Fulton Financial Corp Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Fulton Financial Second Quarter 2020 Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I’d now like to hand the conference over to your speaker today, Phil Wenger. Please go ahead, sir.

Thanks, Matt, and good morning, everyone. And thank you for joining us. Today, we will follow our usual call format beginning with some prepared remarks. First, I'll provide a high-level overview of the quarter. Next, Curt Myers, our President and Chief Operating Officer, will share some thoughts on our business performance for the second quarter of 2020. And then Mark McCollom, our Chief Financial Officer, will share the details of our financial performance. After that, we'd be happy to take your questions. COVID-19 continues to have a significant impact on our world and our company. But all things considered, we are pleased with what Fulton was able to achieve in the second quarter. I want to start by thanking our employees for all they've done to serve our customers throughout the pandemic. It was truly inspiring to watch our team members manage their own needs while continuing to fulfill Fulton's purpose of changing lives for the better for our customers. Thanks to the dedication of our team, the flexibility of our customers, and our investments in technology and digital platforms, we have continued to provide needed banking and financial services throughout the pandemic. We successfully administered the SBA's Paycheck Protection Program or PPP, providing more than $1.9 billion in loans to businesses and non-profit customers. We offered loan deferrals and payment relief to consumers and we implemented new benefit programs to help our employees throughout this challenging time. When I spoke with you in April, Fulton had responded very quickly to keep employees and customers safe, while continuing to deliver essential financial services to the communities we serve. Now, three months later, while our unwavering focus on health and safety continues, we see the virus as just one more factor to manage as we go about our day. We're working hard to ensure our team's energy remains focused on achieving our longer-term priorities of growth, operational excellence, and effective risk management and compliance. In June, we gradually began to expand lobby access for our customers. Currently, we have resumed regular lobby hours at 146 of our 223 financial centers. A team of leaders from across our company has put in place a plan to gradually re-onboard employees who have been working remotely. This process will take place over the remainder of the year and can be adjusted or reversed at any time, depending upon the progression of COVID-19 and the associated safety protocols recommended by health experts. Turning to our financial performance in the second quarter, our consumer and commercial lines of business performed relatively well given the environment. In consumer, we saw increases in deposit balances, growth in residential mortgages, and relatively strong performance in Wealth Management. In commercial, our loan pipeline remains stable. Deposits increased even after factoring in the funds we received through PPP. We also saw continuing resiliency in a number of fee income businesses, including merchant services, investment management, trust services, and swaps. Several credit metrics improved during the quarter, and you'll hear more detail about that in a few minutes. However, we need to wait until we know more about the depth and duration of the COVID-19 pandemic over the next six to nine months to understand the longer-term impact on our customers. We have been and will be actively managing our expenses over the remainder of the year to help mitigate the anticipated negative effects of the pandemic. Other highlights during the quarter included the opening of a new financial center in Baltimore, continuing our commitment to growing our presence in urban markets. We also announced the creation of the Fulton Forward Foundation, an independent non-profit private foundation funded by Fulton Bank. The foundation will provide financial impact gifts to non-profit organizations that share Fulton's vision of advancing economic empowerment, particularly in underserved communities. The foundation is an extension of the bank's Fulton Forward Initiative, which promotes diversity, equity, and inclusion, encourages building vibrant communities, fosters affordable housing, drives economic development, and increases financial literacy in the community's survival. In April, in addition to our traditional and ongoing support of our communities, Fulton Bank made an extra $500,000 donation to the foundation to support COVID-19 assistance programs in the markets we serve. About a week ago, the foundation announced that they had distributed those funds to nearly a dozen worthwhile community programs. So, as you can see, we've accomplished a lot in the first half of this year under challenging circumstances. And now, I'll turn this over to Curt, so he can discuss our business performance in more detail.

