Wsfs Financial Corp Q3 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Bryn Mawr Bank Corporation's Third Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. On the call today, we have Frank Leto, President and Chief Executive Officer, Mike Harrington, Chief Financial Officer, and Liam Brickley, Chief Credit Officer. Before we begin, please be advised that during this conference call, management may make forward-looking statements. Please refer to the disclaimer labeled Forward-Looking Statements and Safe Harbor in the earnings release and presentation for more information regarding what constitutes a forward-looking statement. All forward-looking statements discussed during this call are based on management's current beliefs and assumptions and speak only as of the date and time they were made. The Corporation does not undertake to update forward-looking statements. For a more complete discussion of the assumptions, risks, and uncertainties related to the business, you're encouraged to review the Corporation's filings with the Securities and Exchange Commission located on their website at www.bmt.com. I would now like to turn the conference over to Frank. Please go ahead, sir.

Thank you, Rocco. And I'd like to thank all of you for joining our earnings call today. As we navigate through the remainder of 2020, I'm immensely proud of how our organization has responded to this dynamic and evolving environment. Our company has accomplished so much in 2020 despite COVID-19, a testament to our team and our business model. I'd like to thank our employees for their extraordinary efforts and our clients for allowing Bryn Mawr Trust to serve them during these unprecedented times. Our hard work was recently recognized by Newsweek magazine with the award for Best Small Bank in Pennsylvania. Our recent quarterly results are also a great example of the hard work of our team. In the third quarter 2020, we reported net income of $13.2 million or $0.66 diluted earnings per share. Our net interest income remains under pressure from historically low interest rates, our fee income business continued to produce solid results, a testament to our diversified business. This is most notably seen in our wealth, insurance and capital markets businesses, all of which grew from the previous quarter. Specifically related to our wealth business, Bryn Mawr Trust Company of Delaware recently surpassed $10 billion in assets. As we've discussed on the previous earnings call, we continue to review our expense profile for ways to optimize performance. One topic that has been trending lately in the banking industry is branch optimization. We noted last quarter our plans to exit approximately 33,000 square feet of office space. However, this does not include any of our branches. During the third quarter, one of our branch leases expired and we made the decision to exit that branch. Future changes to our retail network are likely given a change in consumer behavior. We'll communicate these changes, including the impact on our financial performance, when we've completed our planning. Part of the current approach has been to identify and create 15 service centers within our branch network. These client centers accept appointments with clients across all departments of our organization. These 15 locations were specifically chosen because of their ease of access for the majority of our clients. In fact, over 90% of our clients are within 5 miles of each one of these client service centers. As we look at our distribution model going forward, we're assessing the efficacy of the client service center structure and we'll continue to factor this data into our strategy as it relates to branches and possible future expansion. During this third quarter, we saw several other areas of improvement. Our capital ratios strengthened at both the bank and holding company. Many of our asset quality indicators, including net charge-offs, improved, and our liquidity position remained robust. Furthermore, we continue our progress in transforming our operations and technology. As mentioned previously, we've partnered with nCino and their unrivaled client onboarding platform to improve our customer experience and radically streamline our onboarding processes. In the fourth quarter, we'll roll out our small business loan origination system. Our third nCino module, which already includes deposits and consumer lending, will be the first nCino client to incorporate auto-decisioning into that workflow. This is just one example of many ways we are improving our business and positioning ourselves to succeed today and in the future. We believe there will be future obstacles and challenges, but we're confident in our positioning as we navigate through the current environment. Finally, I'm proud to announce the Board of Directors approved a $0.27 per share dividend; this marks our 112th consecutive quarterly dividend. I'd like to ask Mike Harrington to discuss some of our third quarter results. Mike?

