Earnings Call Transcript - MBWM Q3 2020

Operator, Operator

Good morning and welcome to the Mercantile Bank Corporation Third Quarter 2020 Earnings Results Call and Webcast. 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. I would now like to turn the conference over to Tyler Deur from Mercantile’s Investor Relations firm. Please go ahead.

Tyler Deur, Investor Relations

Thanks, Hailey. Good morning everyone and thank you for joining Mercantile Bank Corporation’s conference call and webcast to discuss the Company's financial results for the third quarter 2020. I'm Tyler Deur, with Lambert IR, Mercantile’s Investor Relations firm. And joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, President of Mercantile Bank, Michigan. We'll begin the call with management's prepared remarks and presentation to review the quarter's results, then open up the call to questions. However, before we begin today's call it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the Company's business. The Company's actual results could differ materially from any forward-looking statements made today, due to the factors described in the Company's latest Securities and Exchange Commission filings. The Company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the third quarter 2020 press release and presentation deck issued by Mercantile today, you can access it at the Company's website www.mercbank.com. At this time, I'd like to turn the call over to Mercantile’s President and Chief Executive Officer, Bob Kaminski. Bob?

Robert B. Kaminski Jr., CEO

Thank you, Tyler, and good morning, everyone. On the call this morning we will provide you with detailed information on the company's performance in the third quarter amidst a challenging operating environment, as well as an update on continued activity specifically related to the pandemic. First, I again want to recognize the tremendous efforts of our dedicated Mercantile team for their persistent resolve and ongoing ability to navigate the continuous and often unique challenges presented by the pandemic throughout this year. Our paramount focus has been on the health and safety of our employees, which has created the necessity for flexibility and our team has consistently risen to the challenge by working remotely and in new environments. These efforts have helped Mercantile deliver strong results, successfully serving our customers and fulfilling their banking needs in a variety of ways. Mercantile demonstrated continued strength in a number of performance areas for the third quarter, with share earnings of $0.66, which again included a strong provision for loan losses as we continued to build our reserve as a result of pandemic-related issues. This sustained financial strength allowed us to continue our regular cash dividend program with our Board declaring a fourth quarter cash dividend of $0.28 per share. We are pleased to provide this consistent cash return to our shareholders during this time of uncertainty and Chuck will provide further updates on the many moving parts in our financial statements during the quarter. Next, the health and safety of our communities is a top priority, our facilities have been updated to incorporate physical and social distancing modifications including our lobbies, which reopened in late June. Our team and clients remain adaptable to alternative methods of banking activity engagement, as we continue to closely monitor developments and revise our plans accordingly. The full timeline of COVID-related activities can be viewed on Slide 4 of our presentation. Our commercial lending team remains focused on the paycheck protection program as they successfully originated a significant volume of SBA loans for businesses in our markets. Our teams' work on the forgiveness phase of the PPP process continues into the fourth quarter as we assist loan recipient clients with gathering and submitting the required information to allow the rendering of a forgiveness determination by the SBA. The efficient efforts of our lending group with PPP have helped to create new relationship opportunities with businesses that faced challenges in the application process with the incumbent banks. Having missed the initial stimulus program needs of these clients in the application process, we are now in a position to grow those relationships through discussions about their full banking needs. Our team's diligence and dedication to our communities is illustrated by our timely and responsive assistance to these businesses as they endeavor to take the needed steps for economic recovery and growth. We also remain focused on meeting the traditional credit needs of our existing clients while strengthening our pipeline and identifying new customer relationships. Raymond will provide you with an update on overall portfolio performance and the status of customers receiving assistance through our payment deferral programs, which have largely reverted back to full contractual loan payments. As such, asset quality remains strong and our focus on sound credit underwriting has led to low levels of past-due loans and non-performing assets. With the World Series starting tonight, I want to borrow a baseball term to describe for you that our retail mortgage team knocked the cover off the ball in the third quarter as we achieved another record-breaking level of mortgage banking income. The growth of our mortgage lending team in 2020 has allowed their dedicated efforts towards ensuring a strong pipeline, especially during the upcoming months, which reflect normal seasonality. Within a difficult climate, the team has increased market penetration to enhance revenue and achieve strong residential mortgage loan production levels. Our team put forth a tremendous effort to ensure the entire loan origination process from receipt of an application to closing is completed and is structured in a timely manner. Ray and Chuck will have more detail on mortgage production in their comments. Turning to our operations, with the ongoing investment and deployment of technology as alternative delivery channels, which has only been accelerated by the current environment, an evolution in the way banking is done appears to be at hand. Mercantile has been able to reduce its number of locations from 53 to what will be 37 once our recently announced optimization of our branch network is completed later this year. Our current footprint can be viewed on Slide 3. To continue to engage our customers, we can take a holistic approach to their needs and understand how patterns and preferences of interaction with us are evolving, especially in view of the realities brought about by COVID-19. We consistently aim to re-evaluate our interactions across the board, conforming to industry best practices while seeking to break new ground across several important areas. As we look back on the past two quarters that were so heavily impacted by the pandemic, the health and safety of our people has been paramount. This focus on our people has reinforced our commitment to pursuing best practices in environmental, social, and governance, with particular emphasis on the social component as we work to meet the needs of our stakeholders. Our Board of Directors, which includes the recently introduced members with diverse business experience, our management team, and our staff remain committed to fulfilling the ever-changing roles as reliable and dedicated community partners and leaders. In addition, they continue to build our internal diversity, equity, and inclusion programs that facilitate ongoing meetings featuring guest speakers we have brought in virtually to provide forums for our employees. Our goal with these programs is to help our team members process and address the issues that have been brought to light in our country and our communities in 2020 regarding racial justice and diversity, equity, and inclusion. We have had ongoing discussion groups within our organization where staff are able to listen and learn about others and provide an opportunity for introspection. We are fervently committed to maintaining these sound corporate practices built on integrity and trust, and we are working to diligently cultivate and strengthen our critical relationships with our diverse communities, our employees, our customers, and our shareholders. Together, we have built an incredible foundation that positions us well to sustain and build on these efforts for continued success. Those are my introductory remarks, and I will now turn it over to Ray.

