Welcome to the U.S. Bancorp's second quarter 2020 earnings conference call. Following a review of the results by Andy Cecere, Chairman, President, and Chief Executive Officer, and Terry Dolan, Vice Chair and Chief Financial Officer, there will be a formal question-and-answer session. If you would like to ask a question, please press star one on your telephone touch phone, and press the pound key to withdraw. This call will be recorded and available for replay beginning today at approximately 12:00 P.M. Eastern through Wednesday, July 22nd at 12 midnight Eastern. I would now like to turn the conference over to Jen Thompson, Director of Investor Relations and Economic Analysis for U.S. Bancorp.
Thank you, Amaris, and good morning, everyone. With me today are Andy Cecere, our Chairman, President, and CEO, and Terry Dolan, our Chief Financial Officer. Also joining us on the call today are our Chief Risk Officer, Jodi Richard, and our Chief Credit Officer, Mark Runkel. During their prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the slide presentation, as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, and in our Form 10-K, and subsequent reports on file with the SEC. I'll now turn the call over to Andy.
Thanks, Jen, and good morning, everyone. Thank you for joining our call. Following our prepared remarks, Terry, Jodi, Mark, and I will take any questions you have. I'll begin on slide three. In the second quarter, we reported earnings per share of $0.41. Consistent with the industry, our performance is being impacted by the current economic environment. Loan growth reflected the impact of defensive draws by corporations in March and early April, strong mortgage loan growth, and the impact of the Paycheck Protection Program, which supported small businesses impacted by the COVID-19 situation. Increased liquidity in the financial system and a flight to quality drove strong deposit growth in the quarter. Our healthy fee income growth this quarter is a testament to our diversified business model. Some fee lines, including our payments businesses, were negatively impacted by slower economic activity.
However, we saw very strong growth in our mortgage and commercial products businesses. While consumer spend activity remains pressured compared with a year ago, volume trends in each of our payments businesses have improved as some economies have started to reopen. Expenses were held relatively flat compared with the first quarter. We continue to manage our cost structure prudently and in line with the slower revenue growth environment. Credit quality metrics in the second quarter reflected increased economic stress offset by the beneficial impact of government stimulus and forbearance and deferral programs. During the quarter, we increased our allowance for loan losses in response to economic conditions. We believe our reserve level at June 30th is appropriate based on the information we have available. Changes in the allowance will be dependent on actual credit performance and changes in economic conditions.
In the lower right quadrant of this slide, you can see that book value per share grew 2.8% compared with a year ago, and we remain well-capitalized. Slide four provides key performance metrics. We delivered a 7.1% return on tangible common equity in the second quarter, impacted by lower earnings owing to the current economic environment. Slide five shows our continually improving digital uptake trends. Shelter in place orders early in the quarter and temporary branch closures due to the COVID-19 have increased in digital adoptions. Digital now accounts for more than three-quarters of all service transactions and about 46% of all loan sales. We expect digital adoption by customers to stick even after the economy fully reopens. Let me turn it over to Terry who will provide more color on the quarter.
Thanks, Andy. If you turn to slide six, I'll start with a balance sheet review followed by a discussion of second quarter earnings trends. Average loans grew 6.9% on a linked-quarter basis and increased 10.0% year-over-year. Growth includes $7.3 billion of loans made under the SBA's Paycheck Protection Program during the second quarter. The average loan size to these small businesses was approximately $73,000. Excluding the impact of PPP, average loans grew 5.4% on a linked-quarter basis and 8.5% year-over-year. Excluding PPP, linked-quarter growth was primarily driven by growth in commercial loans and in mortgage loans. In late first quarter, business customers drew down their lines to support business activity and future liquidity requirements. We started to see paydowns of commercial loans in May, and the paydown activity accelerated in June as many customers accessed the capital markets.
As of last week, about two-thirds of the defensive draws we saw in the late first quarter and early second quarter have been repaid. Strong residential mortgage growth reflected the low interest rate environment. