Good morning, and welcome to the joint SouthState Corporation and CenterState Bank Corporation quarterly earnings conference call. Today's call is being recorded, and all participants will be in listen-only mode for the first part of the call. Later, we will open the line for questions with the research analyst community. I will now turn the call over to Will Matthews, CenterState Bank Corporation's Chief Financial Officer. Please go ahead.
Good morning, and welcome. Thank you for joining us. This is Will Matthews, and joining me on this call are Robert Hill, John Corbett, John Pollok, Steve Young, Richard Murray, Dan Bockhorst, and Jonathan Kivett. Given our pending merger, we thought it appropriate to hold a joint conference call to discuss our first quarter results in order to facilitate the sharing of information that may be of interest to investors in both companies. Let me first state that we're, of course, still operating two companies separately and will continue to do so through closing. While we are managing two separate companies, we're actively engaged in integration planning and believe we are making great progress on these plans, and we look forward to becoming one company officially on the same team upon closing.
The format for this call will be that we will each provide prepared remarks about our individual company's performance, and we'll then open it up for questions, which we will take jointly. We will ask when you have a question that you direct it to either a person, a company, or both. Given our inability to travel due to the coronavirus, we're each calling in from different locations. We hope the technology and our operation thereof will cooperate, and we thank you in advance for your patience with the difficulties presented by holding a teleconference with multiple speakers from multiple locations and phone lines. Yesterday evening, each company issued a press release to announce its earnings for Q1 2020. We've also each posted presentation slides that we will refer to on today's call on each company's investor relations website.
Before we begin our remarks, I want to remind you that comments made by management teams of both SouthState and CenterState may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements we may make are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in today's press release and presentation for more information about risks and uncertainties which may affect us. Now I'll turn the call over to John Corbett. He and I will deliver CenterState's prepared remarks, after which we will turn it over to Robert Hill to lead the SouthState team through its comments. We'll then take joint Q&A. John?
Thank you, Will. Good morning to all of you, and thanks for joining us this morning. I hope you and your families are remaining healthy and safe. I'm going to share some high-level observations on our business performance, talk about our efforts to support our employees and clients during this humanitarian crisis, then also give you an update on our pending merger. For the first quarter of 2020, CenterState produced $35 million in after-tax earnings. This is after an elevated CECL provision of $45 million as a result of the pandemic. Even after the special loan loss reserve, the company still produced a return on tangible common equity of about 10%. Capital levels remain strong, with a tangible common equity at 9.1%.
In response to the pandemic, both Will and Steve have begun stressing our capital position on a pro forma basis with SouthState Bank to confirm our ability to travel through this cycle without impacting our dividend or common equity. Together with SouthState, we enter this downturn with a much stronger pre-tax, pre-provision earnings than a decade ago, a conservatively underwritten credit book with significant borrower equity, and surplus capital. Fee income continues to be a bright spot as the drop in interest rates provides a tailwind to both our capital markets business and mortgage business. Both of these businesses are operating at record levels of sales and profitability. Fee income now represents 1.3% of assets, which is above our 1% goal.
The liquidity of the company is also strong, with over $1 billion in cash and Fed funds driven by non-CDI deposit growth of 13% during the quarter. As for asset quality, CenterState ended the quarter in good shape with an NPA ratio of 48 basis points and only five basis points of net charge-offs. While bottom-line earnings are always important, other more urgent priorities took center stage in March and April as we quickly shifted our attention to the health and safety of our teammates and providing financial relief to our clients during the mandatory shutdown. We kept our branches open during the shutdown, but we moved quickly to limit them to drive-through service only to reduce the exposure of the virus to our branch employees. 93% of the remaining non-branch staff have been working from home ever since.
Fortunately, our teams have experience working from home during hurricane season, when there are also mandatory closures. Despite the personal hardships on our team, they were eager to provide financial relief to our clients. Times of crisis are when our clients depend on us the most, and we can really make a difference in their lives. Early in the shutdown, our relationship managers and branch managers began an organized calling campaign to proactively offer assistance to those that are the most vulnerable. We offered loan payment deferrals, fee waivers for ATMs and CD withdrawals. We increased our mobile deposit limits and began ramping up the process to distribute Paycheck Protection loans to struggling small business clients.
I'd like to suggest that it's time to rethink the term banker's hours. When I started in this business 30 years ago, I had a preconceived notion, like many, of a 9:00 A.M. to 5:00 P.M. workday and golf at the country club in the afternoon. Nobody predicted that bankers' hours in 2020 would be 24 hours a day, seven days a week, with bankers at their desks after midnight. That is precisely what occurred in the two weeks after the PPP forgivable loan program was launched by the SBA. Easter weekend was the crucible, as our bankers at CenterState worked around the clock and processed 2,800 loans through the SBA for loan proceeds of a half a billion dollars in just two days, Saturday and Easter Sunday.