Raymond E. Reitsma, President

Thanks, Bob. Our loan portfolio increased $17 million in the third quarter of 2020, which consisted of a $37 million increase in commercial loans and a $20 million decrease in retail and primarily mortgage loans held for sale. The professional manner in which our team administered the origination of over 2,100 PPP loans earlier this year has continued to yield opportunities to grow our base of commercial relationships. Additionally, our construction pipeline remains solid with $99 million of commitments in commercial construction and development loans which we expect to fund over the next 12 to 18 months. Asset quality remained strong as non-performing assets totaled just $4.6 million or 0.11% of total assets at September 30, 2020, despite the items you found in the financial portion of our presentation on Slide 22. Additionally, recurring commercial past due loans at quarter-end are $9 million totaling just $213,000 representing six borrowers. Overall past due information can be found on Slides 11 and 12. During the quarter we took the review of the risk ratings associated with the loan portfolio resulting in a provision for loan losses of $3.2 million, plus the adjustments to the risk ratings of 159 specific credits these and those relationships moved to the watch list. In contrast, in the prior quarter, the provision expense of $7.6 million is generated entirely through qualitative practices. These actions bring the allowance for losses to several loans to 1.27% when excluding the impact of PPP loans. Payment deferrals at the peak of the program in mid-July impacted $738 million in exposure. Presently, as of October 19th, extensions are in place beyond September 30 for clients representing $12 million in exposure as seen in Slide 6. The current modest deferral numbers when combined with our expectations for future requests and a strong payments performance are positive indicators. The risk rating process detects a portfolio of strong characteristics, reflecting strengths similar to that of the pre-crisis economy as seen in Slide 10 maintaining accurate risk ratings will remain a key focus in the upcoming quarters as our borrowers continue to report results impacted by the pandemic. We continue to monitor the financial condition and performance of credits, particularly in the following segments: auto dealerships, hotels and lodging, assisted living, restaurants, and movie theaters. These individual segments account for more than 5.1% of commercial loans, the composition of these segments can be seen on Slide 9. We recorded non-interest income during the third quarter of $13.3 million, up $6.6 million or nearly 100% from the prior year quarter. As can be seen on Slide 15, this improved level of net interest income, largely driven by a 228% increase in mortgage banking income reflecting the success of ongoing strategic initiatives designed to increase market share, a higher level of refinance activity stemming from historically low rates, and increased share in the purchase market and an increased percentage of loans sold. For the third quarter of 2020, purchase mortgage loans originated were up 50% compared to the previous year. While refinance activity increased 103% as seen in Slide 8. October applications and backlog suggest that refinance opportunities will persist in the near future and purchase applications are at seasonally high levels. Continuing to enhance mortgage banking income through increased market share, including increased share in the purchase market remains a priority. We will continue to have higher proven mortgage loan originators as we are able. Non-interest income from payroll services grew 8.7%, despite high levels of unemployment during the quarter relative to the prior year comparable quarter. Severance charges on accounts decreased 4.2%, primarily due to larger balances offsetting charges. Credit and debit card income increased by approximately 5.7% as activity within the accounts began to recover from reduced activity during the pandemic. Year-to-date activity is approximately at last year, despite the pandemic-induced reduction in assets. I conclude my comments, and I will now turn the call over to Chuck.