Thank you, Phil, and good morning, everyone. Our second quarter performance saw solid results in certain areas of our commercial and consumer lines of business. However, we also faced challenges, as the full quarter impact of COVID-19 was felt throughout our footprint. Our participation in the Paycheck Protection Program or PPP was a highlight, as we established processes, redeployed team members, and helped preserve over 100,000 jobs during this critical time. In total, we originated a little over $1.9 billion in loans through more than 10,000 PPP loans. As noted last quarter, we continue to support our customers during this difficult time and are providing payment relief ranging from three to six months, depending on the product. Slide 3 provides you with an update on the loan deferral programs we’ve been offering our customers during this time. New deferral activity has slowed considerably since mid-April. For our commercial customers, we are just now starting to see the expiration of those 90-day deferrals. If an additional 90-day deferral is requested, thorough risk-based underwriting and approval processes will occur. While it is too early to determine the level of second deferral requests, we are confident that the total will be meaningfully less than the initial deferrals. Shifting to loan growth, overall loan growth trends for the quarter were strong but were materially impacted by the PPP program. Excluding PPP, commercial loan balances declined for the quarter, with average balances decreasing $420 million during the period. This was largely driven by reduced line utilization during the second quarter. We have seen a decline in commercial line use from 33% to 25% or $340 million. With PPP funding and the gradual reopening of the economy within our footprint, certain businesses were able to pay down their borrowings. As you can see, this decrease in line utilization accounted for the majority of the commercial loan decline when you exclude PPP funding during the quarter. Looking forward, our commercial loan pipeline at June 30, 2020, remains relatively flat from the first quarter and is essentially unchanged from a year ago. In our consumer lending business, our residential mortgage results continue to be very strong, producing linked-quarter loan growth of approximately 5% despite significant refinance activity. Deposit growth has also been very strong for the quarter as PPP funding-to-date has largely remained in customer deposit accounts, and consumer deposits have benefited from stimulus checks and reductions in consumer spending. Deposits grew over $2.5 billion during the quarter, with $1.7 billion of this growth coming in non-interest bearing accounts. We are also pleased with our progress in re-pricing our deposits; deposit costs declined 26 basis points during the quarter from 62 basis points down to 36 basis points. Turning to fees, our mortgage company had a very strong quarter with both elevated originations and strong gain on sales spreads. Total residential mortgage originations for the second quarter of 2020 were $811 million, an increase of 67% from the same period last year. Refinance activity accounted for 54% of originations in the second quarter of 2020, compared to 18% for the same period last year. Our mortgage pipeline sits at $879 million at quarter end, which is the highest level ever. Our Wealth Management business also performed better than we had anticipated this quarter, as the stock market has rebounded quicker than we expected, and we continue to see the benefit of our high level of recurring fee business. Our assets under management and administration were at $11.1 billion at quarter end. Moving to credit, certain credit metrics showed improvement over the quarter. Our non-performing loans were flat linked-quarter and down $8 million from a year ago. Net charge-offs were $4 million, down from $11 million last quarter, representing 9 basis points on an annualized basis. Despite these positive near-term credit trends, our outlook remains cautious. It is too early to fully assess the impact of COVID-19 on our regional economy and the related impact on our borrowers. As detailed on Slides 4 and 5, we have limited portfolio exposure to some of those industries that have been impacted the most by COVID-19. Our loan portfolio is diversified from a geographic, product, and collateral perspective. I will remind you that our internal house limit is $55 million to any borrowing relationship, which we believe is lower than that of other banks of our size. This strategy has helped us maintain a diversified portfolio. In addition, our owner-occupied commercial mortgages represent close to half of our overall commercial mortgage portfolio. We continue to generally lend to experienced borrowers that have stable cash flow and sizable equity positions. Now I’d like to turn the call over to Mark to discuss the financial results in more detail. Mark?

