Earnings Call Transcript
MERCANTILE BANK CORP (MBWM)
Earnings Call Transcript - MBWM Q2 2020
Operator, Operator
Good morning. Welcome to the Mercantile Bank Corporation Second 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 Investor Relations. Please go ahead.
Tyler Deur, Investor Relations
Thank you, Kate. 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 second 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 second quarter 2020 press release and presentation deck issued by Mercantile today, you can access it at the Company's website ir.mercbank.com. At this time, I'd like to turn the call over to Mercantile’s President and Chief Executive Officer, Bob Kaminski. Bob?
Bob Kaminski, CEO
Thanks, Tyler and good morning, everyone. On the call this morning, we’ll provide you with detailed information on the company's performance in the second quarter, as well as an update on the activities, specifically related to COVID-19. First of all, I want to recognize the efforts of the Mercantile team for allowing us to continue maneuvering through the many challenges brought about by the pandemic since the start of the crisis earlier this year. Our employees have risen to the occasion, quite often working remotely, to allow Mercantile to successfully serve our customers and fulfill their banking needs. Mercantile demonstrated a solid performance in the second quarter with per share earnings of $0.54, which included the strong provision building we foreshadowed at the end of the first quarter. We also announced that our Board has declared our regular cash dividend for the third quarter of $0.28 per share, furthering our achievement of ongoing financial strength amidst the challenging environment. As one might expect, there are many moving parts in our financial statements during the quarter, and Chuck will provide much more detail on our performance momentarily. As we discussed during our call in April, the safety of our employees and customers is our top priority. The vast majority of our staff was working from home until early June, after some physical and social distancing modifications could be made to our facilities, and it was deemed safe for them to return to their offices and workstations. Mercantile Bank lobbies remained closed to walk-in customer traffic until June 26. During the time our facilities were closed, our team and clients adapted extremely well to alternative methods of engagement to perform their banking activities. The full timeline of COVID-related activities can be viewed on Slide 4. The Paycheck Protection Program dominated much of the attention of the lending team during the second quarter, as our bank was extremely successful and originated a significant volume of SBA loans for businesses in our markets. The focus regarding PPP has now shifted to the forgiveness phase of the program, as we work to assist loan recipients in gathering and submitting the required information to allow the rendering of a forgiveness determination. Through the efficient work of our lending groups on the PPP program, we have engaged numerous potential new relationship opportunities, from businesses that approached or were referred to Mercantile when the incumbent banks were slow with their PPP applications. We will provide you with an update later on this call on the portfolio performance, and information regarding customers receiving assistance through our Payment Deferral Programs. The metrics of our bank’s asset quality remained very strong, and we have worked with those clients impacted by COVID-19 to provide relief via payment deferments within the framework of appropriate accounting guidelines. Our customers are working diligently to position their businesses, so they can withstand the impact of revenue and expense challenges with the various closures mandated to help stop the spread of the virus. The performance of our retail mortgage team in the second quarter was extremely strong. Customers were able to take advantage of low interest rates and refinance their existing mortgages, but also with the reopening of the Michigan economy, new purchase activity was also very good. The combination of those trends, when added to the tireless work of our lending and operation teams, allowed our company to achieve record mortgage production during the second quarter. Ray and Chuck will have more detail on this in their comments. Operationally, in late June, Mercantile announced the closure of three branch locations. These decisions were made in part as part of our ongoing efficiency efforts, to ensure the best allocation of our resources. We anticipate nominal attrition as the customers of these branches will be serviced by other Mercantile branches. Since the beginning of 2016, with the ongoing deployment of technology as an alternative delivery channel, Mercantile has been able to reduce its number of locations from 53 to what will be 37 once these locations are closed later this year. We continue to engage our customers so we can fully understand their needs and how patterns and preferences of interaction with us are evolving, especially in view of the challenges brought about by COVID-19. As we discussed at the end of the first quarter, Michigan experienced a higher level of infections than many states, and therefore, the governor has taken an aggressive approach for containment, including stay-at-home orders and a period of widespread closure of all the essential businesses and industries. As the incidence of new infections dropped during May and most of June, the state implemented a phased reopening of consumer and business activity, which has allowed the economy to slowly be reenergized. A recent increase in cases towards the end of June, continuing into July has paused that caused a pause in the further progression of the phases, as we try to understand the evolution, transmission and ramifications of the virus. The state, local governments, and business leaders alike in our state are continually working to keep citizens healthy while allowing them to return to work and businesses to safely reopen. Should the number of infections continue to increase, the government has indicated that the current phase of the state's plan may need to be downgraded, with more restrictions reinstituted on the activities of businesses and consumers. As mentioned earlier, the safety of our employees and customers will continually be our top priority. I’ll end my comments by touching on additional events that have occurred around this nation, capturing the attention and focus of its citizens. The effects of systemic racism manifest themselves in many ways, and most recently, in the form of violence against people of color. The management, staff, and Board of Mercantile Bank are appalled by these tragedies and are committed to working together with our community partners to address and correct the underlying causes. Internally, the Mercantile team is having ongoing conversations about racism and the healthy institution of real change in our communities. We are committed to listening, learning, and making a difference. Those are my introductory remarks, and I’ll now turn it over to Ray.