To put that in perspective, that is three times the volume of loans that we generated a month, and our team did it over a holiday weekend. Since the program launched, CenterState secured in total nearly 7,000 loans for $1.1 billion of cash flow relief for our small business clients. The largest loan was $6 million, and the smallest was just $1,170. Borrowers included everything from doctors to plumbers to retail stores and to churches and schools. In all, CenterState secured continued paychecks for 130,000 workers. I'd like to publicly express my pride and appreciation to our team for their patriotism during a national crisis. They stepped up, and they were there for our clients in a time of need. Finally, I'm happy to announce that the merger between CenterState Bank and SouthState Bank is proceeding as planned.
We filed the S-4, and then we have scheduled the shareholder vote for May 21st. We feel confident that the merger will close on schedule in the third quarter, and there's also a small chance we could complete the merger ahead of schedule. Our joint SouthState and CenterState executive team began working together as one leadership team before the announcement in January, and we continue to meet every Wednesday to integrate the two companies, even during this crisis. Periods like this of crisis and stress can be times when new teams are fragmented and people are driven apart, or they can be opportunities when new teams are strengthened through the trials that they overcome together. As our newly combined executive team with SouthState collaborated through the crisis, the silver lining is that our personal relationships and our trust in one another have grown stronger.
We are eager to move forward to serve our clients and communities and to produce generous returns for our shareholders and to do it together as one high-performing company. Will, over to you for more color on the first quarter financials.
Thanks, John. Our net interest margin was 4.17%, down eight basis points from Q4. Our core NIM, excluding all accretion, was 3.74%, down three basis points. Loan yields ex accretion were down nine basis points. Interest-bearing deposit costs were down 10 basis points. Our teams made good progress again in March after the rate cuts. We had a record quarter for revenue in spite of one fewer day and $2.3 million in lower accretion income versus Q4, driven by our non-interest income businesses. Our correspondent business, which is capital markets and fixed income, had $27.8 million in revenue. Mortgage had a great quarter as well, with revenue of $11 million. Turning to credit and CECL, we had non-PCD net charge-offs of $1.1 million or four basis points annualized, with total net charge-offs of $1.4 million or five basis points.
Non-accrual loans ended at $79.4 million with the new accounting treatment of PCD loans, bringing ending NPAs to assets to 48 basis points. Absent the accounting change, the non-performing ratios were in line with the previous four quarters. Our initial CECL reserve was $115 million, or 96 basis points, plus an additional $6 million for unfunded commitments. Additionally, at quarter end and in light of the impact of the coronavirus on economic forecasts, we made a Q1 provision for credit losses of $44.9 million, plus an additional $1 million expense to increase the reserve for unfunded commitments for a total expense of $45.9 million, in spite of us only recognizing $1.4 million in net charge-offs during the quarter and essentially having very little loan growth. This brings our ending allowance for credit losses to $158.7 million or 1.32%. This represents a 37.7% increase over the day one CECL adoption allowance.
Including the reserve for unfunded commitments, which resides on the liability side of the balance sheet, this would be 138 basis points. We also have on the balance sheet a remaining non-credit discount of $81.2 million for purchased loans, as is disclosed on page six of the earnings release. Turning to non-interest expenses, our efficiency ratio was 54.9% adjusted. Relative to Q4 2019, our compensation expense was up $4.1 million, including $2.9 million in higher health insurance, as we have a self-insured high deductible plan, so Q1 expense estimates are often higher, $1 million in higher FICA expense in Q1 versus Q4 2019 due to the annual resetting of the FICA cap. Included in our other NIE line is the $1 million expense to increase the CECL reserve for unfunded commitments. Our FDIC assessment expense was up $1.1 million versus Q4.
In terms of our tax rate, we recognized a $2.3 million benefit from the ability under the CARES Act to carry back NOLs to prior years with a higher tax rate. We also had some equity comp payout in the first quarter and recognized $1.4 million in excess tax benefits from that. Turning to capital formation. We reported an ROTCE of 9.9% in spite of the $46 million provision for credit losses and unfunded commitments in the quarter. While we did grow the balance sheet to add some liquidity and had 13% non-CD deposit growth and 17% DDA growth, our loan growth was only 1%, so loan growth did not consume capital in Q1.
While margins for the industry will feel pressure in this zero rate environment, which will impact our profitability of course, we're pleased we were able to earn an almost 10% ROTCE in a quarter with this kind of credit cost, and that we earned over $90 million in pre-tax, pre-provision income in the quarter. This equates to a pre-pre ROA of 2.09%. We're also pleased that we ended the quarter with a TCE ratio north of 9% on the heels of CECL adoption and a higher Q1 CECL provision expense. A strong capital position, good core deposit growth, strong pre-pre performance, and a healthy addition to our allowance during the quarter with a respectable ROTCE of almost 10% after all of that. I'll now turn it over to Robert.
Good morning. It is a pleasure to be with you today and hope that you, your coworkers, and your families are well. Our first quarter was strong with record revenues, solid loan and deposit growth, and a strengthened balance sheet with added liquidity and increased provisioning for loan losses. While pre-provision earnings were at record levels, we felt that preparation for the economic environment ahead of us was very important. We therefore bolstered our loan loss provision by approximately $36 million. John Pollok will provide more color on our financial results in just a minute, and I will start by sharing the way our bank is leading and managing through this period. Our bank is a reflection of the people, businesses, and communities we serve. When they are going through tough times, it is our job to be part of the solution.