Thank you, Curt, and good morning to everyone on the call. We have taken feedback from many of you to provide additional COVID-related disclosures during the past two quarters, and this is reflected in today's presentation. Unless noted otherwise, the quarterly comparisons I will discuss are with the first quarter of 2020. Starting on Slide 6, earnings per diluted share this quarter were $0.24 on net income of $39.6 million. Second quarter earnings in comparison to the first quarter benefited from a lower provision for credit losses. Our fee income also produced strong results, and our operating expenses were better than our expectations on a core basis. These positive trends were offset by a linked-quarter decline in our net interest income. Moving to Slide 7, our net interest income was $153 million, a decrease of $8 million linked-quarter, and in line with our guidance. The full quarter impact of the 150 basis point decline in interest rates, as well as a decline in commercial loans excluding PPP loans due to the rapid decline in line utilization drove this overall decline in net interest income quarter-over-quarter. Our net interest income for the quarter was 2.81% versus 3.21% in the first quarter, a 40 basis points linked-quarter compression. Our net interest margin was slightly higher than our internal projections and was driven by the sharp decline in interest rates for the quarter and the influx of PPP loans, along with excess liquidity we are currently experiencing. Our loan-to-deposit ratio declined during the quarter from 98.5% to 95.1%. On the liability side, in addition to the progress we made this quarter in lowering our deposit costs, we believe our deposits can still re-price lower, as CD maturities occur during the second half of the year. These maturities total approximately $900 million over the next two quarters, at a blended average rate of approximately 1.5%. Turning to credit on Slide 8, our second quarter provision for credit losses was $20 million versus $44 million last quarter and $5 million a year ago. This decrease in provision was driven by the pace of decline in the economic outlook during the second quarter compared to the first quarter, as well as lower net loan charge-offs during the quarter. Our CECL methodology utilizes Moody's for the macroeconomic assumptions that drive our models, and we also consider employee qualitative overlays based on a comprehensive review of additional financial and economic data. Non-performing loans as a percentage of total loans decreased to 83 basis points, excluding loans originated under PPP compared to 90 basis points a year ago, and declined to 75 basis points including the PPP loans. Our allowance for credit loss related to loans at June 30 was 1.53% as a percentage of total loan balances, an increase of 13 basis points from the prior quarter. This ratio excludes PPP loans from the calculation. The allowance for credit loss coverage ratio as a percentage of total non-performing loans was 183% at June 30, 2020. Moving to Slide 9, non-interest income excluding securities gains was $53 million, down 3% from $55 million last quarter and $54 million a year ago. This result was better than our guidance which predicted a decline of between 5% and 15%, and was driven by outperformance in mortgage banking, capital markets, and Wealth Management revenues. Mortgage banking revenues were up $3.7 million from the prior quarter, despite recognizing a $6.6 million mortgage servicing rights impairment charge during the quarter, as interest rates rapidly declined and expectations for pre-payments increased. With respect to mortgage loans that we originate for sale, our new commitments were $573 million for the quarter, an all-time high for the company. Our gain on sale spread of 2.89% for mortgages sold was significantly higher than our recent trend, as the sharp drop-off in interest rates has increased demand for mortgage assets. Capital markets revenue, which is primarily composed of swaps revenue, was also higher than we anticipated, coming in at $5 million compared to $5.1 million last quarter. Despite the decline in line utilization, which impacted loan balances, we saw solid originations which drove this result. We executed on a small investment portfolio restructuring during the quarter involving the sale and reinvestment of $85 million of investment securities. This resulted in reporting approximately $3 million of securities gains during the quarter offset by a similar amount of expense to prepay some higher-cost FHLB advances. Moving to Slide 10, our non-interest expenses were $143 million in the second quarter. Included in this amount was $2.9 million of FHLB prepayment penalties as noted above. Excluding this cost, total expenses were at the low end of our guidance and declined $2.5 million from first quarter levels and $4 million from the second quarter of last year. While many of our expenses have declined as a result of COVID-19, certain expenses have increased due to the pandemic including special bonuses for frontline personnel, contributions to COVID-related charities, PPE expenses to keep our employees and customers safe, and certain other costs. These expenses totaled approximately $3 million for the quarter. Our effective tax rate was 14% for the quarter, compared to 10% in the first quarter of 2020, primarily due to higher pre-tax earnings in the second quarter. Slide 11 focuses on our liquidity. Since mid-March, we've maintained excess cash of approximately $200 million to $600 million per day. This number has increased throughout the second quarter, as we have not seen a runoff in PPP funding that we originally expected. This impacted our net interest margin moderately. Despite stabilization in the markets, we would anticipate maintaining extra liquidity until we have a clearer picture on when PPP funds will be utilized. We currently registered to use the PPP loan facility through the Federal Reserve, but we've not yet had to tap that funding source as we've had strong deposit balances throughout the quarter. Slide 12 gives you more details regarding our capital ratios. We've evaluated our capital and liquidity under various stress scenarios, and in all models, both the bank and holding company maintain sufficient regulatory capital and liquidity to uphold our current common shareholder dividend, which is our intention. Lastly, on Slide 13, we'd like to provide our thoughts about forward guidance for the third quarter. With significant uncertainty still existing in the economy, we are not providing guidance beyond the third quarter at this time. Our third quarter guidance is as follows. For loans, we expect overall loan growth to be plus or minus 1% to 2%. Residential mortgages will continue to lead the way with positive growth, while commercial loans are expected to produce flat to modest declines in growth. For deposits, we anticipate deposits to experience growth of 1% to 2% in the third quarter, with seasonal municipal deposit inflows offset by modest PPP deposit runoff. We expect our net interest income to be in the range of $150 million to $153 million for the third quarter of 2020. We are not anticipating material amounts of PPP loan forgiveness to occur in the third quarter, as we currently expect loan forgiveness activity to increase in the fourth quarter. We expect our non-interest income to remain similar to second quarter levels in the range of $50 million to $53 million. Mortgage banking should continue to be a bright spot, as our pipeline is robust, and our third quarter is a seasonally busy time of the year. Overall, we expect operating expenses to be consistent or slightly lower than the second quarter in the range of $139 million to $142 million. Lastly, we expect our effective tax rate to range between 11.5% and 12.5% for the third quarter. With that, I’ll turn the call back over to the operator for questions.