Ray Reitsma, President
Thanks, Bob. Our loan portfolio increased $432 million in the second quarter of 2020, which consisted of over 2,000 Paycheck Protection Program loans totaling $550 million. Noted on Slide 8, and offset by $109 million in reduced outstanding under commercial lines of credit. The professional manner in which our team administered the origination of these loans has resulted in significant opportunities to grow our base of commercial relationships. Additionally, our construction pipeline remains solid, with $78 million of commitments in commercial construction and development loans, which we expect to fund over the next 12 to 18 months. Further details on payments relief systems for commercial retail borrowers can be found on Slides 6 and 7. Our asset quality remains strong, as non-performing assets totaled just $3.4 million, or less than one-tenth of a percent of total assets at June 30, 2020. This breakdown can be found in the financial portion of our presentation on Slide 23. Partial past due loans at quarter end are nominal in dollar terms, totaling $464,000, representing 12 borrowers. Overall past due information can be found on Slides 12 and 13. However, given the uncertainty of the economic environment, we elected to record a provision for loan losses of $7.6 million. This amount was generated entirely through qualitative factors supporting the analysis, as opposed to reserves against specific credits. These actions bring the allowance for losses to total loans to 1.16%, excluding the impact of PPP loans. Payment deferrals numbered 705 for the quarter end, representing $718 million in exposure, with $23 million of deferred payments. As of July 17, sanctions in place beyond June 30 numbered 33, representing $130 million of exposure and $4 million of deferred payments. We expect more requests in the near future; however, these relatively modest numbers combined with our expectations for future requests and our past due performance are positive indicators. The risk rating process depicts a portfolio with strong characteristics, reflecting the strength of the pre-crisis economy. Maintaining the accurate risk ratings will remain a key focus in the upcoming quarters as our borrowers report results impacted by the crisis. We continue to monitor the financial condition and performance of credits, particularly in the following segments: automotive dealerships, hotels and lodging, assisted living, restaurants, construction, movie theaters, and retail. None of these individual segments account for more than 5% of commercial loans. Acquisition of these segments can be seen on Slide 10. We recognized non-interest income during the second quarter of nearly $11 million, up $5.9 million or nearly 118% from the prior year second quarter, excluding $1.3 million in non-recurring items related to that quarter. That can be seen on Slide 16. This improved level of non-interest income was largely driven by increased mortgage banking income, reflecting the success of ongoing strategic initiatives designed to increase market share, a higher level of refinance activities stemming from historically low rates, increased share in the purchase market, and an increased percentage of loans sold. For the second quarter of 2020, purchased mortgage loans originated were up 38% over the comparable quarter in the prior year, while refinance activity increased 469%. June applications and backlog suggest that refinance opportunities will persist into the near future, and purchase applications are at record levels. Continuing to enhance mortgage banking income to increase market share, including an increased share in the purchase market remains the priority. We continue to hire proven mortgage loan originators as we're able. Non-interest income from payroll services grew 4.2%, despite high levels of unemployment during the quarter, relative to the prior year comparable quarter. Service charges on accounts and credit and debit card income each fell by approximately 9%, as activity within the accounts was diminished overall during the period. However, recent activity has shown a rebound, although it is still less than the previous quarter. The exercise of discipline-related overhead costs as we focus on efficient delivery systems and all of our lines of businesses remains the priority, as evidenced by the decision to close three branches where Mercantile locations are available in close proximity to the facility. The onslaught of the COVID-19 virus and its ongoing impact is providing an opportunity to demonstrate the value of community banking, combining high service levels with strong capabilities. Our electronic banking capability, coupled with the availability of drive-through facilities, allowed us to close our branch lobbies on March 25, contributing to the ability to have 75% of our employees work from home until the resumption of normal activities. That concludes my comments, and I will now turn the call over to Chuck.