This has been the foundation of our culture since the bank was started on the heels of the Great Depression, and it continues to this day. Our bankers have served and sacrificed in the last few weeks to support our customers like never before. Beginning in late February, our crisis response team was activated in response to COVID-19. This team has guided us successfully through a number of natural disasters. While this crisis is different, the experience gained from past disasters is invaluable. I would like to talk about where our focus has been these past few weeks and what we're doing to prepare for a more challenging future. Throughout this period, we remain committed to making decisions based upon a long-term view, and we see this as a time where relationships can be forged for decades to come.
Our focus is in two main areas, our team and our customers. Let me start with our team. In addition to the ongoing efforts of running the company, our team has been working around the clock to assist customers. All the while, we are still working to merge our two great companies in the third quarter of this year. I'm very proud of our team and enormously grateful for how they've handled this crisis. Throughout the company, the stories of sacrifice are incredibly inspiring. The SouthState team has responded to the call. As strong as we have been in the past, we have never been stronger as a team than we are today. With 80% of our employees working from home and certain branch and support teams continue to work at their respective locations with almost all of our branches open and providing drive-through service.
We have been fortunate to have just a few employees impacted by COVID-19. As it relates to our customers, while we are not on the healthcare front lines, we are among the economic first responders. We are companies whose deposit and loan relationships are made up of hundreds of thousands of individuals and businesses. This crisis knows no boundaries and is impacting small and medium-sized businesses and their employees across our footprint. Providing customer access to our bankers and our branches has been our top priority. We have expanded our outreach both in person and digitally and have experienced a significant increase in our digital delivery channels. Early on, we mobilized task forces in both our consumer and commercial areas to develop responses to customer needs. We have found that in times of crisis, communication is even more important.
Job one was to proactively call our customers and understand how they are positioned to weather the storm. Much of the efforts to date have been focused on providing principal and interest deferrals to consumer and commercial customers and facilitating loans for small businesses through the PPP program. We took a proactive approach with 90-day payment deferrals for areas most impacted. We've processed principal and interest deferrals of approximately 4% of our notes and 20% of total principal balances. These deferrals were not made because of the inability to pay, but instead, these deferrals allow us to have a more constructive dialogue with our customers and to work together to manage through this environment. Regarding the PPP program, our team has worked around the clock for weeks to support existing customers and welcome new customers to our bank.
To date, we have assisted almost 6,000 small businesses through the program for a total of approximately $900 million. The average loan size is about $150,000. We have a great opportunity to assist those in need, and as other programs are developed, we stand ready to deliver them to our customers. SouthState enters this period in very good financial health. Our operating principles have always been soundness, profitability, and growth. Soundness speaks to capital strength, core deposit funding, liquidity, and a granular and high-quality loan portfolio. While this crisis is certainly different than others we have faced, in many ways, we have been making decisions in preparation for this crisis for decades. Finally, I want to thank both the CenterState and South State teams. While we continue to operate and serve our customers separately during this time, we are becoming stronger as one team.
This crisis we're experiencing today makes the opportunity we have together even more compelling and confirms that this is the right partnership for our banks and for the opportunities ahead. I will now turn the call over to John Pollok to discuss SouthState Bank first quarter financial results in detail.
Thank you, Robert. As Robert mentioned, our teams have been very active risk managers, ensuring that we are taking care of the needs of our great customer base and our shareholders. Our earnings this quarter were impacted by sizable provision of loan losses under the new implemented CECL standard due to a very different economic forecast than what we first imagined at the start of the year. Our provision for loan losses this quarter totaled $36.5 million as compared to $3.6 million last quarter. With much of the attention returning to asset quality, we've added some slides this quarter to help give you some insight into various segments of our loan portfolio, and Jonathan Kivett, our Chief Credit Officer, will speak to many of these during the Q&A session.
We begin this economic downturn with what we believe is a very solid balance sheet with strong levels of liquidity and capital. Beginning with slide number 16, our net income totaled $24.1 million, or $0.71 per share. Excluding merger expenses, adjusted net income totaled $27.6 million or $0.82 per share. Without the impact of a much higher provision for future loan losses, our performance was very strong with growth in total revenues as net interest income and non-interest income improved $1.6 million and $7.8 million, respectively. On slide number 17, you can see our net interest margin increased four basis points linked quarter to 3.68% as the yield on earning assets was unchanged and our cost of funds declined four basis points. Total interest to earning assets advanced a little over $200 million with average loan growth of over $140 million, as seen on slide number 18.