Thank you, Frank, and good morning, everyone. During the third quarter 2020, we posted GAAP income of $13.2 million or $0.66 per diluted share. The main drivers for the quarter included strong fee income from our wealth, insurance, capital markets and mortgage banking businesses. As we explained on the previous call, tax filing extension this year moved the bulk of our tax fees recorded in the wealth line item in the second quarter to the third quarter. During the third quarter, we earned $557,000 in tax fees. As a wealth business overall and adjusting for the mitigation payment recorded in the second quarter related to the unwind of the mutual fund, revenue was up over 4% for the nine months ended September 30 compared to the same period last year. Our capital markets division continues to grow as well by offering new products and services, along with helping clients take advantage of current market conditions. Capital markets revenue grew 11% quarter-over-quarter and 49% for the nine months ended September 30, 2020 as compared to the same period in 2019. Net interest income decreased 6.3% from the second quarter. Our cost on deposits have shown a noticeable decline. The same is true for interest on loans. Our tax equivalent net interest margin decreased from 3.22% to 3.03% quarter-over-quarter. The main contributors to the decline included a decrease through our loan yields, coupled with a 72% increase from the second quarter in our average cash balances. We're actively looking to deploy some of our cash reserves but we will remain prudent as it pertains to liquidity during this uncertain market environment. We expect the margin to begin to stabilize at these levels as deposit rates continue to move lower and excess cash is deployed. The provision for the third quarter was $3.6 million. The slower provision as compared to the second quarter was partly due to lower net charge-offs and some minor modifications to our credit modeling. As a result of this provision, there was a modest 5 basis point build in our allowance for credit losses to total loans. As we approach the end of 2020 and think about 2021 and beyond, uncertainty abounds as to the path of the economic recovery. This uncertainty will likely manifest itself in episodic charge-off activity and will likely lead to changes in both the qualitative and quantitative drivers of our credit modeling. Liam will quickly provide additional color on the credit risk profile later in our presentation. Compared to the second quarter, non-interest expenses were up approximately $1 million. The quarterly increase included higher expenses related to compensation, FF&E, advertising and other operating expenses. Digging a little deeper on expenses, the underlying increase in salary and wages was caused by much lower deferrals related to lower loan closings versus the PPP loan originations in the second quarter and not higher compensation costs, which trended lower as expected, given the workforce actions we undertook in the second quarter. These deferred expenses, an offset to current expenses, were lower by $1.1 million and will fluctuate in the future dependent on loan volume. Also notable as it relates to expenses in the line item of other operating expense, in the second quarter, we released approximately $900,000 in reserve for unfunded commitments and subsequently provided for $200,000 of reserve in the third quarter, a swing of $1.1 million. With regards to liquidity and capital, they remain a top priority for the organization. Our cash balances remain high. We frequently discuss opportunities to optimize our deposit profile and lower rates were necessary. This can be seen in the 20 basis points decrease in deposit yields quarter over quarter. As noted earlier, we would expect deposit cost to drift lower in the fourth quarter. Capital at both the bank and holding company improved in all areas quarter-over-quarter and remains well above the levels needed to be deemed well capitalized. We monitor capital closely and perform stress tests based on the changing economic scenarios. We believe we have a firm hand on the possible outcomes and are well-positioned to absorb unexpected losses should they occur. Consistent with our position related to our capital, we maintained our dividend and are committed to doing so in the future. The Company has ample liquidity at the holding company to support the bank as a source of strength and pay future dividends. As for the stock buybacks, we are taking a cautious approach that will not be in the market until we have further information as to the path of the virus and the resultant impact on the economy and credit risk. As you'll note on Slide 6, asset quality was generally stable during the quarter. In the third quarter net charge-offs decreased $1.2 million. As noted earlier, the provision was slightly lower in the third quarter and the allowance for credit losses to total portfolio loans increased modestly to 1.53%. I will now turn it over to our Chief Credit Officer, Liam Brickley, who will provide additional commentary on the Bank's credit quality and loan portfolio. Liam?