Thank you. Our first question comes from Frank Schiraldi with Piper Sandler. You may proceed with your question.

Good morning.

Good morning.

Good morning, Frank.

Good morning, Frank.

I want to start by asking about provisioning, as it seems to be a significant factor for the latter part of the year. Mark, could you provide an update on your perspective regarding provisioning in the context of CECL, particularly for the third quarter? I understand that you aren't offering guidance beyond that. Any insights you could share would be appreciated.

Yes, Frank, as you know, under the CECL model, you provide each quarter for your current expected future credit losses. If everything goes according to plan, our provisioning in future periods will already cover all the loans on our books. Therefore, the provision becomes the final aspect of the equation once you calculate what your allowance needs to be for the third quarter. You take into account loan growth, changes in your portfolio mix, and net charge-offs. Another factor to consider is changes in your macroeconomic assumptions used in your model. Based on all of this, if we assume that both our company and the industry have made accurate assessments this quarter, then in the next quarter, if there are no changes to those macroeconomic factors, you would only need to account for the other elements, such as portfolio changes and net charge-offs, which we are providing guidance on. You have seen our performance this quarter in terms of net charge-offs and non-performing levels. However, a significant factor will be what happens as loans start to exit deferral, specifically the rate at which those loans remain current during second-round deferrals or if we begin to see any deterioration.

Okay, so in the CECL world the way you're thinking about it if you've gotten things right the models, right. And even in the face of higher charge-offs potentially at some point in the third or fourth quarter, we might see provisioning, not even covering charge-offs as those reserves have actually been taken in the life alone sort of world is that reasonable?

That is a possibility. Yes.

And then just wanted to try and get a sense of how conservative your fee income guide might be. You talked about the record mortgage pipelines. It seems like the MSR impairments based off of expected pre-payments, which I guess is already baked into the model at this point. So I just wondered if you could talk a little bit about maybe the puts and takes in a fee income in 3Q being sort of in line with the 2Q result?

Yes, I think you're right, Frank, when you think of where and again – the folks on the call here judge where we're being conservative or aggressive. But, in that this past quarter, we had mortgage banking revenues that included $6.6 million write-down in our MSR impairment. The current value of that is written down to kind of mid 60 basis points range at this point. So how much further – and as further write-downs might have to occur in the third quarter is really sort of anyone's guess. But, depending on the level of MSR impairment in the third quarter, I think that's where there could be to use your wildcard in those third quarter numbers. We also had swaps revenues in the second quarter that were strong, our pipeline maintains relatively stable, as Curt noted on the call, so depending on what third quarter originations are, that’s another factor. The last thing I would mention on fee income would be Wealth Management revenues and where the stock market is because about 81% of our revenues are really tied to stock market valuations. Although a lot of those are paid earlier in the quarter, so the fact that we had a fairly strong stock market in early July should bode relatively well for that business as well.

I was surprised to see the significant compression in yield within the loan book from the previous quarter, and I wondered if that might be due to something unusual or if it is simply related to variable rate loans in that portfolio. It looks like the yield dropped from 42% to 35% in that timeframe.

Yes, so I mean obviously with rates dropping, Frank, we have $6.4 billion of loans tied to one month LIBOR, another $1.5 billion tied to one year LIBOR both of those dropped pretty fast, particularly from kind of mid-May 1. A lot of those commercial real estate loans are tied to swaps. Our swaps revenue is strong, but then with a higher percentage of that portfolio being variable rate that would account for most of that.