During mid-March, with uncertainty surrounding COVID-19 increasing, we added to our liquidity position with new borrowings totaling $500 million. We anticipate much of our loan demand during the second quarter will be under the SBA Paycheck Protection Program, with a current pipeline of $900 million. Turning to slide number 19, you can see our accretion income totaled $10.9 million, up three and a half million dollars as the result of the adoption of CECL and the change from pool accounting. In the absence of pool accounting, any discount remaining on acquired loans will be accreted in as these loans pay down, renew, or mature. On slide number 20, you can see the $52 million discount that remains on this $2 billion acquired portfolio. Turning to slide number 21, non-interest income increased by $7.8 million this quarter, with mortgage banking income $10.9 million higher.
Of this amount, secondary market income was $4.8 million higher, and our mortgage servicing related income was higher by $6.1 million. The mortgage servicing rights income was unusually high as the hedge gain significantly outpaced the decline in the fair value of the asset. This is the result of the 10-year treasury yield declining much more significantly than the overall mortgage rates during the period. Lower mortgage rates, of course, significantly increased the application activity, and our team has done a fantastic job processing this additional volume. Acquired loan recoveries no longer contribute to non-interest income in the post-CECL world, but totaled $1.2 million this quarter and now flow through the loan loss provision. Wealth management income was $500,000 higher this quarter, and our capital markets group had a strong quarter of back-to-back swap activity during this declining rate environment.
On slide number 22, you can see the net changes in all non-interest expense categories. Excluding merger-related expenses, adjusted non-interest expense increased $4 million, about $2 million of which resulted in higher FICA taxes in the new year. The other expense category was also higher by $2.4 million as it related to higher amortization expense of passive loss investments, which has a positive impact on the income tax expense. Slide number 23 shows our efficiency ratio increased slightly to 62.1% from 61.6% last quarter. Adjusted for merger expenses, the efficiency ratio decreased to 59.7% from 60.7%, primarily due to a $9.3 million increase in total revenues. Tangible book value, as shown on slide number 24, declined $1.12 linked quarter, primarily due to the adoption of CECL.
Until the impacts of the COVID-19 on our economy are in the rear view mirror, we do not anticipate any share repurchase activity at this time. I will now turn the call over to John Corbett, CEO of SouthState Bank.
As a reminder, we are conducting this call remotely, and I ask that you please direct your question to the appropriate individual you would like to respond. This concludes our prepared remarks, and I would like to ask the operator to open the call for questions.
We will now open the line for questions. If you'd like to ask a question, please press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Stephen Scouten with Piper Sandler. Please go ahead.
Hey, good morning, everyone. I guess my first question would be maybe for both teams. I guess maybe first for SouthState. I noticed 100% of the lodging portfolio under deferral. I'm wondering with that portfolio, as well as maybe all the deferred loans in particular, how much of that was you guys reaching out to customers versus inbound calls requesting deferrals? Why you think there haven't been more deferrals on as a percentage basis for the consumer kind of resi book? I've seen kind of various things from different companies this quarter. Seemed like a pretty large percentage at like 89% on the commercial side.
Stephen, this is Robert. I'll start, and then we've got Jonathan Kivett, our Chief Credit Officer. I'll turn it over to him. I think you can take multiple strategies on deferrals. When we knew certain segments were going to get hit, we were talking to those customers instantly. Taking the hotel book, for example, these aren't national hotel operators. These are local operators, who've mostly raised local equity with local investors and have really good liquidity and loan-to-value. We know these people very well. We engaged with them. It wasn't a needs-based approach. It was really, we know that the next 90 days are going to be tougher for the hotel industry. Let's defer for 90 days. During that time, let's engage. Let's get information.
Let's make sure we understand your liquidity position, what you take to break even, and how we come up for air in the next 90 days. That was the philosophy behind it. It was, I'd say, really all proactive on our part to help those customers kind of bridge the gap to get to the other side. Jonathan, I turn it over to you for any additional color.
No, I think that's right, Robert. The numbers that commercial at 90% are almost exclusively based on outbound calling, just being proactive, particularly in those industries, the hotels, retail, and restaurant industries. I think on the consumer book, I think the reason those numbers are a little bit lower is that is more reactive. We just haven't been as proactive in calling and making those outbound calls.
Okay. Maybe, I don't know, Will, if you might be able to comment on kind of the similar ideology in terms of the deferrals and thoughts on consumer deferrals moving forward?
That's probably better answered by John or Dan.
Yeah.
Okay.
Stephen, this is John. Dan, many of you don't know Dan. Dan has been the Chief Credit Officer here at CenterState for about a decade. Prior to that, Dan was the head of special assets for RBC for Florida. Even before that, he worked with Richard and Will back at the Alabama National. Dan's been with us in a combined team for a long time. Dan, you want to address that?
Yes, very similar to what Robert and Jonathan indicated. Very proactive on the commercial side and more reactive on the consumer side. Expect that the consumer side will be continued to be somewhat stable and muted.
Okay. Dan, you don't expect to see any increases on the consumer side, resi mortgage, I guess auto. Do you think that could continue to escalate throughout the coming quarter?
We've seen a noticeable kind of leveling and drop off of the deferral requests. Those that have been impacted have been impacted already. We have very little exposure on consumer side for auto or any of those smaller dollar consumer type loans.