Thanks, Mike, and good morning, everyone. As shown on Slide 7, our portfolio did not change materially during the third quarter and remains diversified across borrower, industry and property types. We remain in close communication with many of our borrowers, specifically those who may be in more vulnerable sectors in this current economic environment. At the end of the third quarter, 13% of our commercial real estate non-owner occupied portfolio was in deferral as compared to 28% at the end of the second quarter. This amount is expected to gradually decline through the end of the year. However, depending on circumstances at our discretion, a portion of these loan deferrals may be extended into 2021. Our leasing portfolio remains a more susceptible segment, given the difficulties in the market, but we have seen the percent of deferred transactions drop from 16% at the end of the second quarter to 6% as of September 30. We remain conservative as we approach this portfolio which is evident in the nearly 6% provision on total leases. The final terms for some of the leasing portfolio may extend into 2021, but to what extent is unknown at the current moment. As we transition to Slide 8, we can see a more detailed analysis of our commercial real estate portfolio. The underlying metrics of these segments have not changed materially from the second quarter. We continue to review our loan portfolio and to make changes to risk ratings as necessary. Again, we are taking a conservative approach in our methodology. This is seen in several of our commercial real estate sectors including retail and hospitality, where we made additional downgrades during the third quarter. We believe it is prudent to rate each loan according to the underlying fundamentals of the property along with current market data. Our trends around lines of credit usage have improved over the last quarter and year-to-date. Since the end of the second quarter, our line of credit usage actually decreased by 0.7% or $5.4 million. On Slide 9, we outlined a detailed schedule of loan deferrals by customer segment. At the end of the third quarter, approximately 9% of the total portfolio was in a deferral program, as compared to 21% at the end of the second quarter. Over the past few months, we have seen this percentage gradually decline and anticipate this will continue as many of these loans come out of their initial 90-day deferral term or second 90-day deferral term. However, as previously mentioned, at our discretion, we may extend some of these deferral periods for select clients based on certain underlying factors. In this case, some deferrals could extend into 2021. However, much of this is dependent on what occurs over the remainder of Q4. During the third quarter, we increased our total criticized loans and leases by $13.9 million based on updated information and additional reviews of the entire portfolio. As a result, our allowance for credit losses as a percentage of criticized loans and leases modestly decreased from 26.2% to 25.2% quarter-over-quarter. Moving on to Slide 10. In early September, we disclosed new deferral information as part of an investor presentation. This information has been updated as of September 30 and is included in slides 12 through 14 of the third quarter investor presentation. Slide 10 provides a deferral summary by loan segment. As indicated on the slide, the peak for deferrals was reached at the end of June and has since declined considerably. The months shown after September 30 are based on our current assumptions but may change as circumstances progress for our customers. Slide 11 is a different visual for the information contained in Slide 10 on total loan deferrals. On this slide, it is broken out between first and second deferral terms. As we move through the fourth quarter, we could see a third deferral segment that carries into 2021, however to what extent is currently unknown. Slide 12 shows the deferral information on a more granular commercial real estate concentration view. As I indicated earlier, the retail and hospitality segments are more vulnerable to current market conditions, but we have seen a steady decline in deferrals even under these two segments. While we anticipate continued volatility in the market, I share Frank's sentiment in our preparedness and the experience of the team to handle any uncertainties that may arise. And with that, I'm going to turn it back over to Frank.

Thanks, Liam and Mike. Rocco will open the line for questions at this point.

(Operator Instructions) Today's first question comes from Michael Perito with KBW. Please go ahead.

Thanks for taking my questions. I wanted to first start on the expense side. Obviously you guys have already done or in the process of doing a few things, it sounds like there's maybe another smaller item, some smaller items brewing as well. I guess two-part question. One, Mike, I mean any dots you can provide us on where that expense run rate might settle once the actions that you guys have already announced kind of take place all else equal. And then second part. Just as I think about the cost side, can you help us get ahead a little bit here? I mean, what is the kind of the main driver for some of these decisions. Is there like an overall cost structure that you guys think you need to have to remain at a certain level of profitability in this rate environment or is it really more strategic just in trying to make the platform as efficient as possible as the delivery of products and services evolves here?

Mike, why don't you take this one and I will take the second part.

Yes. Okay. I don't know how specific you want me to get, Michael. And I'll try to just level set back on Q2, for Q2, and what I said in my prepared remarks as there's a couple of items in there that made this cost look a little bit lower than they actually were. So we're really pleased with how things are trending from an expense standpoint if you make some of those adjustments. The actions we took and the workforce actions we took in the second quarter, some of the work-through dates and the timing of when that hits really happens in the third and fourth quarter. So we would expect to see the continued benefits of those actions play out through the end of the year and then the full effect of those actions really manifest themselves in the first quarter of 2021. So other than that, I want to bounce back and forth. I'll let Frank maybe jump in on the strategic question you asked. And then we can play off that.