Got you.

Okay. Thank you.

Thank you. Our next question comes from Casey Haire with Jefferies. You may proceed with your question.

Thanks. Good morning, guys.

Hey, Casey.

I wanted to address the NII guidance, but I'm curious about the NIM outlook given the significant variation in loan growth and the potential challenges and opportunities that may arise. Mark, you mentioned some benefits from CD re-pricing, but could you provide some clarification as we consider NIM for the third quarter?

Sure, yes. So we don't give NIM guidance, we give NII guidance, but to give you some other data points to help, one thing I would comment is we have about $10.5 billion of interest bearing deposits in either demand or savings. Those averaged about 21 basis points for the second quarter, but we've continued to very actively manage that. For the month of June, those interest bearing non-maturity deposits were 15 basis points, so in addition to CDs, I would expect to see that non-maturity demand continue to price down a little bit lower as well. When you also consider margin, our PPP loans for the second quarter that impacted margin negatively by about 3 to 4 basis points; the excess liquidity that we're currently sitting on impacted margin by about 7 basis points for the quarter. So the question really then starts to become for margin again, when do those PPP customers use those funds or do they not utilize them, in which case then we will take other measures as other loan maturities and securities that come through over the back half of the year to lock down that cash position. But until we know that for sure, as I mentioned, we're going to continue to hold higher liquidity; we just think it's the right thing to do at this part of still an unknown economy.

Yes, I get that. So on the PPP, sorry, if I missed this in the release for the deck, but the blended loan yield on that?

Yes. So as you know, it's a 1% coupon, and our fees are just about $60 million. We're amortizing that over two years, so that's about $7.5 million a quarter that comes in, so the blended yield on our PPP would be about 2.5%.

What can you share about your credit forecast, especially as we prepare for our next conversation in three months? I understand the situation is constantly changing, but what does your current forecast indicate? Are there any expectations for more stimulus or macroeconomic factors related to GDP that we should consider when assessing the outlook in three months?

Yes, sure, Casey. Yes, we don't have any additional stimulus in there. We're currently using Moody's for all the macroeconomic variables. Both we employ in our models, as well as some of the macroeconomic variables that we look at for our qualitative overlays. So we're using the Moody's model of June 9; that model assumes an unemployment rate as of the end of December of 10.2%, and at the end of 2021 of 8.5%. Now, unemployment is not actually embedded in our models, but it is one of the larger qualitative overlays that we consider. We also use Moody's for all the other economic data for assumptions on that BBB bond rate, housing starts, et cetera; really all comes through their analysis that we rely upon.

Thank you.

Thank you. Our next question comes from Chris McGratty with KBW. You may proceed with your question.

Good morning.

Hey, Chris.

Hey, Chris.

Hey, Chris.

Curt, Mark, I want to go back to the NII comment just to make sure I'm clear. The guidance you gave for Q3, I guess first question, Is that an FTE number or is that just a GAAP number?

That's a GAAP number.

Okay. And I know you said most of the fees will come in Q4. Was there any PPP fees recognizing in Q2, and does that guide assume that 7.5 that's the right way to think about it?

Yes, it does. We've been – as those loans have been onboarded, we started amortizing them over the two years at that time.

Okay, great. And then maybe my last question. Your branch has gotten a lot of attention at the industry level given the revenue headwinds. Can you just remind us where you guys are in terms of thoughts on branches? I know you collapsed the charters a few years back. Just want to get your sense on the ability to run expenses out over the next year or so?

Yes, we are going from 270 branches down to 223. We continue to look at opportunities for consolidation, and I believe that they do exist. So we do believe we can drive more expenses out.

Thank you. Our next question comes from Daniel Tamayo with Raymond James. You may proceed with your question.

Hi, good morning, guys.

Good morning.

I wanted to discuss the deferral information and I appreciate all the details provided. How many of those deferrals are there? You mentioned there's an expectation for the amount to decrease after renewal, but of the amount you disclosed, are there any re-deferrals included in that figure? What is the trend regarding what is becoming current versus what is still being renewed?

Hey, Dan, it's Curt. Just a little more insight into that: we have just started to have those first 90-day deferrals expire, and we are evaluating second deferral requests. Less than a third of them have expired, and of those, it’s been a meaningful reduction in the request for second deferrals. I think we'll have better data for you in the third quarter. But as we are starting that process, we are seeing a meaningful decline in second deferrals.