Okay, great. Very helpful. Maybe, I don't know if this is Will or John, but curious if you could give us any kind of visibility, and I know this is hard, into where you think the combined NIM could basically shake out at this point. I mean, there's a lot of moving parts obviously heading in the next quarter with rates, just kind of get some kind of directional thoughts on where the combined NIM could go and how we can think about that.
Yeah, Stephen, this is John. I'm going to let Steve Young answer that.
Sure. Hey, Stephen. I want to speak for SouthState here, but from a CenterState perspective, yeah, we were pretty pleased with how the NIM shook out this quarter. The core NIM was only down three basis points. I think that really reflects, we can't help what's going on the asset side, but there is a real discipline from both banks around our core funding as well as we can control. There's been a lot of effort to reduce rates on the deposit side. To give a prediction from here is difficult, as we know, because the environment's a little uncertain.
I guess if we look backwards, I think we're really pleased at CenterState on how the core margin, I think we were at 374, and maybe John Pollok, you want to talk to SouthState's margin in the past. Obviously in the future margin's going to be a little bit more challenging. I do think the balance sheets are a little bit bigger, which will help offset some of that. John, do you have any comments?
Sure. I appreciate the question, Stephen. I'd say a couple things. I think first, as we've talked a lot about over the past six months, is we knew going into the first quarter of this year, the impact of CECL on our margin. As we've talked about the discount now, it's coming through faster. I think a slide that you ought to look at, Stephen, really it's in both decks is on page 20 of both of our decks, we show you the discount. That discount that we each have, $52 million for us, about $81 million for CenterState, that accretion's going to keep coming through, and it's going to come through probably faster. That clearly is having a positive impact on the margin. As we all know, there's clearly going to be pressure with the way rates have come down.
Let's talk about the funding side a second. You can kind of see in terms of our cost of funds for the quarter has gotten down to 59 basis points. Well, if you look at March now, just kind of carve out March, it's down to 53. We're seeing really on the funding side a lot of relief there. We're getting tons of funding. In fact, our deposits are up over $1 billion since the end of the quarter. Obviously we got these PPP loans that have come through. We both got a big slug of that. Trying to model that, Stephen, the fees are going to run through the margin, 70% of those loans probably get forgiven in the next few months, and then you'll kind of have a tail off of that.
Definitely a lot of moving pieces around it, but got to have good core funding in this environment, and we continue to see good opportunities. I think as both teams mentioned, we played some offense on the PPP side to get new customers.
Okay, great. Maybe just one last one for me. Curious, John, maybe if you could comment on expectations around service charge revenues. Obviously, that's a pretty big chunk of non-interest revenue for you guys, and just curious how you think that could play out with maybe fees being forgiven or less activity on cards and other things of that nature.
This is John Pollok. I guess I'll start with that. I'd say, let's just think about the PPP fees for a minute, is we're going to be after expenses north of $20 million. These contracts are written in pencil, right? The rules continue to change. Are we going to have to put up a loan loss reserve? Stephen, I'm not 100% sure, but +$20 million in fees clearly pays a lot of bills that we've all been experiencing. I know CenterState could comment on their number, but clearly that's going to help in terms of trying to pay for all that.
Yeah, I guess I meant more like deposit account fees and just like directionally if that, if we should see a big drop off there.
Well, they'll be tougher. Clearly, the consumer's out less. The bottom line is the unemployment rate's going to drive a lot of these things, what the charge-offs are, what the fee income is. The consumer's clearly getting a lot more cash right now. They've gotten a few stimulus checks, I think you're seeing with all people, they're kind of being a little bit more stingy with their cash and kind of holding onto that. Yeah, it should have some impact, I would think, on those fees, Stephen.
Okay, great. Thanks for the color, guys. Appreciate it.
Thanks.
Our next question today comes from Catherine Mealor, KBW. Please go ahead.
Thanks. Good morning.
Good morning, Catherine.
Morning.
I wanted to see, and maybe we can-- I guess I'll direct it maybe to John first and then to Will, just to talk about the economic assumptions that went into your calculation for this provision and your reserve build this quarter, and then how you think about how maybe some of those economic assumptions have changed since quarter end. Just kind of to help us get a sense as to how you're thinking about what kind of level of future reserve builds that we may see. Thanks.
This is John. I'll start, Catherine. When we have developed our CECL model, we use Moody's Analytics for the economic forecast. Obviously Moody's has put out three different forecasts, one on the 10th, the 20th, then the 27th of March, then we didn't really get the final until April the 2. We're kind of using the Moody's baseline COVID-19. It's got clearly a recession in the first part of the year, unemployment going up to 9% in the second quarter. Kind of peak to trough GDP about -6%. Hopefully a partial bounce back in the third quarter. Then I think the key number in that forecast is when does full employment come back? In that forecast, it's 2023. You kind of have that, it kind of helps you accumulate the data. I say, Catherine, so you got that piece.
