Hope Bancorp Inc Q3 FY2020 Earnings Call

Good morning, and welcome to Hope Bancorp's 2020 Third Quarter Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. Now, I'd like to turn the conference over to Ms. Angie Yang, Director of Investor Relations. Please, go ahead.

Thank you, Nick. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2020 third quarter investor conference call. As usual, we will begin using a slide presentation to accompany our discussion this morning. If you have not done so already, please visit the Presentations page of our Investor Relations website to download a copy of the presentation; or if you are listening in through the webcast, you should be able to view the slides from your computer screen as we progress through the presentation. Beginning on slide two, I'd like to begin with a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding the future financial performance of the company and future events. These statements are based on current expectations, estimates, forecasts, projections, and management assumptions about the future performance of the company, including any impact as a result of the COVID-19 pandemic, as well as the businesses and markets in which the company does and is expected to operate. These statements constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We refer you to the documents the company files periodically with the SEC, as well as the safe harbor statements in our press release issued yesterday. Hope Bancorp assumes no obligation to revise any forward-looking projections that may be made on today's call. The company cautions that the complete financial results to be included in the quarterly report on Form 10-Q for the quarter ended September 30, 2020, could differ materially from the financial results being reported today. In addition, some of the information referenced on this call today are non-GAAP financial measures. Please refer to our 2020 third quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures. Now, we have allotted one hour for this call. Presenting from the management's side today will be Kevin Kim, Hope Bancorp's Chairman, President, and CEO; and Alex Ko, our Executive Vice President and Chief Financial Officer. Chief Credit Officer, Peter Koh is also here with us as usual and will be available for the Q&A session. With that, let me turn the call over to Kevin Kim.