Chuck Christmas, CFO
Thanks, Ray, and good morning, everyone. As noted on Slide 14, this morning we announced net income of $8.7 million, or $0.54 per diluted share for the second quarter of 2020, compared with net income of $11.7 million, or $0.71 per diluted share for the second quarter of 2019. Net income during the first six months of 2020 totaled $19.4 million, or $1.19 per diluted share, compared to $23.5 million or $1.43 per diluted share during the first six months of 2019. Proceeds from a bank-owned life insurance claim increased net income in the previous second quarter by $1.3 million, or $0.08 per diluted share. Excluding the impact of this transaction, diluted earnings per share decreased by $0.09 or about 14% during the current year's second quarter compared to the respective prior year period. Proceeds from bank-owned life insurance claims and a gain on the sale of a former branch facility increased net income in the first six months of 2019 by $3.1 million or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased $0.05 or 4% during the first six months of 2020 compared to the respective prior year period. Turning to Slide 15, interest income on loans declined in 2020 periods 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 March of this year. Interest income on securities during the 2020 periods benefited from accelerated discount accretion from called U.S. government agency bonds, totaling $0.9 million during the second quarter and $2.7 million during the first six months of 2020. In total, interest income declined $2.7 million during the second quarter of 2020, compared to the second quarter of 2019, and was down $3.4 million during the first six months of 2020 compared to the first six months of 2019. Interest expense declined in all categories during the 2020 periods compared to the 2019 periods, reflecting the decline in interest rate environment. In total, interest expense declined $2.1 million during the second quarter of 2020 compared to the second quarter of 2019, and was down $2.5 million during the first six months of 2020 compared to the first six months of 2019. Net interest income declined $0.5 million during the second quarter of 2020 compared to the second quarter of 2019, and was down $0.9 million during the first six months of 2020, compared to the first six 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 $7.6 million during the second quarter of 2020, and $8.4 million during the first six months of 2020, compared to $0.9 million and $1.8 million during respective 2019 periods. The large provision expense recorded during the second quarter of 2020 was primarily comprised of an allocation associated with the newly created COVID-19 pandemic environmental factor, and an increased allocation related to the existing economic conditions environmental factor. 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 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 an incurred loss model as of June 30, 2020. Turning to Slide 16, fee income increased in the 2020 periods compared to the 2019 periods, primarily reflecting significantly higher mortgage banking income, which more than offset reductions in certain other fee income categories. Excluding a bank-owned life insurance claim during the second quarter of 2019, fee income during the second quarter increased $5.9 million or 118% when compared to the second quarter of 2019. Excluding bank-owned life insurance claims and the gain on the sale of former branch facility during the first six months of 2019, fee income during the first six months of 2020 increased $7.7 million or 79% when compared to the first six months of 2019. Reflecting increased refinance activity and the successful implementation of several strategic initiatives, mortgage banking income was substantially higher during the 2020 periods compared to the 2019 periods. Second quarter 2020 mortgage banking income was $6.3 million higher in the second quarter of 2020, and income during the first six months of 2020 was $7.9 million higher than during the first six months of 2019. Credit and debit card income was lower during the 2020 periods when compared to the 2019 periods, reflecting lower transaction volume during the second quarter, especially during the first half of the quarter. Activity volumes have been increasing over the past six to eight weeks. Service charge income was also lower during the second quarter of 2020 compared to the second quarter of 2019, and is almost the same when comparing the first six months of 2020 with the first six months of 2019. The lower level primarily reflects fewer transactions from business customers, and high average deposit balances from individual customers that alleviated certain monthly service charges. Continuing on Slide 17, overhead costs increased in the 2020 periods compared to the 2019 periods, primarily reflecting higher compensation costs, especially related to residential mortgage lending activities. Salary and benefit costs were up $0.8 million or 6% during the second quarter of 2020 when compared to the second quarter of 2019, and up $1.4 million or about 5% during the first six months of 2020 when compared to the first six months of 2019. Occupancy, furniture, and equipment costs were up a combined $0.5 million during the second quarter of 2020 when compared to the second quarter of 2019, and up a combined $0.9 million during the first six months of 2020 when compared to the first six months of 2019, largely reflecting the fall of 2019 completion of our main office expansion. Continuing on Page 18, our net interest margin was 