Charles E. Christmas, CFO

Thank you, Ray. As noted on Slide 13, this morning we announced net income of $10.7 million or $0.66 per diluted share for the third quarter of 2020, compared with net income of $12.6 million, or $0.77 per diluted share for the third quarter of 2019. Net income for the first nine months of 2020 totaled $30.1 million or $1.85 per diluted share, compared to $36.1 million or $2.20 per diluted share for the first nine months of 2019. Proceeds from bank-owned life insurance claims and a gain on the sale of a former branch facility increased net income in the first nine months of 2019 by $3.1 million or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased $0.16 or 8% during the first nine months of 2020 compared to the respective prior year period. The lower levels of net income during the third quarter and first nine months of 2020 compared to the respective 2019 periods resulted from higher provision expense and overhead costs, along with lower net interest income which more than offset increased fee income. Turning to Slide 14, interest income on loans declined in the 2020 period compared to the 2019 period, primarily due to FOMC rate cuts aggregating 225 basis points since the beginning of the third quarter of 2019, with 150 basis points of those cuts occurring in the first quarter of 2020. Interest income on securities during the 2020 period benefited from accelerated discount accretion from called U.S. government agency bonds totaling $0.3 million during the third quarter and $3.0 million during the first nine months of 2020. In total, interest income declined $4.7 million during the third quarter of 2020, compared to the third quarter of 2019 and was down $8.1 million during the first nine months of 2020, compared to the first nine months of 2019. Interest expense declined in all categories during the 2020 periods compared to the 2019 periods reflecting the declining interest rate environment. In total interest expense declined $2.6 million during the third quarter of 2020 compared to the third quarter of 2019 and was down $5.1 million during the first nine months of 2020 compared to the first nine months of 2019. Net interest income declined $2.1 million during the third quarter of 2020 compared to the third quarter of 2019 and was down $3.0 million during the first nine months of 2020 compared to the first nine months of 2019. Provision expense increased significantly in the 2020 periods compared to the 2019 periods, primarily reflecting the coronavirus pandemic and its impact on the economic environment. Provision expense totaled $3.2 million during the third quarter of 2020 and $11.6 million during the first nine months of 2020, compared to $0.7 million and $2.5 million during the respective 2019 periods. The relatively large provision expense recorded during the third quarter of 2020 was primarily associated with a commercial loan risk rating adjustments Ray mentioned earlier. By the large provision expense recorded during the second quarter of 2020, it was primarily comprised of the allocation associated with the newly created COVID-19 pandemic environmental factor and an increased allocation related to the existing economic conditions and environmental factors. The COVID-19 factor was added to address the unique challenges and economic uncertainties resulting from the pandemic and its potential impact on the collectability of the loan portfolio. We elected to postpone the adoption of CECL as permitted by the CARES Act. However, we are running our CECL model concurrently with our incurred loss model. Based on preliminary results, we do not believe the loan loss reserve balance determined by the CECL model is materially different than the loan loss reserve balance as determined by our incurred loss model as of September 30, 2020, similar to the results at the end of the first quarter and second quarter. Continuing on, Slide 15 fee income increased in the 2020 periods compared to the 2019 periods, primarily reflecting significantly higher mortgage banking income. Excluding bank-owned life insurance claims and the gain on the sale of a former branch facility during the first nine months of 2019, fee income during the first nine months of 2020 increased $14.4 million or 88% when compared to the first nine months of 2019. This reflected increased refinance and purchase activity, along with the successful implementation of several strategic initiatives over the past couple of years. Mortgage banking income was substantially higher during the 2020 periods compared to the 2019 periods. Third quarter 2020 mortgage