Thank you. I'm looking at the criticized classified loans on Slide 4, and I'm surprised to see no criticized classified loans in the hotel motel category within investor real estate. What is your perspective on why that segment has remained stable?

Yes, I don't have any specific details. I mean, we are very conservative in our underwriting in hotels overall. Again, we have 75% loan-to-cost or market value at origination, and we also have very strong cash flow when we originate, and then that portfolio has been performing over time.

Okay. All right. That's all for me. Thank you.

Thank you. Our next question comes from Erik Zwick with Boenning & Scattergood. You may proceed with your question.

Good morning, guys.

Hi, Erik.

First, just a follow-up on the deferral discussion. I think Curt, in your prepared comments, you mentioned that for any of those that have received deferral and make a second request, they'll go through a thorough kind of risk-based underwriting process. Given that those that make the second request are likely businesses or consumers who've had their cash flow severely impacted, and your businesses may be operating with revenue significantly below what would be considered normal, what does that kind of risk-based process entail at this point? What factors are you looking at? And at what point do you make the decision that you may need to take a charge-off? I’m just kind of curious how that plays out since some of these loans, if you were to look at them and there's new loans today, may not meet your typical underwriting requirements?

Yes, a great question. So we are looking at those kind of like the markets looking at the bank stocks right now. We're looking at it from a capital standpoint, we're looking at it from a liquidity standpoint, and we're looking at borrower and guarantor support to get through the crisis. So it's really those mitigating factors beyond just performing cash flow, so that it's very difficult to establish or understand ongoing cash flow with those borrowers right now. So we're looking at capital, we're looking at liquidity, and we're looking at guarantor ability to keep those loans performing through this.

That's helpful. And then just turning to your loan growth on Slide 13, you've got the range of plus or minus 1% to 2%. I think you mentioned the pipeline remains stable at this point. Just curious, what you're seeing if there's any particular sectors where the pipeline is stronger or weaker than you'd expect, and what could potentially lead to that loan growth coming at the bottom or the top end of that range for your outlook.

Yes, as we look at the pipeline being stable, it is very diversified. There are certain things that are not in the pipeline because they've been impacted businesses, but it still remains a very diversified pipeline. I think the variability in our growth will essentially be the same as this quarter. It's going to depend on how much line paydown that we have, how much early prepayment we have, and how much residential mortgage refi that we have. I think that's what will move us towards the lower or upper end of that range.

Got it. Just one last small one on the FDIC insurance expense that was down quarter-over-quarter, even with the balance sheet getting larger. Just kind of curious what's driving that calculation today, and if the 3Q value should be similar to 2Q?

Yes, our 3Q values should be similar to 2Q, and it was a function of our sub raising capital actually in the tail end of the first quarter, and we downstream some of that money to the bank. So the way the FDIC now calculates that ratio is they look at bank-level capital ratios. The leverage ratio at the bank level becomes one of those factors. So with excess capital, the holding company raised and downstreamed some of that, it lowered the ratio or the assessment.

Thanks for taking my questions.

Thank you. Our next question comes from Russell Gunther with D.A. Davidson. You may proceed with your question.

Hey, good morning, guys.

Hey, Russell.

Hi, Russell.

Just a follow-up on the deferrals. So given where they stand today, and it sounds like, likely headed lower in the second and the third quarter, do you guys consider these customers higher risk given that they're in a forbearance program? And if so, is that accounted for in the current reserve level today?

The current level of deferral, just to clarify the question. So in the current deferrals are worth considering them all high risk.

That's right. Yes. I'm just trying to get an understanding, and to maybe give you some context for my question, very different answers from bank management teams in terms of how they handled the deferral process, and I've received answers to this question in terms of what we think 80% of these are money good, and others a different answer. So I'm just curious, maybe at a high level in terms of your view of this deferral level and whether they're higher risk or not because they're in the forbearance program. And if you think they are, is that reflected in the current reserves?

Our initial deferral program was offered to all customers to accommodate given unknown factors at that time. We made the process very simple for customers to obtain a deferral, and we did very limited credit underwriting to do that. So we were very accommodating to customers for the first round of deferrals. The now second round of deferrals will have a thorough credit underwriting to qualify for a second deferral, and again we are seeing a meaningful decline in the second round of deferrals. So to answer your question directly, the first round of deferrals, we do not feel is a risk factor. It was a customer accommodation. This round of deferrals will be more in line with where there's potential emerging credit risk.