3.17% during the second quarter of 2020, down 46 basis points from the first quarter of 2020, and down 52 basis points when compared to the second quarter of 2019. The yield on earning assets declined 69 basis points during the second quarter of 2020 when compared to the first quarter of this year, while the cost of funds declined 23 basis points during the same time period. When comparing the second quarter of 2020 with the second quarter of last year, the yield on earning assets declined 100 basis points while the cost of funds declined 38 basis points. The yield on loans was down 51 basis points during the second quarter compared to the first quarter, and down 100 basis points when compared to a year ago, largely reflecting the Fed’s aggregate 225 basis point reduction and the targeted federal funds rate mentioned earlier. We are recording the origination fees and direct origination costs of PPP loans, equating to a $14.7 million net increase to interest income on commercial loans using the level yield method. Second quarter 2020 net accretion totaled $2.8 million. Assuming no forgiveness transactions, we expect to record net accretion of $2.9 million and $2.5 million during the third and fourth quarters of 2020, respectively, and $2.1 million, $1.6 million, $1.2 million, and $0.8 million during the first, second, third, and fourth quarters of next year, respectively, with the remainder during the first half of 2022. The yield on securities during the second quarter of 2020 and the first six months of 2020 benefited from accelerated discount accretion from called U.S. Government Agency Bonds. Accelerated discount accretion totaled $0.9 million during the second quarter of 2020, positively impacting the quarter’s net interest margin by 10 basis points. The accelerated discount accretion totaled $2.7 million during the first six months of 2020, positively impacting the period's net interest margin by 15 basis points. Negatively impacting our net interest margin during the 2020 period, and especially the second quarter of this year, is 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 $247 million during the second quarter of 2020, and just shy of $200 million during the first six months of the year, 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 at least the remainder of 2020. The cost of funds has also been on a declining trend, primarily reflecting the following interest rate environment, but in terms of magnitude and scale, not to the degree we experienced on the yield on loans. For our net interest margin for the remainder of 2020, assuming no forgiveness activity on PPP loans, and a steady level of excess funds as we depicted as of June 30, we expect our net interest margin to be in a range of 2.85% to 2.90%. Under normal excess funds, which again we do not expect, but if we did have normal excess funds, our core margin, if you will, would be 3.10% to 3.15%. On the next few slides, we discuss mortgage banking. Mortgage loan originations increased substantially during the 2020 periods, and especially during the second quarter of 2020, largely reflecting significant refinance activity stemming from the decreased interest rate environment, coupled with the ongoing success of strategic initiatives designed to expand market penetration, enhance gain activities, and operate more efficiently. Mortgage loan originations totaled $275 million during the second quarter of 2020, compared to $80 million during the second quarter of last year, an increase of almost 250%. Mortgage loan originations totaled $408 million during the first six months of 2020, compared to $125 million during the first six months of last year, an increase of about 225%. Almost 80% of the mortgage volume during the second quarter of this year consisted of refinanced applications, compared to about 48% in last year's second quarter. Approximately 82% of the mortgage loan originations during the second quarter of this year have been or will be sold on the secondary market, up from about 62% during the second quarter of 2019. In recent weeks we have seen an increase in the origination of purchased mortgage loans, and as Ray mentioned earlier, the pipeline of purchased mortgage applications is currently at a record level. On the next couple of pages, Slides 22 and 23, we discuss asset quality. The standard quality metrics of the loan portfolio remain very strong, with continued low levels of non-performing loans and loan charge-offs. Non-performing loans as a percent of average loans equal only 10 basis points at the end of the second quarter. The balance of other real estate-owned was less than $200,000 at quarter end. Gross loan charge-offs totaled $300,000 during the second quarter of 2020, while recoveries of prior period loan charge-offs totaled about $150,000. The resulting net loan charge-offs of less than $200,000 equated to just 2 basis points of average total loans annualized. Additions to non-performing assets totaled just over $200,000 during the second quarter of 2020, with a net reduction of about $300,000 recorded in non-performing assets on an overall basis during the quarter. As shown on Slide 24, we remain in a strong and well-capitalized regulatory capital position. The bank’s Tier 1 leverage capital ratio was 10%, and a total risk-based capital ratio was 13.5% as of June 30, 2020. The total risk-based capital ratio was over $113 million above the minimum threshold we categorize as well-capitalized. There was no share repurchase activity during the second 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 uncertainties surrounding the COVID-19 