banking income was $6.6 million higher than the third quarter of 2019, and income during the first nine months of 2020 was $14.5 million higher than the first nine months of 2019. Credit and debit card income returned to pre-COVID levels during the third quarter, reflecting a recovery in transaction volume in the second quarter. While not quite returning to pre-COVID levels, service charge on account income during the third quarter was much improved in the second quarter in large part reflecting a higher transaction levels from our business customers. Continuing on Slide 16, overhead costs increased in the 2020 periods compared to the 2019 periods, primarily reflecting higher compensation costs and the expansion of our main office back in 2019. Salary and benefit costs were up $3.1 million or 22% during the third quarter of 2020 when compared to the third quarter of 2019. Mortgage banking-related compensation costs were up $1.3 million while the bonus accrual increased $1.2 million. The bonus accrual recorded during the third quarter equated to three quarters worth of accrual as no bonus accruals were recorded during the first and second quarters due to the economic environment. Salary and benefit costs were up $4.4 million or 11% during the first nine months of 2020 when compared to the first nine months of 2019. Mortgage banking-related compensation costs were up $3.7 million while the bonus accruals were essentially the same. Occupancy, furniture, and equipment costs were up a combined $0.6 million during the third quarter of 2020 compared to the third quarter of 2019 and up a combined $1.5 million during the first nine months of 2020 when compared to the first nine months of 2019, in large part reflecting the fall of 2019 completion of our main office expansion. We expect fourth quarter overhead costs to be similar to that of the third quarter. Included in the fourth quarter will be a $1.5 million writedown on branches that we are scheduled to close this quarter and being offset by a much lower bonus accrual as there's no catch-up involved in the fourth quarter. Continuing on Slide 17, our net interest margin was 2.86% there in the third quarter of 2020, down 31 basis points from the second quarter of 2020 and down 85 basis points when compared to the third quarter of 2019, but it was within the guidance we had provided in the previous call. The yield on earning assets declined 40 basis points during the third quarter of 2020 when compared to the second quarter of 2020 while the cost of funds declined 9 basis points during the same period. In comparing the third quarter of 2020 with the third quarter of 2019 yield on earning assets declined 128 basis points while the cost of funds declined 43 basis points. The yield on loans was down 15 basis points during the third quarter of 2020 compared to the second quarter of 2020 and down 103 basis points when compared to the third quarter of 2019, in large part reflecting the FOMC’s aggregate 225 basis point reduction in targeted federal funds rate mentioned earlier. We are recording the origination fees and direct origination costs of PPP loans equating to a $15 million net increase to interest income and commercial loans using the level yield method. Third quarter 2020 net accretion totaled $3.0 million. Assuming no forgiveness transactions, we expect to record net accretion of $2.5 million during the fourth quarter of 2020 and $2.1 million, $1.6 million, $1.2 million, and $0.8 million during the first, second, third, and fourth quarters of 2021 respectively, with the remainder during the first half of 2021. The yield on securities during the third quarter of 2020 and the first nine months of 2020 benefited from accelerated discount accretion on called U.S. government agency bonds. Accelerated discount accretion totaled $0.3 million during the third quarter of 2020, positively impacting the quarter's net interest margin by 3 basis points. Accelerated discount accretion totaled $3.0 million during the first nine months of 2020, positively impacting the period's net interest margin by 11 basis points. Negatively impacting our net interest margin during a 2020 period, especially the second and third quarters of 2020, was a significant volume of excess on-balance sheet liquidity depicted by low-yielding deposits with the Federal Reserve Bank of Chicago and a correspondent bank. The excess funds are primarily a product of federal government stimulus programs, as well as lower business and consumer investing and spending. Overnight deposits averaged $450 million during the third quarter of 2020 and $280 