Thank you, Angie. Good morning, everyone, and thank you for joining us today. Let's begin with slide three, with a brief overview of our financial results. Despite the ongoing challenges presented by the COVID-19 pandemic, we are very pleased to have delivered a solid performance this quarter, highlighted by positive trends in many key areas, including among other things, quality loan and core deposit growth as well as an expansion in our net interest margin. We generated net income of $30.5 million or $0.25 per diluted share in the third quarter, compared with $26.8 million or $0.22 per diluted share in the preceding second quarter. We also recognized a 14% increase in our pre-tax pre-provision income to $61.7 million in the third quarter from $54 million in the second quarter of 2020. More importantly, we were encouraged by trends we observed in the health of our borrowers this quarter, with many deferred loans returning to regular payment schedules as well as recognizing a decline in nonperforming loans. The trends we are seeing strengthen our perspective that we are well positioned from a capital and reserve standpoint to effectively manage through the current economic environment. Our performance this quarter is also reflective of the progress we are making on our long-term initiatives designed to enhance the value of our franchise, particularly in terms of improving the characteristics of our deposit composition and expanding beyond our traditional legacy customer base. Over the past few years, we have discussed our strategies designed to develop broader banking relationships with commercial customers and the investments we have made in personnel and technology to enhance our ability to gather lower-cost core deposits, including upgrading our treasury management capabilities. We are now beginning to see meaningful results from these efforts as evidenced by the growing deposit relationships with our larger commercial customers. During the third quarter, our non-interest-bearing deposits increased by $452 million or 11% quarter-over-quarter with the growth largely attributable to the expansion of the existing commercial relationships with our corporate banking customers. Our success in growing our base of lower-costing transaction deposits has enabled us to continue to reduce our reliance on higher-cost time deposits. Over the past year, our non-interest-bearing deposits have increased from 24.8% of our total deposits to 32.1%, while time deposits have declined from 42.4% to 31.7%. In the third quarter, the significant improvement in our deposit mix combined with an overall reduction in the rate environment helped to drive a 23 basis point reduction in our cost of deposits, which was a primary driver in the margin expansion we achieved in the third quarter. Moving on to slide four. We had a strong quarter of business development with total loans increasing at an annualized rate of approximately 8%. We originated $1.2 billion in new loans in the third quarter with total fundings of $782 million. Excluding PPP loans, our total loan fundings increased by $430 million, more than double the level of fundings in the second quarter, which reflects the improvement we are seeing in loan demand as the economy strengthens. For the 2020 third quarter, we funded $244 million in commercial real estate loans; $433 million of C&I loans; $105 million of consumer loans primarily consisting of residential mortgages; and SBA loan production which is included in the CRE and C&I fundings just discussed totaled $48 million for the third quarter. The important takeaway from our third quarter loan production is that as evidenced by our growth in demand deposits, we are now getting full commercial banking relationships, meaning both loans and deposits with a greater percentage of our customers which is a key priority for the bank. Another important note is that commercial loans accounted for 28% of our loan portfolio at September 30, 2020 up considerably from 22% a year earlier, underscoring the successful growth of our corporate banking group. Now moving on to slide five. Let me provide an update on the loan modification program we implemented to help our borrowers manage through the impact of the pandemic. At September 30, we had approximately $1.1 billion granted in Phase 2 of our modification program, accounting for 8.8% of our total loan portfolio. This represents a significant decrease from the 24.2% of loans modified as of June 30. For the bank, to consider a second round of modification support, we are requiring borrowers whenever possible to provide credit enhancements in the form of additional collateral or personal guarantees in order to mitigate potential losses in the event of a default. The vast majority of the COVID modifications to-date in Phase 2 have been related to our CRE portfolio with just $31 million for C&I loans and $99 million in consumer loans, which largely represents residential mortgage volumes. Hotel/motel and retail properties account for the majority of modifications, representing 41% and 21%, respectively of all modifications. Moving on to slide six. Let me briefly comment on the type and duration of modifications being granted under Phase 2 of our modification program. It is apparent that the impact COVID-19 is having on the economy is longer-lasting than we first expected on the onset of the pandemic crisis. While Phase 1 modifications were predominantly 90-day full payment deferrals, under Phase 2, we have been offering for the most part either full payment deferrals or interest-only payments or a hybrid combination that includes deferrals for a period followed by interest-only payments for the rest of the modification term. In Phase 2, we have also offered some longer-term modifications particularly for our hotel/motel and retail borrowers. In exchange for the longer-term durations, we have been collecting additional collateral or guarantees whenever possible that we believe will effectively work to reduce our loss potential. So moving on to slide seven. I would like to provide an update on the two segments of our portfolio that are viewed to be the most impacted by the pandemic crisis beginning with our hotel/motel portfolio. At September 30, we had $474 million of loan modifications in our hotel/motel portfolio, down from $1 billion at June 30. All but a handful of these modifications represent borrowers that have been granted a second modification. As part of our heightened portfolio monitoring, we are getting current financial data and occupancy trends from our borrowers on a much more frequent basis. In general, we have seen improving trends over the past few months as the majority of our borrowers operate limited-service properties which have benefited from more travelers opting for drive-to hotels versus the destination type of properties that involve air travel. As a result, many more of these properties have started operating at closer to a breakeven level. The occupancy and revenue for available room or RevPAR trends that we are seeing with our borrowers are also generally consistent with the industry-wide trends reported for the type of limited-service hotels and motels in our markets. In our discussions regarding any extension of loan modifications for our COVID-impacted hotel/motel customers, our goal is to put these borrowers on the best possible path back to regular payment schedules with the unique circumstances of each customer determining the solution that we put in place. And you can see in the upper right pie chart of slide seven that nine-month, 12-month, and six-month hybrid agreements account for 26%, 14%, and 10% of modifications for this portfolio respectively. The primary goal of this approach is to provide time for our borrowers to stabilize their operations and build the liquidity they need to go back to a full payment status after the modification period ends. Although we continue to track recent positive trends within our hotel portfolio, we are cognizant that the pandemic will weigh on the speed of the recovery for this industry. As such, during the third quarter, we increased our allowance on the hotel/motel portfolio in excess of 140% quarter-over-quarter which brought our coverage to 3.01% of total hotel/motel loans from 1.23% at June 30, 2020. We have also provided on this slide the geographic distribution of our hotel/motel properties 70% of which is located in California followed by 10% in the Pacific Northwest. Moving on to slide eight. Looking at our retail CRE portfolio at September 30 we had $236 million of loan modifications in our retail CRE portfolio which is down significantly from $809 million at June 30. This equates to just 10% of our retail CRE portfolio currently under modification underscoring the improving conditions for this segment of our portfolio. As we have mentioned many times before, the majority of our retail CRE portfolio is represented by strip mall types of properties many of the larger properties of which are anchored by grocery markets. Given the service-oriented nature of most of the tenants of these retail properties, our borrowers are receiving at least partial rent payments, so we are pleased to see greater stability for these borrowers. As discussed earlier, we have taken as many opportunities as possible to shore up the bank's position with additional collateral or guarantees, particularly when offering longer-term modifications that we believe will increase the likelihood of these borrowers returning to normalized payments. In terms of geographic distribution of our modified retail CRE properties, 63% is located in California and 28% in New York and New Jersey. Now I will ask Alex to provide additional details on our financial performance for the third quarter.