pandemic. We currently have about $10 million available in our current repurchase plan. Concluding on Slide 25, I want to make a couple of comments on our forecast considerations for the remainder of 2020. Due to the high degree of uncertainty that currently exists, we will not be providing earnings performance guidance as we've done on past conference calls. However, we are able to offer key considerations that should be factored into any earnings forecasts for our company. These include on net interest income, PPP loan, and PPP LF volume. The PPP loan portfolio totaled $549 million at the end of the second quarter, while still originating new PPP loans, maybe one to three a day, aggregating less than about $100,000 each day. We expect that trend to continue until the planned deadline slated right now for early August. We did borrow about $44 million in late April under the PPP LF program; however, due to a large and growing volume of on-balance-sheet liquidity, the PPP LF advance was fully paid off in early June. Given current and expected ongoing excess on the balance sheet liquidity, it is likely the PPP LF program will not be as excessive in future periods. However, we currently have over $450 million in borrowing capacity if need be. In regards to PPP loan forgiveness, net deferred SBA loan origination fees and direct loan origination costs will be accreted into interest income on loans over the life of the loans using a level yield method, as I detailed earlier. The vast majority of PPP loans were underwritten for a 24-month period; the degree to which PPP loans are forgiven and the loans are effectively paid off by the SBA will impact net deferred loan accretion. Of course, any increase in the volume of non-accrual loans may negatively impact loan interest income. Provision expense may be impacted in future quarters by items such as net loan growth, the degree to which loans are downgraded in accordance with our loan grading paradigm, the degree to which loans become impaired due to being placed into non-accrual or TDR status, and the qualitative environmental or reserve allocation factors that are formally reviewed at the end of each quarter; certainly, any changes may impact the required reserve calculation. In regards to fee income, mortgage loan originations for the purchase of homes have been steadily increasing over the past couple of months, and the current pipeline of applications for the purchase of homes is at a record high. However, the degree to which changes in COVID-19 measures are made by Michigan's governor are difficult to predict on our mortgage banking operations. Michigan's shelter-at-home declarations also had a substantial impact on credit and debit card interchange fees, as card usage dropped. However, activity has recently increased. The degree to which changes in COVID-19 measures are made by Michigan's governor are difficult to predict on these operations. Finally, regarding overhead costs, any increase in problem loan relationships could result in an increase in collection costs. In closing, while there are many uncertainties that may impact Mercantile's financial condition and operating performance in future periods, we note that we entered a stressed environment with strong asset quality and a solid capital position. We are pleased with our second quarter operating results and financial condition as of June 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, and I'll now turn the call back over to Bob.
Bob Kaminski, CEO
Thank you, Chuck. That now concludes management's prepared comments. We will now open the call for the Q&A.
Operator, Operator
We will now begin the question-and-answer session. Our first question is from Brendan Nosal from Piper Sandler. Go ahead.
Brendan Nosal, Analyst
Very good morning, guys. How are you?
Bob Kaminski, CEO
Good morning, Brendan.
Brendan Nosal, Analyst
Just want to start off on deferral trends here. So just help me think about how we should kind of interpret the two buckets, the $740 million that's three months or less versus $130 million that's three to six months. Is the expectation here that that $740 million number will decline as we move forward, with some moving into a three to six month bucket, but hopefully more of that just no longer being on deferral at all?
Bob Kaminski, CEO
Well, I guess the biggest perspective around this is that we were fairly liberal in providing deferrals early on in the crisis, and the guidance was consistent with that from those who regulate us, and the experience around the industry. On the second go-around, we were much more concerned with the credit dynamics that surrounded that. We had the opportunity to review more information, financial information from those borrowers, and as a result, we saw that trend decrease rather significantly. If you look at some of the buckets that we were paying particular attention to, the number of deferrals—for instance, automotive dealers went from 17 to 7, restaurants went from 55 to 1, hotels went from 19 to 3. So, in those categories, we’re seeing the ability, at least, through July 17 to function well without further deferrals. Now I would be remiss if I didn't mention that it is July 17, and there are days ahead which could include requests for more referrals, however, the liquidity within the system is such that in total it provides some cause for optimism. But unprecedented is the right term for these times, and what the future holds remains to be seen. But as we evaluate deferrals as of this date, they’re down considerably or less than 20% of what they were in the first quarter.
