Mettee, CFO

Yes. Good morning, Stuart. And so the quarter had a couple of things in there around merger expense. And then obviously, you mentioned FSB, then Chris mentioned in his comments, we expect to see some costs right there. We had some payouts from higher payroll in the first quarter. So we expect to return to normal a bit in Q2. So March was a little bit elevated, but we think that, as Chris mentioned, we will be monitoring expenses very closely as we go through the next couple of quarters and prepare for FSB and...

Christopher Holmes, CEO

So, Stuart, regarding expenses, there has been roughly a 2.5% growth when making an apples-to-apples comparison. Over the past few years, managing expenses has been essential, especially in banking, where expense control is critical. However, we have made many investments in recent years, and this area may not have received as much focus as others. Moving forward, given the current environment, expense control will be increasingly important. We are currently evaluating which investments to pursue and which to postpone. We've communicated to our team that we should implement a hiring freeze. While we are hiring for some replacements, we are not looking to expand our staff at this time. We have implemented some measures, and as we assess the remainder of the year, controlling expenses becomes crucial. While we have established a hiring freeze, there will be some exceptions for specific reasons. Generally, we are not expanding our staff significantly at this time. Additionally, we must consider the $10 billion threshold related to the combination with Franklin Synergy, as we may be close to exceeding that amount. There will be some associated expenses to keep in mind as we balance our expenses this quarter.

Stuart Lotz, Analyst

Chris, I appreciate all the color on that. Sorry, last one for me. If we turn to the revenue side, obviously, we're going to have some margin compression coming forward, obviously given the rate shock we got in March from Fed cuts. And your guidance for the $5.7 million net of origination costs coming through from PPP. In terms of geography, could we expect that in spread income? And do you expect to realize most of that in 2Q and 3Q? Or how can we kind of think about that flowing through?

Christopher Holmes, CEO

Yes, it will be included in spread income, and we will recognize it cautiously. This program has been implemented with some uncertainty regarding the rules, which is not a criticism since the rollout by the government, agency, treasury, SBA, and the banking system has been impressive. Despite its challenges along the way, when considering the broader context and what has been achieved, it is quite remarkable. That being said, as we roll it out, there are a lot of things we don't know. And so we're going to be cautious probably by going back to the reserve side before we just take all that into income, we're going to be careful. Make sure we get paid back by the SBA. In some cases, you may get paid back by a customer; in other cases, you may have to get paid back. And so the way to take it is through spread, and it would come in over the life of the loans. So theoretically, that's probably the next 2 quarters, but we're going to be cautious in reserving before we really take any of that in with of course following proper accounting principles; but we're going to be cautious by reserving before we take any of that in.

Michael Mettee, CFO

Yes, you are required to defer both the fee and the direct expenses, which include some related costs. Therefore, both of those should be deferred. However, in this situation, it's a shorter-term deferral with a two-year loan duration, but you expect most of these to be forgiven in a significantly shorter timeframe.

Christopher Holmes, CEO

And so I'd summarize that, Stuart, by saying, we're not going to be taking a lot of that in the income immediately.

Stuart Lotz, Analyst

Got it. And that $5.7 million is pretax, obviously?

Christopher Holmes, CEO

Yes, that's correct. That's correct.

Stuart Lotz, Analyst

Given that round 2 is now in progress, do you expect to provide additional guidance if that funding is exhausted, considering your involvement and so on? For the moment, we will likely utilize the $5.7 million, but it seems like you all have been active in round 2. I'm just trying to consider how we will factor that in over the next few quarters.

Christopher Holmes, CEO

Yes, thanks, Stuart. We'll provide some updates and revised guidance as we progress through the program. We have been very active in round 2, and we'll keep you updated. Last night, I mentioned we had completed 985 loans, and I'm sure it's over 1,000 now, compared to about 1,500 in round one. This is just within the first 2 days of round 2, so I expect that trend to continue. These loans have had smaller balances, which translates to a higher fee. We'll aim to keep you informed on that.

Operator, Operator

Mr. Holmes, there appear to be no further questions. I'll turn the call back over to you.

Christopher Holmes, CEO

All right, very good. Thank you. We appreciate it. Again, we're sorry for the delay. Some things are beyond your control, and so we apologize that we got delayed, but we appreciate everybody joining today. And we appreciate your interest in FB Financial, and we will look forward to moving forward with another exciting quarter. Thanks, everybody.

Operator, Operator

Thank you. That does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your lines.