I think how we're thinking about it, clearly predicting the future is a complete guess in this environment. Nobody really knows today. I think unemployment's clearly the key, was the key last time. How unemployment goes is how past dues are going to go and how defaults are going to go. We've obviously had an instant shock of supply and demand. Finally, a lot of people like to use letters. We clearly don't think it's a V. I hope it's not an L. It feels like it's more of a wider U, or it might be a W. What I mean by a W is stimulus comes in, we kind of see an uptick, and then we see a downtick as we kind of rationalize some of these businesses. That's how we kind of think about it.
I think in the second quarter, clearly, I guess I'm going to get three more forecasts from Moody's this quarter, I'm sure they'll all be a little different. I think our view is we would continue to see some pressure in the second quarter, but still a bit of time to play out. With that, I'll kind of toss it over to Will.
Yeah. Thanks, John. Yeah, Catherine, our models are not exactly the same, but they share a lot of the same components. We also use the Moody's baseline COVID forecast. As John said, that has been changing on a very rapid basis. Within that, the factors that are probably most correlated with loan defaults and provision expense would be unemployment, number one, housing price index, CRE price index, homeowner vacancy rate, things like that. I'll echo what John said, what I think a lot of other banks have said, which is that at March 31, based on the information available, everybody felt that their provision was appropriate and their allowance was appropriate.
If we get the same type of changes daily, weekly that we've gotten before, it's likely that we get onto June 30th, you'll see the industry, ourselves included, continue to build reserves because it doesn't look like the economic forecasts at this point are getting any brighter. Last comment I'll make is just to remind ourselves as much as you that these are models and built off historical data, in many cases, different underwriting practices going into them. Today, it's a geography question because the capital moved from Tier 1 to Tier 2, our hope is that it doesn't flush out of Tier 2 into losses. Time will tell, and our ability to manage through the crisis will govern that as well.
Okay. That's very helpful. Thank you. Maybe a follow-up is just as you're thinking about the merger, any updated thoughts on how you're kind of thinking about CenterState's loan mark, and kind of balancing reserve builds from this quarter and next quarter before the deal closes versus an updated mark upon closure? Thank you.
Yeah, Catherine, I'll start with that. John may jump in. We've been talking together on this. As we just alluded to, the economy's changed a lot since we first modeled this deal when we announced it in late January. We will model our book at close because that's the proper way to do it. Certainly when the times are changing like this, you need to wait until close. Clearly and logically, given the change in economic forecasts, the credit mark should increase from what we originally modeled. Additionally, it's likely that the percentage of PCD loans would also increase, which would mean that the double counting impact of the non-PCD loans would decrease. CDI is likely to be lower today than it was before. Rate mark's likely to be lower today than it would've been before.
If that's all still true at close, those are some of the directional impacts. I'll also remind you, just looking back to our modeling, though, our combined CECL reserves, the two companies at March 31 were some $105 million higher than what was in the original merger model. We're not yet ready to say what the revised marks will be, and we won't really be able to do that until we're at close. Those are directionally, I think, where you should be thinking about it. John, do you have any additions?
I think that I agree with your comments.
Great. Very helpful. Thank you.
Again, if you have a question, it's star then one to enter the queue. Our next question comes from Michael Rose at Raymond James. Please go ahead.
Hey, good morning, guys. How are you?
Good, Michael.
Hey, just wanted to dig into the restaurant book a little bit. I know some of the markets in Florida, John, are obviously diverse. Orlando, a little bit more travel and tourism. Tampa, a little bit more business-oriented. I guess I was a little bit surprised to only see 35% deferral at this point. Can you give a little color on, and I'm sorry if I missed it, but on the concepts, the split between fast casual and maybe fast food and et cetera. Just any sort of color there would be great. Thanks.
Yeah, sure. The nice thing is we're going into this without concentration there. I think it's 3%, a little bit less than 3%, but I'll ask Dan to address that. Dan?
Yeah. I can give you kind of some overview on the restaurant side. Our top two exposures are Darden, three of the top 10 are Darden. We have good, strong guarantors. If you look at the top 25 credits, seven requested deferrals. The guarantors have high seven-figure or higher liquidity. We are seeing a little bit of borrowers, guarantors accepting a deferral when there's probably not a short-term need for that based on that guarantor support. We do skew higher to the quick service, the Chick-fil-A's, some of those type of restaurant credits as well.
Okay. That's very helpful. Then maybe just on the retail CRE book, which is obviously a little bit bigger, 23% on deferral. Can you just give some color there on whether it's type of store, location, geography breakdown, just a little bit more color to get us comfortable on why you feel that portfolio will hold up? Thanks.
Yeah, happy to do that. I think our disciplined underwriting and approach to lending will pay off, especially in this sector. Our guiding principles have always been cash equity, guarantor liquidity, dealing with borrowers who were successful in the last downturn, relationship driven. Our typical center is a neighborhood center. It's going to be in dense markets with barriers to entry. Good example would be a neighborhood center in Boca Raton. You've got the ocean on one side, the Everglades on the other. It's going to be dense and where the demand for the services will continue for the long term. A good example is some of the tenant exposure in these type of centers, Dollar General, Pizza Hut, Allstate Insurance, they're all in the top 10. These are national type tenants that are going to have long-term need for these local communities.