Brendan Nosal, Analyst
Okay, understood. And then, just one more for me and then I’ll step back. We’d just be curious to hear an update on how some of the larger, let’s call them at-risk portfolios are doing today versus three months ago, in areas like hotels, restaurants, entertainment, just any color on things like occupancy rates or capacity in restaurants today versus two months ago will be quite helpful?
Bob Kaminski, CEO
Yes. As it relates to restaurants, they opened under the governor's orders in Michigan, and most of them are active and operating at a percentage of the normal occupancy. But the take-out business is just absolutely thriving, as is the drive-through business. So we've seen results that range from better than they were before the crisis to similar and slightly worse. And so, that's an area that I think we will see no more stress in the future, but it hasn’t happened yet, and to be able to quantify that is absolutely impossible. As it relates to hotels, occupancy in many of those has made a turn and started to come up a bit, still well below the levels that you have observed prior to the crisis. And so, the experience there is that the performance is still going to be diminished in the next few months; we'll see where it goes from there, which will hinge on the pace of the recovery.
Brendan Nosal, Analyst
All right, great. Thank you for taking my questions.
Bob Kaminski, CEO
Thank you.
Operator, Operator
Our next question is from Damon DelMonte from KBW. Go ahead.
Damon DelMonte, Analyst
Great. Okay. So, first question, kind of on the margin here, probably for Chuck. So your reported margin was 3.17% this quarter, and you noted that there was a 10 basis point benefit from the salary accretion from the called agency securities. So then that would put the core margin kind of around, call it 3.0%, 3.07% or so, and you're kind of guiding down to 2.85% to 2.90%. Is that right?
Chuck Christmas, CFO
Yes. I think part of that is the impact of the excess liquidity that we have on our books, which is going to be higher. And the excess liquidity as we have today, and that we've had over the last few weeks is quite a bit higher than the average excess that we had during the second quarter. So what you're seeing there is the impact of the ongoing and increased excess level of balance sheet liquidity.
Damon DelMonte, Analyst
Got you. Okay. And you expect that to kind of stay on through the end of 2020, and then eventually move off once the PPP proceeds are deployed? Is that correct?
Chuck Christmas, CFO
Yes. I mean, yes, that's been the difficulty of the impossibility of trying to predict. I think all of us bankers thought that, hey, once PPP money hits within eight weeks, 10 weeks, a lot of that money would be out of the bank. And what we've seen, and I know talking to other bankers, they've seen the same thing, is that a large portion has remained in the bank. So when we made the loans, we went ahead and credited deposit accounts like we typically would. And we certainly have seen some money leave the bank. But if you just very simply look at the going ons of your balance sheet changes, we can definitely see that some of those proceeds remain with the bank, and it's impossible for us to predict when those monies would go out for operational use. We have over 2,100 loans that we did. As you know, money is very fungible, so trying to trace proceeds for one credit would be very difficult; 2,100 would be simply impossible. So, my assumption is that a lot of that money is going to be staying at least for some time. I think when we can get past the COVID-19 environment, I think we'll see businesses start to expand, obviously bringing all their employees back. So I think I would expect more movement. But I would say that over the last few weeks, the movement of our deposit balances has been pretty steady.
Bob Kaminski, CEO
I think what it does point to also, Damon, is it points to the strength of much of our customer base. And as they were really well positioned as we headed into the pandemic, they took advantage of the various offerings and the government programs through the SBA to help fund their payroll costs. And as their businesses have contracted, due to some of the stay-at-home orders and business shutdowns, they're sitting in a pretty hefty cash position right now. But as we talked about in our comments, as the economies continue to open back up around the country, and hopefully, continue with the phased reopening, they'll go back to more of a normal operating environment as much as we can at this point in time. But I think the factor of the strength of our customer base is also one that I don't want to escape mention in the conversation as well.
Damon DelMonte, Analyst
Got you. Okay. It's helpful. And then with respect to this quarter's provision and kind of how you're looking at the reserve going forward, you noted, if you exclude the impact on the PPP loans, the reserve is actually 1.16%. So, pretty sizable build this quarter. Do you feel like you're at an adequate level, or do you think that additional reserve building is likely as we progress through 2020?