Yes Michael, let me put it in certain terms. I mean, we don't target a specific dollar amount, we're looking for expense savings. I think from our perspective, we look across the enterprise and we're focused on creating efficiencies in a lot of different ways. First and foremost technology, which you've seen a lot of and you see some of the investments. And by the time we have this call next year, we'll be fully baked in with nCino. And we'll just start to see some of those benefits start to play out. But we'll look for those efficiencies and process improvement, and it’s a continuous ongoing process at the bank, just like a lot of the investments we've made, strategic investments we've made for a much longer term, not the quarter-to-quarter kind of benefit. This is an ongoing discipline that we've tried to instill at the bank of continuously looking for where we can cut and save without impacting obviously client service or creating excessive risk. I don't know if that helps. I mean, I know you would like a specific target number, but we just don't target that.

Some of that stuff hasn't hit yet so I mean, is it fair to say that there is still other overall CECL as we look at the $35.7 million in third quarter run rate. There is still—at least it would seem like a million bucks or so that has to come out as soon as—we'll reach the end of the year and the early part of first quarter, or is it more than that at this track?

Not all things being equal, it should trend lower. That's correct. Yes, because—and all the occupancy actions we said about, they don't happen until the first quarter. So we're still actually occupying the buildings. We've mentioned a 33,000 square foot decrease in that run rate expense doesn't happen till Q1.

Then switching over to the balance sheet. The liquidity built up a little bit, I mean, it seems like based on your commentary and your prepared remarks that you're expecting some of that to kind of be maintained here. I guess any feedback from customers or thoughts? I mean it seems like based on a lot of your peer commentary that that liquidity is expected to be around for a little bit here at least. Is that consistent with what you guys are seeing? And if you do get the chance to kind of deploy it, where are you hopeful to kind of move to deploy that cash over the near-term, if it's going to stick around for a little bit?

Well, we did some rebalancing to that versus the endpoint—the endpoints are much lower. So the way we've been doing that is we just had some funding that matured, where we've repriced some funding out of the institution, most of that on the wholesale side. So, we're trying to drive it out by using those actions on the pricing side, and then just repaying some maturities that came up.

Okay.

And I think, we've got—we don't know the level of precision here, the analysis of how much PPP money is still sitting in the institution, but it's a fair amount. So, we know there is going to be—there could potentially be a short-term need for those pursuits to get utilized. So that's one of the reasons we're holding some—maybe more cash than we normally would. And then we're just looking, we'll probably get the question about loan growth. And I think it's going to be—we should probably talk about the market at some point. But we're definitely try to deploy some of that excess liquidity into loans. And then maybe just get some of it invested in the—through the investment portfolio instead of having it sit in overnights, which it did for the most part in the third quarter. And that's what drove the margin lower and we're definitely trying to move that money out into something that's higher earnings.

Okay, but so I mean, all else equal I mean, when you say the margin should stabilize here, I mean, that's kind of a 4Q, 1Q thing. And then where it trends from there will depend on the long end of the curve, obviously, but also just how and when you're able to move that liquidity back to a normalized level?

Yes, and I think the dynamic around that is just a marketplace and all three of us could comment on this. It's competitive. It feels like it's getting more competitive. There is—and so that dynamic around new pricing for new loans is going to be a variable that we're going to see how that plays out in terms of new volume. One good piece of news is in new originations, where we're originating new loans versus where the loan portfolio overall yield and the portfolio are getting pretty close. So at least in the near term, that's why we're getting a little more confident that the margin is going to stabilize here because the new volume we're bringing on is close to the yield that was recorded that's already on the balance sheet.

Just going to sneak one more in if I can, just on the fee side, Frank any more specific thoughts you can give on the outlook for wealth and capital markets and insurance. I mean, all three I thought showed really good sequential growth. And clearly gave you guys some ammo at a time when rates are really not helping you. I am just curious, if you can provide maybe a little bit more of a specific update on how the growth opportunities for those look and how we should be thinking about the revenue opportunity in the current environment?