And then Russell, this is Mark. I think your second part of your question related to CECL and how we think about those deferrals. While the deferrals because the loan is not showing up as delinquent in our system, it’s not reflected in the base model but it is reflected in the qualitative overlays that are part of our overall CECL methodology. So it would be captured in our provision for the quarter.

That's very helpful. I appreciate the information and thank you for your patience with my questions. For my last inquiry, I would like to shift to consumer fees. I understand the overall picture, but could you provide an update on the decline percentage due to lower activity compared to fee waivers? Additionally, could you enlighten us on the exit rate at the end of June compared to April to gauge the run rates for the third quarter?

Yes, there was a minimal impact from fee waivers. We were very accommodating, and we participated in the CARES program for all five of the states that we operate in, so we were very accommodating to customers. However, the customer requests for fee waivers were very limited. The driver of that revenue was really activity-based overdraft fees and credit card and debit card activity. We do see both of those climbing month-by-month as there is more activity overall.

Great. Thank you very much. That's it for me.

Thank you. Our next question comes from Matthew Breese from Stephens Inc. You may proceed with your question.

Good morning. A couple of follow-up questions. So on the deferrals that go through the re-deferral process and don't meet the hurdles, and therefore need additional forbearance, how are you thinking about moving those loans into either criticize or classified or traditional non-performing loans or non-performing asset buckets? Should we expect those that don't cure on the next round to move into those traditional deteriorating asset quality buckets?

I think you'll see some of that, but again, it's an underwriting process. So some of those borrowers may request the second deferral, and we will grant that based on their capital, their liquidity, and their guarantor support. It won’t necessarily mean that they are a non-performing or distressed borrower at this point. Some of them, as we re-underwrite them, probably we will adjust their risk rating and those could potentially be classified, criticized, or non-performing. But again, it's an underwriting process that we will look at for each one of those customers before we grant them the next deferral.

Understood. And then could you just talk about how much flexibility you have from the CARES Act and/or from the regulators to push deferrals out, meaning it now seems like there's likely going to be businesses and sectors of the economy impacted well into 2021. Do you have the flexibility to extend deferrals out that far into mid-2021? And we could be carrying these for that long?

Well, I would just say, regarding the regulators, they have much more flexibility and willingness to work with banks than existed in ‘09, ‘10, ‘11 time period. So I think we'll have the ability to extend. How long it lasts is really hard to say.

Okay. And then going back to Frank's question on the provision, just wanted to get a sense for how the Moody's forecasts have evolved in 2Q. And if you have them into July, have the forecast started to stabilize and become a little bit more consistent? Or have they been as volatile as they were in April and May? Just want to get a sense for how they have been moving?

From my perspective, Matt, they have stabilized. I would say they stabilized because if you think back to March, I think there were some banks that were using different models on the 23rd, and there was another one on the 27th and they were coming out every couple of days; things were so fast and furious. For this quarter, I mean, the last model that Moody's developed was on June 9. That was the model that everyone was using for the quarter end. Again, I know there are a lot of midsize banks that rely on Moody's for their macroeconomic variables. The fact that they're just slowing down the pace to me implies that you're getting a better lens into the future, although there’s still certainly a lot of uncertainty out there.

Understood. And then just last one for me, I know regulatory capital ratios are well in excess of minimums, tangible common equity. Could you just give us some sense of where you're comfortable moving that down to or is that even something you're looking at?

Yes, so TCE I really think this quarter is going to be the low watermark. We've expected to climb back from there, and that was really a function of PPP loans putting those on; obviously, it's a 0% risk-weighted asset for your regulatory ratios. But the PPP loans impacted both TCE and your Tier 1 leverage ratio unless you're using the PPPLF, which we haven't had to use yet as a funding source because the deposits are still sticking around. We knew that both of those ratios, Tier 1 leverage, potentially tangible common equity here in the short run would drop as a result of PPP. We viewed that as both the right thing to do in our communities and the short-term nature of the program, and we were comfortable with that number coming down to 7.4 and then climbing back towards closer to probably the seven or eight range by year-end.

Great. I appreciate all that. That's all I had. Thank you.

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Phil Wenger for any further remarks.

Well, thank you all for joining us today. We hope you'll be able to be with us when we discuss third quarter results in October. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.