Okay, maybe just one final one for me, just maybe for Steve on the correspondent banking business. Obviously some good numbers this quarter. Just in the very near term, would you expect any sort of change in activity levels within the various components of the business? Thanks.
Yeah. Thanks, Michael. Just to back up for a second on the correspondent business and really just on these fee income businesses that John and Will both talked about. Big picture, a few years ago, we wanted to make sure we built the bank to have diversified revenue streams in any rate environment. Just if you look at this quarter, our net interest income to revenue was around 73%, which means we had 27% worth of non-interest income. A year ago, March of 2019, our net interest income represented 80% of our revenue. What it does is it really hedges these businesses, really hedge the downside risks of margin and rates. As it relates to correspondent, it was a record quarter. Our interest rate swap business was up from the fourth quarter, which was a record quarter, about $2.9 million.
We also were pleased to see our fixed income business increase about $1.7 million. That was about $4.5 million is your number there. In the future, as we think about it, coming off a record quarter, you're not going to be able to do that every quarter. We think the fixed income should continue to be a real positive. The interest rate swap business will slow down as new purchases will not be as robust. You will have some refinances, but we see that business slowing down some but still at a higher elevated pace. Hopefully that helps you.
It does. Hey guys, thanks for taking my questions.
Thank you, Michael.
Our next question comes from Christopher Marinac at Janney Montgomery Scott LLC. Please go ahead.
Hey, thanks. Good morning. We really appreciate all the information that both companies provided on the disclosures. I just wanted to ask more about kind of the deferrals, and to what extent do we see that translate over time into criticized classified loans or do you think that we'll see some catch up on those loan grades by the end of next quarter, or will it take longer for that to play out?
Hey, Chris, this is John. Jonathan, you want to take a stab at that and then maybe Dan can follow up?
Yeah, sure. I think initially we're not going to see that change in grade. I think over time, and I think that's the question is how long is it going to take? I would say over the next two quarters, you're going to start to see that catch up. Most of the borrowers are under a 90-day P&I deferral. That P&I deferral, probably the vintage of that is, call it mid-March. You're talking about mid-June for the deferral to come to an end, and then we're going to obviously be having ongoing conversations. But I think at the end of that deferral period, you're going to have, so call it late second quarter, early third quarter, you're going to really start to know. And hopefully we're a little further through this pandemic.
We got a better understanding of how the economy's going to get kicked back into gear and the long-term outlook for some of these businesses is going to be better, and these industries. We'll know a lot better. I think into Q2 might be a little early, but I'm certainly thinking that Q3 will have a real good gauge on long-term prospects and grades.
Yeah, I'll echo some of the same timing as Jonathan. Remind everybody from a regulatory perspective, the regulators gave guidance that six months was kind of a timeframe that they were looking at before something would be classified as a TDR. The majority of ours are on a 90-day deferral. At that end of that 90 days, we'll evaluate if another 90 days is needed. At that time, maybe there's an opportunity to shore up with additional collateral, additional guarantor support. I would say that a lot of the ones that are getting deferrals do have solid guarantor support with strong liquidity, where we don't think there's going to be a significant impact to the risk rating long- term.
Okay. Chris, this is Robert. I just kind of add on to what they said. I think trying to draw a correlation between deferral and loss or problem loan at this stage is just not really a leap you can make. I think it's a unique situation. We're handling some industries in a unique way, but I think as Dan said, well, the guarantor support and the liquidity that they have, we feel really good about. In fact, the larger ones are the ones that are really well-positioned, and most of these are at significant equity and significant guarantor strength. Some of the smaller ones actually could be the ones that struggle. I think that's where it gets back to trying to make the correlation between the two. Most of our markets don't have significant COVID-19 impact. It's not Manhattan where you've obviously got significant impact.
We feel like over a certain period of time, these businesses will begin to reopen and be able to operate and pay principal interest on a normal payment without having 80% occupancy like they're used to. I think that's why we felt like we needed a proactive, engaged approach with the customer was just a better approach. I just think it's way too early to try to draw a correlation between the deferrals and any future problem assets.
Sounds good. I appreciate that background a lot. Thanks.
Our next question today comes from Jennifer Demba at SunTrust. Please go ahead.
Thank you. Good morning.
Good morning, Jennifer.
Question for Will. Will, does all that's going on right now with the pandemic and the shutdown, does that change at all the timing on the merger cost savings? You said the closing should happen on time.
Yeah, Jennifer, I think you're going to hear a theme, depending upon how many questions we take today that will state a couple of things. One, we're focused on our teams, and we're focused on our customers. You'll also hear us say that we think this is a pretty significant opportunity, really a generational opportunity for us to seize the moment to strengthen our bonds with our customers and with our team members. Obviously, as John alluded to when he talked about the PPP process, we've had to all convert an assembly line that's used to churning out a certain number of larger units per day into one churning out multiple numbers of smaller units with different forms and whatnot a day and done a great job of doing that. We've been focused on those things.