Sure, and I'm glad you asked the question, because I think this ties directly to our strategic plan, as it relates to diversifying our revenue streams. We've been talking about this now for five or six years. And it was obviously not designed for a pandemic, but it was certainly designed for a slowdown or a time like we're in currently. Obviously, you're looking out in the future, what I can tell you is how we've gotten to where we are today. It's through a lot of discipline and execution on a strategic plan that Jen Fox was instrumental in creating and executing on, changing a little bit of the culture of those departments into much more sales-focused, as opposed to solely client service focused. And we see that playing out in the success we've had in growing numbers of accounts not just AUM which obviously we can't completely control the fluctuations in the markets on. We see a very similar kind of activity in insurance with the consolidation of multiple acquisitions we've made over the last couple of years fairly well baked in this year. I think Kim Trubiano, who is the President of our Insurance Group, has done an excellent job of integrating and consolidating those businesses. So, I think that gives a lot more renewed focus on the sales component of it even in this very difficult time. So, we see that playing out, and capital markets has been obviously our shining light over the last couple of years. It continues to grow; we can see lots of opportunities with expanded business just within the bank. We see some real good synergies obviously with the commercial lending and with our Private Banking Group and our SBA group. They've been able to really offer a level of sophistication that I think is unrivaled in our peer group. And I think that's also what is driving a lot of the results that we see. So that all being said, it's obviously a continued focus moving into 2021, 2022, 2023 because by all accounts we're going to be in this low interest rate environment for a long time.

Right. It does. And thank you guys for taking my questions and providing all the insights. I appreciate it. Stay well.

Thanks Mike.

And our next question today comes from Casey Whitman with Piper Sandler. Please go ahead.

This is Charlie Hough. I'm on for Casey today. So I guess I’ll ask the loan growth question, Mike. I mean, before COVID hit, you guys had spoken about growing C&I at a faster pace than CRE over the longer-term. I was wondering if that's still a goal, maybe in the near term on the other side of this crisis or if your stance has changed? And then in that being, I guess what’s a reasonable loan growth outlook as we think about 2021?

Yes, certainly Charlie it hasn't changed, that's just a continuation or expansion of the diversification of what this bank does. So we are focused on that, we're focused on acquiring talent in that area and it makes sense. Going forward, it's really hard to say. We're just—there is such a—I wish I had a crystal ball, probably wouldn't be talking to you if I did. It just—we have no idea, we're being very selective on credit at this point in time, just given where we are in the market, and I think we have to see how waves play out and where we are with the virus, really as we go into the first and second quarter. So I think it's going to have a lot of impact on the balance sheet and how we look at credit going forward from there. Mike or Liam want to add anything to it, but hopefully this will help you.

Yes, this is Mike. I just—pricing and risk appetite are going to be really important variables for us to monitor and risk appetite right now is probably lower than normal. And then pricing again is very dynamic right now and getting very competitive that's what we're seeing in the market. So yes, I agree with Frank, just trying to predict that right now is very challenging, and we're not ready to throw a number out there for 2021.

I would agree with both Mike and Frank, it's a pretty choppy market. Ultimately, the opportunities are driven by demand. And we're seeing spotty and episodic demand, as a lot of our entrepreneurial clients are waiting out the pandemic before making big decisions on capital plans or replacing their current banks. So it's not entirely frozen, but it's very choppy and very episodic in terms of our opportunities. And, again, we need to be selective given the uncertain economic outlook over the next several quarters.

Understood, that's all very helpful, thank you. And then Liam, I had one for you so starting with the uptick in classified loan balances this quarter about $20 million that you mentioned on the call. Can you give us a sense if there's any sort of geographic concentration within that bucket? And then, if those loans had been on deferral, I guess what the status is there would be helpful?

Sure, well a significant portion of our criticized and classified loans are in the hospitality and restaurant sector; essentially, that whole book was downgraded in Q2. So, the geographic concentration is all within our footprint, there's no outliers in terms of specifics there. And in terms of the Q3 stuff, it was one medium sized borrower in an industry that is very impacted by work from home. The rest is just one-off episodic kind of transactions; we haven't seen any wholesale deterioration outside of the stress seen in our hospitality and restaurant portfolios.

And our next question today comes from Christopher Marinac with FIG Partners. Please go ahead.

I also had a question for Liam, which just goes back to the off balance sheet reserve for unfunded commitments. Did that change at all from June to September?

Yes, it was up to $200,000.

Right okay, yes.

And that's separate from the allowance.

Yes, the experience changed.

Correct that's what I thought, great. Okay, thank you for that. And then Liam, do any of the deferrals come back into criticized or are they already in the criticized classifications at this point? I'm curious how that plays out in future quarters?