Thank you, Kevin. Beginning with slide nine, I will start with our net interest income which totaled $117.6 million, an increase of 7% from $109.8 million in the preceding second quarter. The growth in net interest income was due to a significant reduction in interest expense as a result of lower deposit costs as well as the redeployment of excess liquidity. During the third quarter, we recognized $2.6 million in net PPP fees we have earned and have a net $8.8 million remaining to be recognized in the future. As we indicated on our last earnings call, we expected to see some expansion in our net interest margin in the second half of the year and this has proven to be the case in the third quarter. Our net interest margin increased 12 basis points to 2.91% and the improvement was largely driven by a 23 basis point decrease in our average cost of fund, which benefited from a higher average balance of non-interest-bearing demand deposits and lower rates on deposits as our higher CD costs continued to mature and renew at much lower rates. Overall, the reduction in our cost of deposit had a 15 basis point positive impact to our net interest margin in the third quarter. Our net interest margin was also positively impacted by the actions we took in deploying our excess liquidity during the quarter. Our cash and cash equivalents decreased by $840 million from the end of the prior quarter. We used this fund in a variety of ways including prepaying $300 million in FHLB advances, which will have a positive impact on net interest margin, reducing our broker deposits, funding our loan growth in the quarter, and adding to our investment security portfolio. Looking ahead, we believe the same factors that drove our net interest margin expansion in the third quarter will continue to drive additional expansion going forward. Earning asset yields are stabilizing. We continue to see lower deposit costs as time deposits mature and are replaced with lower-costing transaction deposits. And commencing in the fourth quarter, we will get the full quarter's benefit of the actions we took to redeploy our excess liquidity. Accordingly, we continue to believe that our net interest margin will exceed 3% in the fourth quarter. Now moving on to slide 10. Our non-interest income was $17.5 million for the 2020 third quarter, an increase of 56% from the preceding second quarter. This increase was primarily due to gains on sale of investment securities of $7.5 million. Excluding these gains, non-interest income declined by approximately $1.25 million. Consistent with the general increase in business activity and the transactions we saw during the quarter, we had increases in service fees on deposit accounts, international service fees, and wire transfers, and an increased volume of residential mortgage production resulted in a higher net gain on loan sales. These increases were offset by a decline in other income, due to variances in fair value changes in derivatives and lower swap fee income. Moving on to non-interest expenses on slide 11. Our non-interest expense was $73.4 million, an increase of 9% from the preceding second quarter. In terms of significant variances, we incurred a $3.6 million penalty related to the prepayment of FHLB advances, which we view as non-core to our operations. Excluding this prepayment penalty, non-interest expense was $69.8 million, which is in line with our target range on a quarterly basis. The notable quarter-over-quarter variance, include our salaries and employee benefit expenses, which increased by $1.4 million. This was primarily due to a more normalized amount of deferred loan origination costs in the third quarter, related to the preceding second quarter when origination costs were elevated due to the PPP program. This variance offset the savings to be recognized in the quarter from the staffing adjustment we made early in the third quarter. Now, moving on to slide 12. I will discuss some of our key deposit trends. We continue to run off higher-cost time deposits and replace them with non-interest-bearing deposits through our business development efforts. Our non-interest-bearing deposits increased by $452 million during the quarter and accounted for 32% of total deposits at quarter end versus 28% at June 30, 2020. In the fourth quarter, we have $1.6 billion of CDs maturing at an average blended rate of 1.15%, so we are looking forward to having another quarter of meaningful reductions in our cost of deposits. Now moving on to slide 13. I will review our asset quality. Despite the ongoing impact of the COVID-19 pandemic, we saw generally positive trend in the portfolio. Non-accrual loans and restructured TDR both declined during the quarter, with the overall non-performing loans decreasing 16% quarter-over-quarter. The decrease was primarily due to payoffs, including one long-standing commercial loan, which contributed to the recoveries this quarter. The one area where we saw some negative migration was in criticized and classified loans, which increased by $45 million quarter-over-quarter. This was driven by downgrades of three shared national credits, which aggregated to $69 million. These three companies are all strong national brands, with ample liquidity to weather any cash flow shortfalls. We have good access to capital markets for additional funding and/or have very strong parent companies that can provide additional capital, if needed. Taking these factors into consideration, we believe the likelihood of any loss being incurred on these loans is very low. However, due to the direct impact these companies are experiencing as a result of the pandemic, we believe the downgrade to special mention is prudent at this time. Excluding the impact of the downgrade for these three shared national credits, we would have seen a reduction in our criticized and classified loan balances. In terms of credit losses, we had another quarter of relatively low level of losses with net charge-offs representing 12 basis points of average loans in the quarter. The primary contributor to charge-offs this quarter was one long-standing problem hotel construction loan. Now moving on to slide 14. We recorded a provision for credit losses of $22 million in the quarter. A key driver of the provision expense this quarter was our modification extension activity and the recognition of increased risk as we grant longer-term modifications. As such, we have allocated more reserves to those areas of the portfolio that we believe will require longer recovery period, primarily in the hotel and motel sector. Our allowance for credit losses increased to $179.8 million as of September 30, 2020 and from $161.8 million at the end of the second quarter. Moving on to slide 15. As a percentage of total loans, our allowance for credit losses increased to 1.37% at September 30 from 1.26% at June 30. When purchase accounting discounts are included, our coverage ratio increased to 1.58% of total loans or 1.63% of total loans if you also exclude PPP loans. Now moving on to slide 16. Let me provide an update on our liquidity and capital position. Our overall liquidity position remains very strong as of September 30, 2020. Our primary source of funds continues to be customer deposits and we recognized a significant increase in non-interest-bearing demand deposits over the past two quarters. We continue to maintain a robust capital position with our total risk-based capital ratio, Tier 1 common equity ratio, and Tier 1 capital ratios all generally stable quarter-over-quarter. We also continue to increase the shareholders' equity with our book value per share and tangible common equity per share increasing quarter-over-quarter. As of September 30, 2020, we continue to maintain a meaningful amount of excess capital above the amount required to be classified or considered well capitalized. And given our strong capital and liquidity positions, we maintained our quarterly dividend at $0.14 per share. With that let me turn the call back to Kevin.