We have delayed some of our integration planning as part of that. If you recall from our early announcement, we weren't expecting to achieve much of the bulk of the cost saves until sometime mid-next year. We do have a conversion date, as you see in the deck, in the early second quarter of next year or sometime the same quarter. That is really going to drive a lot of the cost saves. While I think we're more focused right now on taking this opportunity to build bonds with two very important constituents, we are still very focused on the benefits that this merger affords us in cost saves to both entities, and particularly in a time where pre-tax, pre-provision income may be more challenging for some. We are very glad to have that opportunity to help boost our profitability when we get through conversion.
Do the circumstances now with using the physical branches less and doing it more in drive-through or by appointment, does that make you rethink? I know you don't have a lot of branch overlap between the two companies, but does it make you rethink the branch network longer term?
Go ahead.
Yeah, Jennifer, this is John. Maybe Robert have a thought here as well. My guess is that this pandemic is going to change and accelerate the way a lot of things occur. I think it really will be an acceleration of an adoption of the digital channels that we've all been working towards. I don't know that there's anything immediate in our thought process relative to branches, but I do see an acceleration of the path that we were already on. Robert, anything to add there?
Similar to John's comments. I think Jennifer, just to maybe talk about just the deal overall, not just the expense save number is, I think when John and I were talking about this over the last couple of years. We kind of both felt that we were at the end of a cycle. Obviously, what we're going through right now, nobody could have recognized, but clearly we're at the end of the cycle. One of the things that we had hoped by putting our companies together was that we could, whatever economic downturn there was, be it deep or shallow, that we would come out the other side stronger. There's kind of this short-term economic impact that we have an opportunity to manage through.
There's the long-term change in the whole business model, and we're hearing that not just from ourselves and our bank, but from our customers as well. They're looking at the short-term economic impact, but the long-term structural impact for their businesses. One of our challenges was, how do you digitize more of the bank? We have encouraged, pushed, had adoption, and over a three or five or seven-year period, we thought we could really make some good gains there. Well, I think this is going to accelerate it significantly. Just data points, but March of this year, we did 90% more in digital deposits than we did March of last year. Zelle was 200% increase. We're seeing how we can run this company in a very different way and how the adoption of these digital products is going to accelerate.
I think that all the things we thought would happen, there'd be a downturn, that there would be digital adoption, I just think all those things are going to happen, but just at a much faster pace and create some opportunities for us along that path.
Thank you so much.
Our next question today comes from Kevin Fitzsimmons at D.A. Davidson. Please go ahead.
Good morning, everyone.
Morning.
Hey, Kevin.
I just had a quick follow-up question. I believe it was John that mentioned earlier about the origination fee coming through, whether that's in third quarter or some a little later, and that that pays a lot of bills. Just in that line of thinking, should we not be viewing that as necessarily flowing to the bottom line, that some of that can be used for incremental expenses that you'll have, whether that be compensating some of your frontline employees, whether it be additional reserve building like you referred to, just how we should be looking at that. Thanks.
Yeah. This is John Pollok. To be clear, that little over $20 million pays really for all the expense with it. The only caveat, as you know, the rules continue to change, would we have to establish a loan loss reserve? I think our view today is 70% of that fee will come through the next couple of quarters, and then 30% or so would come back over the next year to year and a half as the loan's repaid. Clearly it's net of the operating expenses.
Kevin, this is Steve. The same view we would have as far as how that gets forgiven over time, at least what we know today. The CenterState number, depending on funding, could be in the mid-30s after expenses. That's going to happen, as John mentioned, over time, so hard to really predict it.
I'll just add on this, Will, that you asked about provision. Obviously, the level of provision expense is uncorrelated with that. It certainly provides another source of revenue that could help fund any necessary provision expense, but those would be independent decisions from one another, of course.
Got it. Thank you. Just one quick follow-up on deferred loan process. You detailed before how you're proactively reaching out to customers in some of those at-risk industries. For larger credits that come to you guys, are you going through some kind of credit-driven process in terms of scrutinizing that? Just trying to get a sense of what you're going through. Thanks.
Maybe Dan, you want to start there?
Yeah. We're taking a disciplined approach on analyzing that, having honest, frank discussions with clients, making sure that they're using their liquidity first in some cases. Hopefully, they're relying on the bank. Yeah, we're going through a process to make that determination.
Jonathan, anything to add?
No, same here. We're just kind of relationship banking. We're having a one-on-one conversation with these borrowers, and we're working with them to understand their capital needs, their prospects for the industry, and we're just working with it really on a case-by-case basis.
Okay. Thank you.
There are no further questions, so I'd now like to turn the call back over to John Corbett.
All right. Thank you again for calling in this morning. This is certainly unique times that we're living through. We are planning on participating virtually with the D.A. Davidson conference and the SunTrust conference in May. We hope to talk to many of you then. Have a great day.
This concludes today's conference. You may now disconnect your lines and have a wonderful day.