We took the tack of downgrading the majority of the second deferral population when—going back to Q1 when this was a dynamic event and customers were looking for relief. We did not initially downgrade stuff, but we've instituted a series of ongoing portfolio reviews, which resulted in the big step up in criticized loans in Q2. So, the bulk of those Q2 deferrals are in criticized, at least a substantial portion. And we don't see a backlog of stuff that's going to drift into criticized, because there'll be stuff coming out. And there'll be some puts and takes. Ultimately the outcome is going to be driven by the economy. If it's steady as she goes with no repeat shutdowns based on public health issues, yes, we don't see a lot of movements. But obviously, events on the ground are going to change everything. And we're watching every day.

Got it, thanks for that background, I appreciate. And then just a quick one, Frank you mentioned on the nCino adoption, some of the new bells and whistles they do. Can that benefit you in the near term or will the benefits of that piece of nCino take a couple quarters to get realized?

I think it's going to be out in a couple of quarters and even a little bit longer. I think what it does is slow down the pace of hiring more than seeing an immediate benefit today. There's actually—no, take that back: there are immediate benefits to our clients and customers, a much better experience. It creates a lot of efficiencies internally, but there's a learning curve to work through it. As things materialize or as we grow, you're going to see less hiring at the pace at which we were hiring before. Because this creates that capacity within the system, it also should really free up a lot of time for our lenders; that's an immediate impact because of the way this system operates. It's less manual, less pushing paper around and more straight through processing. Liam, you want to add anything to it, you're really impacted by it, more so than anyone you might think?

Sure, the benefits are as Frank said, they are largely in the future, because there's a learning curve for the people who operate the system, both customers and bankers, before you can fully realize the efficiencies. So it will be a continual ramp up over the next multiple quarters, before we're fully optimized. But it is especially in our consumer and small business segments, a much faster, much more streamlined approach to getting stuff done. The benefits are in the future.

Yes, I think this ties directly into our overall strategy which we really talked about at the end of Q2, which is less focus on the traditional retail kind of model and more focus on technology. We really saw the impact of what we did last year, which is the deposit module and being seamless during the PPP process and opening the accounts in PPP. It was virtually all through the nCino portal. So, hopefully those will start to land sooner than the commercial one, which is going to have the biggest impact. But we will be through three modules by the end of this first quarter, and we should start to see some of the benefits sooner rather than later.

Great, thanks again for all the background this morning.

Sure.

And our next question today comes from Matthew Breese with Stephens Inc. Please go ahead.

Just on the margin, I know that the messaging was stable. I would like to just parse it apart a little bit. Could you talk about the maturity schedule and the retail time deposit book seems like that's where the most repricing opportunity is? How fast is that reprice and what are the new rates?

Well, the new rates are, I think our top rate is about 20 to 30 basis points. You can look at the line item and see what the delta is there. The bulk of that maturity happens in the next nine months. So that's part of the drifting lower comment besides what we're doing just in our non-maturity side; there's a little bit of room left to move there. But I think we've almost at this point done pretty much everything we can do there.

Okay. And then on the loan yield side, I know you mentioned a fairly stable gap there. What is the incremental new loan yield for new loans?

It's less than 10 basis points at this point.

Yes, okay.

We're around 3.97% recorded in the press release, and right around that area for new volume. So again, I'm hedging that with the dynamic marketplace we're operating in. We've been trying to be very disciplined around floors and spreads, and spreads have widened, which is good. But it's going to be this trade-off—if competition keeps grinding lower in terms of spreads, then we have to make a decision around whether we're playing that market or we don't. And that's—we'll just have to see how things play out.

Understood, and maybe just going back to the loan growth question. I just want to get a better sense for overall activity. I mean if you feel like you're not getting the deals, is it because of it's overly competitive or is it just a general lack of activity? And if that continues for another couple quarters, I know the overall strategy is to lean into commercial more, but just in terms of maintaining the overall size of the book, could we see you go back to consumer segments just to maintain the size is that an option?