Thank you, Alex. Let's move on to slide 17. We are very pleased that our third quarter unfolded much as we expected. We saw an improvement in traditional commercial loan demand, increased production in our residential mortgage origination group, lower deposit costs, and an expansion in our net interest margin. We expect these positive trends to continue in the fourth quarter and adding to these positive trends will be lower operating expense without the FHLB prepayment penalty that impacted expense levels in the third quarter as well as the impact of other expense management initiatives that we are working on. We recently finalized and our Board of Directors has approved a branch rationalization plan that will further enhance our operational efficiencies. The plan which is subject to regulatory non-objection and expected to be implemented by the middle of the first quarter of 2021 will impact up to six branches in California, Illinois, Washington, and Texas. We expect to incur a onetime pre-tax charge of approximately $3.1 million in the fourth quarter of 2020 related to the plan. Projected savings are expected to be approximately $2.6 million pretax on an annual basis the initial benefits of which will be recognized beginning in the first quarter of 2021. This branch rationalization plan follows a comprehensive review of our market presence, branch profitability, and opportunities for more efficient customer engagement channels. While the fourth quarter tends to be a seasonally slower period relative to the third quarter, we entered the quarter with a solid pipeline and expect to close out the year on a high note. So, overall, we are optimistic about our ability to deliver another good quarter of core operational profitability to end a most challenging year. From a business development perspective, we continue to be in a good position to add more commercial relationships that will further improve our deposit base. With the investments we have made to enhance our treasury management platform and increase our sales efforts in this area, we are seeing a fundamental shift in the type of customers that we are attracting to the bank. Our progress on this initiative is creating a lower-cost deposit base that will be even more valuable to us when interest rates eventually rise in the future as we believe we will have a much lower deposit beta in a rising interest rate cycle. With a sustainable lower-cost deposit base, we believe we will be able to generate a net interest margin that is higher than what we have typically achieved in the past and this should have a positive impact on our overall level of profitability and the returns that we generate. 2020 will be remembered for a lot of things and most of them very negative. But when we look back on it from the perspective of the evolution of Hope Bancorp, we believe it will represent an important inflection point in our efforts to enhance the overall value of our franchise. Now, we would be happy to take any questions and add additional color as requested. Operator, please open up the call.