million during the first nine months of 2020 compared to our typical average balance of $50 million to $75 million. We expect a level of overnight deposits to stay at elevated levels for the remainder of 2020 and well into 2021. This excess liquidity lowered our net interest margin during the third quarter of 2020 by about 30 basis points. The cost of funds has also been on a declining trend, primarily reflecting the falling of the interest rate environment but in terms of magnitude and scale, not to the degree of experience and our yield on loans. We currently expect our fourth quarter net interest margin to be in a range of 2.75% to 2.80%, again that assumes no forgiveness of PPP loans. As noted on Slide 18, 19, and 20, our mortgage banking income has experienced increases. Mortgage loan originations increased substantially during 2020 periods and especially during the second and third quarters of 2020, in large part reflecting significant refinance activities stemming from the decreased interest rate environment coupled with the ongoing success of the strategic initiatives designed to expand market penetration, enhance gain in activities, and operate more efficiently. Mortgage loan originations totaled $237 million during the third quarter of 2020, compared to $133 million during the third quarter of 2019, an increase of almost 80%. Mortgage loan originations totaled $646 million during the first nine months of 2020 compared to $258 million during the first nine months of 2019, an increase of about 150%. About 61% of the mortgage volume during the third quarter of 2020 consisted of refinance applications compared to about 53% during the third quarter of 2019. Approximately 81% of the mortgage loan originations during the third quarter of 2020 have been or will be sold on the secondary market, up slightly from the 79% during the third quarter of last year. Continuing on Slides 21 and 22, a standard quality metrics of the loan portfolio remain very strong, with continued low levels of non-performing loans and loan charges. Non-performing loans as a percent of average loans equaled only 12 basis points at September 30, 2020. The balance of other real estate loans was about $500,000 at quarter end. Gross loan charge-offs totaled only $125,000 during the third quarter of 2020 while recoveries of prior period loan charge-offs totaled $250,000. The resulting net loan recoveries of $125,000 equated to two basis points of average total loans annualized. Additions to non-performing assets totaled $1.6 million during the third quarter of 2020, with a net increase of $1.2 million recorded in non-performing assets during the quarter. Over the past 12 months, the balance of our loan loss reserve has increased by over $11 million or about 45% while the coverage ratio excluding PPP loans grew from 88 basis points to 1.27%. Capital, as shown on Slide 23, we remain in a strong and well-capitalized regulatory capital position. The tier one leverage capital ratio was 9.8% and the total risk-based capital ratio was 13.8% at quarter-end. The total risk-based capital ratio was over $126 million above the minimum threshold to be categorized as well-capitalized. There was no share repurchase activity during the third quarter of 2020 as in late March we elected to temporarily cease share repurchase activity to preserve capital for lending and other purposes due to the uncertainty surrounding the COVID-19 pandemic. We currently have about $10 million available in our repurchase plan. On Slide 24, to conclude my remarks are some comments on 2021. Due to the high degree of uncertainty that currently exists, we will not be providing earnings performance guidance as we have done on past conference calls. However, we are able to offer key considerations that should be factored into any earnings forecast of our company. Clearly, economic conditions, asset quality, PPP forgiveness activity, and mortgage banking operations are expected to have the most impact on our operating results for the remainder of this year and into 2021. In closing, while uncertainties remain that may impact Mercantile’s financial condition and operating performance in future periods, we note that we entered this stress environment with strong asset quality and a solid capital position. We are pleased with our third quarter operating results and financial condition as of September 30, 2020, and believe we are well positioned to navigate through the unprecedented environment created by the coronavirus pandemic and other events. Those are my prepared remarks. I'll now turn the call back over to Bob.