Well, your comment around just the commercial side and what’s happening there—we're going to continue to evaluate that from a risk appetite standpoint. As Liam said earlier, some of this is demand as well. So we've got the issue with how much demand is there. That's this period of uncertainty; the longer this lasts, the more we'll be stuck within this period of reduced demand because business people don't want to borrow money, they're waiting to see how this plays out. So we've got the demand aspect. Then on the terms and structure side, we're seeing not just pricing pressure and this hunger for yield, but then just selectively episodic loosening of credit standards, which you wouldn't expect to happen in this environment. So it's the same dynamic we always see and I think that just puts a lot of uncertainty around the commercial side.

I mean, I think exactly what Mike described is happening. And it's—I see that particularly in institutions that don't have diversified revenue; they stretch. That's the one thing we've always relied upon: our credit culture. That's something we're never going to give up on. As Mike was describing, you would not expect to see at a time like this covenants or guarantees being relaxed in ways that we're just not comfortable with. When institutions stretch, they may take on risks we're not willing to take. So as Mike talks about risk appetite, that is not our risk appetite to take that kind of risk in our portfolio at this point in time. When we go into other segments, we've never really been a consumer lender; that's not been our strength or our forte, and I don't know that we would jump into it now. But what it does do is gives us a unique opportunity to really focus hard on our non-interest income segments. If you go back to our history in 2008–2011, that's when we really jump-started our wealth group. We've been on the run since then. I think that gives us a lot more opportunity now to focus marketing efforts in those specific areas.

So the capital shift or the capital management shift wouldn't be towards other portions of the lending. The loan portfolio consumer wise would be more into fee income areas like BMT Delaware, things like that?

Fee income, I mean, there could be some other things going on the commercial side. But at this point in time, it's just—we don't know where we're headed. I think we're taking a very cautious eye on everything right now until we get a little better clarity and who knows when we're going to have that. It will be great to say we'll have it before the end of the year, but who knows. When we get that clarity, then we can start to talk about where we're going to be moving at that point in time.

Understood, and then capital is quite a bit—

Matt could I just add one example of what Frank is describing: when you see us suddenly the residential portfolio growing at an accelerated rate as an example from a pivot perspective, does that help in terms of a pivot? It's an example.

Right, just curious if capital is up quite a bit since last quarter, the dividend is intact. Do you feel more comfortable on that front or do you feel comfortable enough to maybe do something even like a buyback? Curious your thoughts there?

Again I think we have a very disciplined capital planning process. We go through looking at everything at our disposal and it's clearly on the table. But again, it's just about let's get through the next couple of months, and then everything is back up for discussion. We had our board meeting yesterday; we talk about these things all the time. It just—we don't feel at this point, given the industry, the economy, and the country, that it's the right time to start to jump into the buyback mode yet. So yes, I mean, we've got the capital, it's good. I think it's really good if we need it. And if we don't need it, there are a lot of things we can do with it in addition to buybacks.

And then my last one is just to go back to the expense discussion. Is it fair to say that this quarter’s expense rate, which includes the FT reduction, and includes the wind-down of BMT Advisors, this is a better starting point to work off of when we reduce that square footage for next year?

Yes, and I appreciate that some of that hasn't hit yet. We aren't seeing the full effect of the workforce actions either; you won't see the full effect until Q1. We started to see it immediately because some of those actions took place immediately, but there was also a lot of work-through days that went all the way through to the end of the year.

And our next question today comes from Erik Zwick with Boenning & Scattergood. Please go ahead.

One follow-up on the loan growth discussion, I appreciate all the commentary you've given so far about risk appetite being more cautious today and the pricing dynamic. Curious if you can provide any kind of quantitative numbers behind loan pipeline at September 30 versus maybe June 30 and also kind of into 2019. I'm just curious to maybe frame the change in borrower demand with some numbers if you have anything handy there?

I think we'd prefer not to give anything forward-looking. I'll say this is more anecdotal, and Frank and Liam can weigh in. But pipelines are obviously much lower than they were a year ago. Whether that's 50% or 60% or 40% I don't have a precise answer. We do have a loan pipeline that we're working. But yes, definitely demand is much lower than it's been, Erik. And that's all back to the conversation we've been having this morning.

And I think it's quite fair to say, again without getting into specific numbers, 9/30 looks better than 6/30 for certain. And the other thing to understand: demand has been there. It's not that it hasn't been there. It's just these may not be the credits or things we want to jump into right at this moment. So, we're just trying to be very selective and thoughtful about how we're deploying this liquidity at this point in time.