We'll now begin the question-and-answer session. First question comes from Matthew Clark of Piper Sandler. Please go ahead.

Hey good morning everyone.

Good morning.

Good morning.

Do you happen to have the average balance of PPP loans in the quarter just so we can try to isolate the core NIM?

Sure. No, there's not much movement for the entire SBA loan PPP. We had a beginning total originated $480 million, but each quarter pretty much remained the same at $473 million. So, the average I would say $473 million.

Great. And then on the margin guidance, I think last quarter you talked about getting over 3% on a core basis excluding the PPP and purchase accounting accretion. Is that still the case that you expect the core NIM to be over 3% in the fourth quarter as well?

Yes. We would expect to increase in excess of 3%. And as you know, we have been very disciplined in deposit pricing and also access to liquidity deployment strategies including the FHLB prepayment. So, we think that will position us to increase our net interest margin on a core basis in excess of 3% by next quarter.

Okay. And then what was the weighted average rate on new loan production this quarter?

New loan originations, we have a total of 2.88%. I know it's a little bit decrease from the last quarter, but we had a large production on warehouse loans which was a little bit lower. But to answer to your question, 2.88% is our average rate for the new production.

Okay. And then just on the deferrals, I think you mentioned that most of your round one deferrals were 90 days. So, I would think that the round two deferrals are your total deferrals. Those don't exclude any that are still in round one do they?

What we are currently monitoring is the active modifications, which include some remnants from round one. While most of those have since expired, there are still a few that have a longer duration. Regarding Phase 2, the $1.1 billion we reported as of September 30 reflects the modifications we have booked under this phase. Additionally, we are separately tracking the active modifications, which involve many changes. There are numerous modifications from the second round that are set to expire in the fourth quarter as we continue to implement new modifications.

Okay. So, there's another item that you're still working on at round one. Do you know the amount or does that bring you closer to the August figure, or is it significantly less than that?

So, in terms of trying to track the actual percentage, I think we did about 8% or so by the September end. I think there's going to be additional modifications that we are also considering as we move forward. But I guess the point I was trying to make was that even as those modifications continue to book, we're going to see some outflow of modifications as well. And so, that's what we'll be tracking as we move forward. Does that help clarify?

Yes, that does. And then, just on the shared national credits, can you quantify how large that portfolio is and what are the underlying businesses that migrated this quarter?

Sure. We have approximately $700 million in shared national credits, a significant portion of which consists of larger syndicated credits that are often broadly syndicated. This portfolio includes a variety of industries, and the three downgrades we experienced this quarter span different sectors. Specifically, these downgrades are related to the food industry, some healthcare services, and a few entertainment industries, indicating a well-diversified portfolio. All three downgraded names are at special mention and criticized levels, yet they exhibit strong liquidity and good access to capital markets. None of these loans have been modified, so all shared national credit loans remain unchanged. We see considerable strength and stability in this area, but we recognize the challenges faced over the past period, which have affected some companies. However, many of these companies are currently experiencing upward trends as the economy recovers.

Okay. And then last one for me. Just on the other fee income with the negative mark this quarter relative to last and the lower swap fees, I guess how do you think about a good run rate there going forward?

Sure. Those two components, the fair value changes and a swap fee income reduction, we expect that will be actually increasing in Q4 a little bit. First, the fair value is more interest rate lock commitment on the mortgage loans that we will resell. And in Q3, we had a lower volume for those loans that are subject to the derivative accounting. Because of that, we did have a reduction on our fair value. Actually, it turned to be net loss position in Q3. But as we actually have more production on those mortgage loans, I would expect to have the value, will be increasing to positive. So, specifically, last quarter, the fair value was $925,000 loss, but I would expect that will turn to a positive in Q4. And the swap fee income that fluctuates kind of quarter-over-quarter. So, I don't have a real accurate expectation. But I think overall, those two combined, we will see some improvement in Q4.

Okay. Thank you.

Thank you. Next question comes from David Feaster of Raymond James. Please go ahead.

Hey, good morning everybody.

Good morning.

Good morning.

I wanted to start by discussing the modifications and follow up on some of the questions. I know you set aside a significant amount for the longer duration modifications, but were there any risk rating downgrades or changes in risk?

All the modifications have been downgraded to a new COVID-19 watch grade. This change allows for better management and indemnification of these loans. As we move forward, we will continue to evaluate that portfolio for any additional risk rating changes. As these loans transition off of deferrals, we hope that a significant number will be upgraded. However, we acknowledge that there is also the possibility of further downgrades if there is additional deterioration in the portfolio of modified loans.