Robert B. Kaminski Jr., CEO

Thank you, Chuck. That now concludes management's prepared comments and we will open the call to the Q&A.

Operator, Operator

Our first question today comes from Brendan Nosal with Piper Sandler.

Brendan Nosal, Analyst

Hey, good morning everybody. How are you?

Robert B. Kaminski Jr., CEO

Good Brendan, how are you?

Brendan Nosal, Analyst

Three things, just want to start off on the margin here and thanks for all the puts and takes you guys offered in your prepared remarks. Just thinking back to the last quarter's call, I believe that you said the expectation for the margin with a normal level of liquidity and PPP forgiveness was about 310 to 315. Just curious if this is a decent expectation once liquidity does eventually roll off to a more typical level or is there more pressure from that figure from what you've got previously?

Charles E. Christmas, CFO

I believe there may have been some miscommunication because the figures you just referenced did not account for the excess liquidity. That was the distinction between our reported numbers and that calculation. During the third quarter, we observed that our balance sheet remained relatively stable compared to the end of the second quarter. This stability included our excess liquidity position. We concluded the second quarter with around $450 million deposited with the Fed, and that level was consistent throughout the quarter and continues to be the case now. Thus, we have seen significant stabilization, which is positive, but we also have an abundance of excess liquidity that we do not necessarily need. We would prefer our borrowers and depositors begin utilizing those funds to help support economic recovery. So far in the fourth quarter, we have not detected any changes in our balance sheet structure. Regarding our margin for the fourth quarter, compared to the third quarter, we anticipate some decline for a few reasons. Primarily, we expect a reduction in the fees from PPP loans that we will record, as we are using a yield method that decreases over time. Additionally, we do not forecast prepayment fees, which can vary each quarter and are hard to predict. Lastly, our strategy to manage interest rate risk through purchasing heavily discounted bonds during periods of rising rates saw most of those bonds get called, leading us to expect limited activity in future quarters, including the fourth quarter. These factors will likely result in our margin decreasing from the mid 280s to potentially the mid 270s.

Brendan Nosal, Analyst

Got it, that's perfect and totally understood that the first thing I quoted excludes any impact on excess liquidity. Perfect. Just one more for me, hoping you can offer a little bit more color on the credit downgrades that drove the provisioning this quarter, just kind of any top-level thoughts on industry concentrations or characteristics, etcetera? And then as you look ahead, are there any more credits that are on your short list for further downgrades or did this quarter's action pretty much true up the risk ratings to what the environment is today?

Raymond E. Reitsma, President

So this is Ray, your last question, definitely as we made these downgrades, we feel like we completed the job. We try to even look ahead and say, are there any in the fourth quarter that could potentially give us issues and we downgraded those as well. So we feel like based on all the information that we have today, we completed that job and also worked hard at all the credits that had requested and experienced deferrals in their payments and went through those very carefully. About 45% of those showed no change in risk rating. We downgraded about 40% of those one notch in the balance, which is a relatively small number of another 14% another notch. So, we feel like all the information that's available to evaluate our credits are taken into account and we've downgraded everyone that we see having some small issues now or anticipate having issues in the next quarter.

Robert B. Kaminski Jr., CEO

Yeah, this is Bob. Just to amplify that, we had a definite plan as we went through the summer months. Our intention when the pandemic first started and the severe economic shutdowns were occurring, that we weren't just going to have a knee-jerk reaction and downgrade the portfolio without some empirical data from our clients and financial statements and do it in a very systematic way. That occurred during the summer, into the fall, and as Ray indicated, concluded with the end of the third quarter. And we feel really good about where we stand working with our clients, knowing exactly where they are in terms of their economic recovery, and any challenges that remain ahead for them. But to underscore, we feel really good about the status of the portfolio and the reserve and the associated grades with those particular credits.

Brendan Nosal, Analyst

Alright, fantastic. Thank you for taking the questions.