And just one last one from me, trying to understand your expectations for how the CECL model impacts provisioning going forward. The big change and the big build in reserves this year came in 1Q as the economic forecast changed. Then the second quarter and third quarter provisions have been more modest even as you've made some risk downgrades in the portfolio. Mike, in your prepared comments you mentioned episodic charge-offs as those charge-offs and losses occur if the economic forecast stays the same. My understanding is under CECL you would not necessarily have to replace reserves at that point, but reserves start to come back down as the cycle plays out. Can you clarify reserves and provisioning as the cycle plays out?

Yes, I'll answer that and then let Liam speak to it. The answer could be yes. If things stay the same and we move through time, that means we're getting closer to a time when things are normal. To the extent there were no charge-offs between now and that time, you would naturally expect the allowance to come down, because you would have predicted those losses. But to the extent those losses happen—and when they happen and how large they are relative to the allowances—that's the interplay. It's a pooled concept. Which loan charges off and how that loan is accounted for as a function of the pool is where this gets tricky, and that's where you could have some lumpy provisioning. The industry will have to deal with this situation because of the pooled methodology. Liam, do you have anything to add?

I think that's generally correct. It is done on a pool basis and there is a series of underlying assumptions. It really comes down to how quickly we revert to the mean—how quickly we revert to a baseline economy that's on an uptick and what's the damage between now and then. Frankly, none of the models can factor in some of the extraordinary mitigants out there that nobody could model for—PPP, interagency guidance that allowed for substantial loan deferrals, or whatever the next round of stimulus looks like and how that flows through to various customer segments. We think the correct path is to be constructively engaged with clients who are going to make it right. To the extent charge-offs happen, charge-offs happen. But the impact on ACL depends on these macro drivers and you could have some lumpy movements. To the extent the trend of charge-offs is reasonably modest, you could reasonably expect the ACL would decline over time.

And our next question today comes from Stan. Please go ahead.

I just wanted to touch on a couple things. We didn’t see across the industry solid sequential deposit growth, kind of across the board, even in the face of some lower time and broker deposits. Can you talk about what trend you're seeing there that showed pretty significant decline here sequentially?

Yes, some of what you saw happening with us is the bulk of the reduction in deposits quarter-over-quarter was really a lot of actions we were taking to just push some excess liquidity out. Generally speaking, the retail deposit profiles remain pretty much intact and normal for us. We have a very established seasonality pattern, and typically late second quarter into third quarter, we actually see some run-off, and then we start to see a build going into the end of the year, and we're seeing that pattern play out as it typically does in that early part of Q4 here. So, we haven't really seen a huge change in that pattern. So the large increase in deposit balances earlier is really related to PPP and that activity.

I understand that. I've heard a couple comments from other CEOs across the country that even in the face of the PPP, which obviously drove a good chunk of it in the second quarter, some of them are a little surprised that the deposits are not going out—people using cash for various purposes. It seems like you guys bucked the trend a little bit?

Keep in mind our base—we have a large commercial base of customers. So I think we have a slightly different pattern than someone more retail oriented.

Okay. And then, can I get a little bit more granularity on the deferrals in the hospitality space? Is that the bulk of them or around there?

The hospitality book in general is a little under $100 million and certainly more than half of that is on deferral. That sector was hit hard and right now many of those deferrals roll off in Q4. We would anticipate some subset of that potentially seeking some incremental deferral action into 2021. Although I would caution folks the deferral doesn't mean necessarily a 100% payment deferral. Some of the deferral activity contemplated is moving folks from an amortizing basis to an interest-only basis for a period of time. So a big hunk of our hospitality book was on deferral. Some have rolled off and resumed payments, and the rest will be rolling off deferral in Q4 and subject to any individual properties that might be looking for relief over the winter and into the spring.

Of course, that's the sector that's going to take quite a bit of time to get through. All right, that's about all I have for now. If I have any other questions, I'll give you a shout.

Thanks Stan.

Ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any further remarks.

Thanks Rocco. And just a quick thank you to all of you for your interest in the bank, to our shareholders, to our employees and our clients again a big thanks. We'll talk to you next quarter. Thank you.

And thank you, sir. This concludes today's conference. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.