Okay. And just listening to your prior comments it sounded like you are still getting some requests for new deferrals. Is that coming from the SBA portfolio? And I guess how big is your SBA portfolio, and how are conversations going with those borrowers now that the agency is no longer paying P&I?

Yes, yes. The government payment relief just ended in September, so we are now actively in discussion with our SBA borrowers. So it's a little bit early on the SBA side but we are starting to have those conversations with our borrowers. I think our unguaranteed portion of SBA that we carry is roughly about $300 million there. And so we'll have to dive into that. Everyone is hoping for additional government stimulus. And so that's something that lenders and borrowers are hoping will come to fruition. But if that doesn't happen, we're right now preparing the portfolio for additional modifications there. So that process has just started.

Okay. I'm curious about your thoughts on loan production. You have done a tremendous job gaining a couple of significant new warehouse clients. What are your thoughts on the origination front? What is your appetite for new credit? How are payoffs and pay downs trending? Where are you seeing new loan opportunities?

Well, the growth in our loan balances is largely driven by the growth in our commercial loan portfolio under our corporate banking group. And within the corporate banking group, middle market lending and mortgage warehouse lending have led the loan growth in the recent quarters. And in terms of the credit appetite, Peter will be in a better position to talk about that. But looking at the reserve buildup and the actual loss experience, I think these credits have a lot better security than our legacy loans that we used to have as a smaller bank. So in terms of credit appetite, I think we have budgeted continued growth in these sectors and we will continue to have loan growth in the middle market customer base as well as mortgage warehouse customers.

Yes, definitely. From a credit perspective, we are focused on identifying industries that are stable or performing well in the current environment. We see opportunities in the warehouse sector, particularly with larger mortgage warehouse or mortgage companies where our platform enables us to act swiftly. In the middle market, we also recognize industries like telecom and certain financial institutions where there are promising opportunities. We will be concentrating on these sectors as we progress through the recovery period, and we plan to expand our focus as market stability increases.

Okay. Just one quick follow-on. How big is the warehouse? And where are you comfortable with that portfolio growing to?

We don't have kind of a target right now. I think we're just taking it kind of quarter-by-quarter in a sense. I do think with the level of credit loss that is anticipated here, which is very low. I would say this is probably one of our lowest expected loss segments of the portfolio. I think there will be more room to grow here. So, we are currently assessing that and we'll continuously do that as we move forward.

Yes. Just to add for the warehouse business. As Peter mentioned, in terms of credit, it's very low risk. But also we are expanding our deposit relationship from them. A big increase on non-interest-bearing demand deposit, I think is coming from them as well. So there is a greater potential to expand our deposit relationship from them as well going forward.

Okay. That's helpful. And how big is the warehouse right now?

The warehouse balance at the end of the third quarter is a little more than $800 million.

Okay. All right. Thank you.

Thank you. Our next question comes from Chris McGratty of KBW. Please go ahead.

Good afternoon everyone. Alex wanted to revisit a previous question about margin and frame it differently regarding net interest income. How are you considering net interest income dollars in this environment if we exclude the PPP impact, particularly in light of the deposit flows and liquidity deployment?

Sure. Let me touch on the PPP loan first. We don't expect that PPP would have any significant impact on our margin. We actually calculate it, but it's only one basis point changes in Q3, so, very small or almost non-impact in terms of margin. I think our overall rate in the loan yield is higher than our PPP yield including those amortization, but not much of differences. So that's why, margin impact is very minimum, again from these PPP loans. Having said that, our net interest income composition, we would expect to increase. It might not be huge percentage of increase. But again big savings from the deposit costs. And also, as you know, we paid off $300 million of FHLB borrowings. We will pay $3.6 million of prepayment penalty this quarter Q4. We would expect about $1.6 million of savings from there. So, there will be some benefit in terms of interest expense savings from this FHLB borrowing payoff. So, I think it will increase a little bit going forward in terms of net interest income.

Got it. That's good color. Thank you. If I could ask a question about credit, I appreciate the additional disclosures. Looking at the slide that shows the reserve by portfolios and I had a question about the reserve on the retail book. Directionally, it went down in the quarter. Is that the resolution of the credit you talked about? And again, maybe, any comment on debt service coverage ratios updated for the hotel portfolio? Thanks.