Bob Kaminski, CEO
The key question we're focusing on right now is our confidence in the reserve as of June 30. We conducted our provision building based on the qualitative factors discussed by Chuck and Ray, which was a sensible approach. This aligns well with the CECL model, and we expect it to remain consistent for the rest of the year. Moving forward, we will keep monitoring and making necessary adjustments to qualitative factors, as well as addressing any specific quantitative changes needed due to the performance of certain loans in the portfolio. So far, we haven't observed any significant issues, and we're pleased with that. However, we recognize that if the pandemic-related shutdowns extend longer into 2020, it could negatively affect our clients. For now, the qualitative factors are serving us well, but we are prepared to respond appropriately if we see specific declines in certain credits. Overall, we are comfortable with the reserve. Our cautious provision build during the second quarter and our standing as of June 30 reflect what we believe is appropriate. We will adapt as this quarter progresses and definitely in the fourth quarter as needed. But at this moment, we are optimistic about it.
Damon DelMonte, Analyst
Okay, great. And then just one final question. I want to make sure I'm reading this properly. So, the initial 90-day deferrals on the commercial portfolio is the total of $790 million. Then you have another $130 million that's from four to six months. So in total, that's around, call it $850 million, so basically 30% of the commercial portfolio is deferred right now?
Chuck Christmas, CFO
Yes. When you examine the three months or less, many of those have already phased out. What we observe is that the four to six-month group consists mainly of what we classify as second-round deferrals. The vast majority, if not all, of the original payment relief was within the three-month period. For customers requesting additional relief, we typically offer another three months. Consequently, that additional three months is what you're seeing on Page 7. It's important not to combine those two slides since anyone listed on Page 7 is also represented on Page 6. That provides a clearer understanding.
Ray Reitsma, President
And all the ones on Page 6 that were three months or less, both payments have resumed.
Damon DelMonte, Analyst
Okay. So, is there a way based on this information I can look at your portfolio and say x% of the commercial portfolio is deferred right now? Or no, because they overlap?
Bob Kaminski, CEO
What I would say, if you wanted to simply do that Damon, look at Page 7. I think as Ray indicated, we’re definitely having ongoing conversations with certain borrowers to talk about potential additional needs. So, as we sit here today, Page 7 would be the number you want to use.
Damon DelMonte, Analyst
Okay. So, Page 6, gives you a snapshot of what your initial round of deferment requests were, and then subsequent to that some of that has gone back to performance and then others have migrated into the four to six months?
Chuck Christmas, CFO
Right. The vast majority have gone back to making payments and then what you see on Page 7, at this point in time, these are the ones that have said, 'I need additional help.'
Bob Kaminski, CEO
Yes. It's been a long-standing tradition for us to continue to work with our clients to understand and react according to their evolving needs.
John Rodis, Analyst
Good morning, everybody. So, just back to the previous question. So Page 7. So if you include retail, that's $132 million. So that's roughly 5% of core loans excluding PPP, correct?
Chuck Christmas, CFO
That’s correct, John.
John Rodis, Analyst
Okay. So, that’s what's on deferral right now?
Chuck Christmas, CFO
As we speak today, yes. As of Friday, I need to mention.
John Rodis, Analyst
Chuck, your margin guidance 2.85% to 2.90% for the second half, does that include your "normal amortization," I guess, of the PPP loans that you outlined?
Chuck Christmas, CFO
That’s correct. Yes, that includes that schedule that I provided.
John Rodis, Analyst
Okay. And then, I guess what is your assumption as far as forgiveness? What percent? I know it’s a guess, but what percent do you think is ultimately forgiven? And as far as timing, is it a third quarter, fourth quarter or mostly fourth quarter, first quarter? What are you sort of thinking today?
Chuck Christmas, CFO
I think, John, the assumption by our customers, and we believe that there are so many that their loans are going to be forgiven. But since the fact that there’s been some guidance but not complete guidance by the SBA and the government, it's difficult to predict how the forgiveness part will work. We’re trying to make our best guess at this point in time. But the assumption of our customers is that their loans were used for payroll as the program prescribed, their loans will be forgiven. But until you have the actual guidance, you can’t make that final determination, so it is a big question mark.
Bob Kaminski, CEO
It seems to me, John, if I could add, it doesn’t seem like it's going to be a lot of third-quarter activity. We don’t even have the guidance out yet as to how to apply or help our borrowers apply for forgiveness. We have been hearing maybe early August that will be published, but we have heard dates before. And then I see that the treasury has allowed up to 90 days to go ahead and approve the request, or to act on the request. So certainly, Congress and other banking trade groups are trying to get more of an automatic forgiveness or at least a much simpler form for the smaller loans. That would obviously speed up the process if there is something like that. But if it's loan-by-loan, it's going to take quite a while, and I would think it's going to be more of a fourth quarter or first quarter activity without some way of streamlining the smaller loans forgiveness program.