Robert B. Kaminski Jr., CEO

Thank you.

Operator, Operator

Our next question today comes from Damon DelMonte with KBW.

Damon DelMonte, Analyst

Hey, good morning guys, how's it going today?

Robert B. Kaminski Jr., CEO

Good day, Damon, how are you?

Damon DelMonte, Analyst

Good, thanks. First question, I wanted to clarify, Chuck, regarding your comments on expenses. You mentioned that you expected the fourth quarter to be similar to the third quarter. You also noted that there would be about $1.5 million in write-downs for the branch closures happening in the fourth quarter. Is that $1.5 million included in your outlook for a flat quarter-over-quarter basis, or is it excluded?

Robert B. Kaminski Jr., CEO

So that includes it, Damon, so on an overall basis we expect the cost to be flat. Included in that is the $1.5 million in write downs that we'll be reporting throughout the quarter as the branches close. But as I also mentioned, with the bonus accrual we did not accrue anything in the first and second quarter because of obviously the pandemic. As we work our way through the year and we see our performance and as we talk with our compensation committee, we are in the process of formally formulating bonus plans and based on those discussions in our calculations, we needed to not only accrue for the third quarter, but we needed to catch up for the first and second quarter. So on an overall basis those two items, so a lower bonus calculation in the fourth quarter compared to the third kind of offsets the $1.5 million expected in write downs on the branches.

Damon DelMonte, Analyst

Got it. So, is it reasonable to say that something around 20 to a little bit over 25 million is expected?

Robert B. Kaminski Jr., CEO

So it would be the same as the third quarter, Damon.

Damon DelMonte, Analyst

Okay, I just was saying that they offset perfectly. Okay and then I guess with respect to the PPP forgiveness process, what are your thoughts and what are you guys hearing on the timing of this? Do you think we are kind of well into the fourth quarter here, do you think we're going to see much forgiveness in the fourth quarter or do you think everything is going to kind of be put on hold until we get into 2021?

Raymond E. Reitsma, President

This is Ray, it is very hard to predict how that process is going to go. We stand ready to act on whatever guidance and actionable items we get from the SBA. And those have been somewhat sparse to date. How those will roll out for the remainder of the quarter is very hard to predict. But the bottom line is we'll be ready as soon as practical, as soon as that information is available to us. We have the mechanisms in place electronically to deal with that information. We also have people in place to deal with the information. So we are ready and waiting.

Robert B. Kaminski Jr., CEO

We've actually started the submission process working with our clients, providing them with the tools, as Ray said, to be able to make those submissions for their forgiveness. Some customers are still working through that process with their financial advisers on the accounting side and their legal side to make sure that documentation is in order. But through our electronic portal, we've now started the submissions to the government and have not received any responses yet, but we understand that they've got a lot that they're trying to work through on their end from the SBA standpoint. So, as Ray said already, we're very transparent with our clients and available to assist the process towards its conclusion for each client.

Charles E. Christmas, CFO

This is Chuck, and I would like to add my thoughts. The entire banking industry has been eagerly awaiting a faster process with the trade groups to lower the threshold for forgiveness from $150,000 to a lower amount. It looks like the new threshold will be $50,000. Although the SBA has issued some guidelines, their portals for accepting those specific applications are not yet open. Loans under $50,000 account for about 45% of the total, which is around 2,100 loans we originated under the PPP.

Damon DelMonte, Analyst

Well, okay. Great. And then so make sure I'm reading this correctly, your loan deferrals are now down to like 43 basis points alone, only $12 million, correct?

Charles E. Christmas, CFO

Correct.

Damon DelMonte, Analyst

Okay, so how do we think about provision going forward? You know, it sounds like this quarter you adjusted the ratings on some and you kind of built up some additional reserving as a result of those indicators. Do you think you go back to a similar level in the fourth quarter or do you think you can even go lower than that in the fourth quarter, kind of absent any major macro changes?