On the retail sector, it appears to be showing significantly more signs of stability compared to the hotel/motel sector, with an evident diversification. While we categorize the retail sector into one overall group, certain parts of the portfolio, like supermarket properties or national regional tenants, are performing very well. Some areas of retail have consistently thrived during the pandemic and continue to demonstrate strength. Consequently, we are witnessing a decrease in reserves from that sector. Additionally, tenants who were impacted by the pandemic are now showing notable signs of recovery. Many tenants are now making payments, with some making partial payments and many making full payments. This indicates increasing stability in that space. We are also noticing a reduction in the level of modifications in retail compared to the hotel portfolio, which has a higher rate of modifications as expected. This reduction in modifications in retail corresponds to a smaller reserve, which is only a $6 million difference in absolute dollar amounts, indicating it is relatively insignificant. Regarding debt coverage ratios and loan-to-value ratios, the retail sector shows a solid coverage ratio of 1.75 and a loan-to-value ratio of 50.2%. In comparison, the hotel sector has a coverage ratio of 2.07 and a loan-to-value ratio of 52%. This suggests we have adequate buffers as we navigate through the pandemic situation.

If I could ask one more question. It seems that the likelihood of tax rates increasing is rising. Is there anything significant in the way you are currently managing taxes that would indicate that any proportional increase in our returns wouldn't be similar, but rather the opposite direction from what we experienced in 2017?

Sure. After the election, the general expectation is that the corporate tax rate will increase, and our management is working with our outside tax advisers to determine what tax strategies we can implement to ensure we maintain the appropriate effective tax rate. I don't have a specific plan at the moment, but we are preparing for the anticipated rate increases.

Okay. Thank you very much.

Thank you. Next question is from Gary Tenner of D.A. Davidson. Please go ahead.

Thanks. Good morning. Just wanted to clarify a couple of questions. So first on mortgage warehouse, you gave us I think the period end number. Can you give us the average for the quarter and what the average yield was for that segment for the quarter?

Mortgage warehouse. I think that you're asking the rate and the dollar amount? I think...

The average dollar amount for the quarter and the average yield.

Looking forward to corporate banking.

Mortgage warehouse the average balance during the third quarter was $828 million.

And do you have the yield available for the quarter?

I'm sorry. The outstanding balances amount to $828 million, and the average is approximately $473 million due to fluctuations during the quarter. The rate is slightly below 2%, around 1.95%.

Okay. So as you talk about your margin direction for the fourth quarter, obviously the average of the quarter, mortgage warehouse is well above the period end number but does that assume a decline in average outstanding balances just from a kind of seasonal slowdown in terms of the volume?

Yes. I don't expect many changes in average balances for the warehouse. However, we anticipate increased recognition of the higher SBA and more production. Therefore, I don't foresee any significant reduction in the warehouse line and its usage.

Okay. Thanks. And then just to, also clarify something I'm maybe not, understanding this correctly. The data you gave on the Phase II modification is the $1.15 billion of Phase II. I think somebody else had asked the question, but I don't think you actually provided the kind of total modifications still in place, Phase I and Phase II combined as of September 30?

Are you inquiring about active modifications? Active modifications are not significantly different from the $1.1 billion, so we can add that most of wave one has expired. There are some remnants, but we are around $1.15 billion. Most of that, in fact, the majority, is coming from wave two.

Okay. All right. Thanks for the clarification.

Our next question comes from Steve Marascia of Cap Sec Management. Please go ahead.

Hey! Good morning folks. Just two quick questions for you, number one, do you still feel comfortable with the current level of your dividend distribution rate? And I don't know if I missed this during your presentation but, you had loan growth of about 2% during the just concluded quarter. Is it safe for us to expect the same type of loan growth rate during the fourth quarter?

Well, let me respond to that. First, as to the loan growth, the current market condition is very competitive and challenging but our targeted goal is still high-single digit or low-double digit for the year of 2020. In terms of dividend, we are intent on keeping our quarterly dividend at current level. And we believe our reported earnings have been sufficient so far to maintain the level. With that said, we will remain prudent and make that decision on a quarterly basis, taking into account all of the relevant factors.

Okay. Thank you very much.

This concludes our question-and-answer session. Now I'd like to turn the conference back over to management for any closing remarks.

Thank you. Once again, thank you all for joining us today. And we hope everyone stays safe and healthy. And we look forward to speaking with you again next quarter. So, long everyone.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.