John Rodis, Analyst
Chuck what percent of your loans are under a $125,000 balances?
Chuck Christmas, CFO
I had that with me. I did bring it with me to the room here. I think what you would find is that if you look at the number of loans, a majority fall under that dollar amount. But if you look at the dollars, a majority of the dollars that we lent out are from our larger customers or larger borrowers.
John Rodis, Analyst
Yes. Okay. One other question just, obviously mortgage has obviously done very well in the quarter. As we go forward, do you expect to see some normal seasonality? Clearly, I would think in the fourth quarter, maybe. But third quarter, do you think just directionally, do you think mortgage is down from the second quarter? Or just what are you thinking?
Ray Reitsma, President
Yes, this is Ray. The mortgage backlog has been rather steady for the last six weeks or so. So that would portend similar results into at least the beginning of the third quarter, or at the end of the third quarter. In the fourth quarter, seasonality will certainly take effect. But particularly, as it relates to purchases, but if rates continue as they are, refinance activity will be a strong contributor. So, in sum, I think the answer to your question is the seasonal pattern will persist, but it will be at a higher level than it's been in the past.
John Rodis, Analyst
Okay, fair enough. Okay. Thank you guys.
Operator, Operator
Our next question is from Kevin Swanson from Hovde Group. Go ahead.
Kevin Swanson, Analyst
Hi, guys.
Bob Kaminski, CEO
Hey, Kevin. Good morning.
Kevin Swanson, Analyst
Hey, I appreciate the commentary around the NIM and the guidance there. But I'm sorry if I missed this, but was there any guidance around what it actually means for spread income?
Chuck Christmas, CFO
I'll let you guys do those calculations. So I feel comfortable with assumptions that I gave to talk about the spread and margin. Under my assumptions, I don't think we're going to see a huge change in average earning assets. So I think those two combined will probably get you to where you want it to be.
Kevin Swanson, Analyst
Okay, fair enough. Yes, I appreciate that, because as much as the margin contracts, if NII doesn't really change all that much, then I guess there's some moving points there. But just one more question, I appreciate the increase in the balance sheet from the liquid assets and the PPP. But you guys kind of jumped pretty far ahead of the $4 billion number. Given, how do you think that shapes out longer-term? Are you now considering yourself north of $4 billion for the longer-term? Just kind of curious in your thoughts on how that all shakes out.
Chuck Christmas, CFO
No, I don't think we'll see that. We certainly expect all or a vast majority of our PPP loans to be forgiven. I think maybe where you're going is that while they're forgiven, so that means our loans now become overnight investments to the Federal Reserve. And we'll have to work those off over time. So, I think it's going to be quite a while for that money to work its way out of our balance sheet. But I don't think a majority of that's permanent. But having said that, and Ray kind of touched on that, we're still talking to current customers about their loan needs. We're certainly talking to prospects. Ray touched on the PPP program prospects; some opportunities there. So we certainly would expect over time that our commercial loan portfolio will continue to grow. But when you have $550 million in PPP portfolio, that's a slug of money to have to work through.
Kevin Swanson, Analyst
Got it. Okay. Thanks, guys.
Chuck Christmas, CFO
Thank you.
Operator, Operator
Our next question is from Brendan Nosal from Piper Sandler. Go ahead.
Brendan Nosal, Analyst
Hey. Just one follow-up for me on the margin. I appreciate that the 2.85% to 2.90% includes both typical PPP fees as well as the excess level of liquidity. And then the 3.10% to 3.15% that you gave does that exclude both excess liquidity as well as any impact of PPP? In other words, does that kind of be the expected underlying run-rate for the NIM going forward?
Chuck Christmas, CFO
No, Brendan, the 3.10% - 3.15% still includes the PPP accretion. But it brings our balance sheet back normal on excess balance sheet liquidity. So just the latter.
Brendan Nosal, Analyst
Got it. Okay. Thanks.
Operator, Operator
As there are no more questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Bob Kaminski for closing remarks.
Bob Kaminski, CEO
Thank you, Kate. Thank you all very much for your interest in our company. We hope you and your families stay healthy and safe. We look forward to speaking with you next at the conclusion of the third quarter. This call is now concluded. Thank you.
Operator, Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.