Charles E. Christmas, CFO

It's an interesting perspective you're presenting, and we're examining it ourselves. We approached the second and third quarters with two primary drivers: the environmental factors and specific downgrades. We focused heavily on the environmental factors in the second quarter, especially due to the impact of COVID-19, which pushed our economic indicators to very low levels. There’s still potential for further downgrades related to COVID, which might lead to additional provisions. This factor was intended to account for uncertainties. Currently, we're pleased with our asset quality, but we still have a way to go. We will continue to monitor this factor. Additionally, we haven't yet addressed traditional regulatory factors such as trends in past due loans and changes in collateral values, which have remained stable. As we approach the end of the fourth quarter, we will keep reviewing these aspects and make adjustments as necessary. Ray and Bob have effectively detailed what we did regarding downgrades in the third quarter. Overall, we feel confident about our reserves at the moment, but we'll keep an eye on all relevant factors. If downgrades are needed, we will proceed with that, and if changes to environmental factors are required, we will implement them. Overall, we are comfortable with our current position.

Damon DelMonte, Analyst

OK, that's all I have for now. Thank you very much, guys.

Robert B. Kaminski Jr., CEO

Thank you, Damon.

Operator, Operator

It seems we have a follow-up question from Damon DelMonte with KBW.

Robert B. Kaminski Jr., CEO

I think you must have pressed star Damon.

Damon DelMonte, Analyst

I did, well. Nobody else is in the queue, I figured I could get a couple more questions while I had the opportunity.

Robert B. Kaminski Jr., CEO

Well, that is so kind of you.

Damon DelMonte, Analyst

I'm not going to take off that easy. No, just kidding. With regards to the capital, can you give a little perspective on where the shares are trading today and the possible use of capital to do a buyback or even look to raise some additional sub debt to kind of bolster regulatory ratios to maybe facilitate buyback down the road, kind of what are your thoughts around that?

Robert B. Kaminski Jr., CEO

I believe there are various factors at play, as you've mentioned with many banks and companies exploring issuing subordinated debt, while some are considering share buybacks. As we consult with our Board and examine our financials, we're adopting a cautious approach. As Chuck mentioned, we are currently not engaging in buybacks, but we will keep assessing the situation to ensure we do not miss any potential opportunities based on our stock price. It's essential to find a balance in managing our capital responsibly while preparing for any economic challenges or potential investment opportunities in 2021. Our goal is to be well-prepared to handle any situations that arise and to capitalize on opportunities as they come. We will continue to review our position each quarter, but for now, we are satisfied with our current stance.

Damon DelMonte, Analyst

Got it, okay, that's good. And then I guess just last question, just quickly on mortgage banking, could you just give a quick update on your pipelines here in the fourth quarter and kind of how you think that shapes up for the actual fourth quarter result?

Charles E. Christmas, CFO

Yeah, typically in the fourth quarter, there is a seasonal decline in the mortgage business, and as we observe our pipeline over the very recent past that has not shown any of those classic signs of a seasonal decline. So it may very well come towards the very end of the year, but in the next month or two we expect it to hold up at similar levels to what we've experienced in the last month or so.

Robert B. Kaminski Jr., CEO

Just anecdotally Damon, still when you look at houses as they pop on the market, considering that we're almost in November, just from my neck of the woods in the Kent County area of Grand Rapids, the houses are on the market very long before they're snatched up and purchased by prospective new homeowners. So the market continues strong as Ray alluded to and it's going to be interesting winter months. But I think because of the fact that the spring season was pushed back because of the shutdowns of the pandemic, I think it could create some interesting volume opportunities for us as we go through the winter of 2020 and 2021.

Damon DelMonte, Analyst

Okay, very helpful. This time that's all that I have. So thank you very much.

Robert B. Kaminski Jr., CEO

Thanks, Damon, take care.

Operator, Operator

This concludes our question-and-answer session, and I would like to turn the call back over to Bob Kaminski for any closing remarks.

Robert B. Kaminski Jr., CEO

Thank you, operator. Thank you very much for your interest in our company. We hope that you and your families stay safe and healthy, and we look forward to speaking with you again at the conclusion of the fourth quarter come January. This call is now concluded. Thanks again.

Operator, Operator

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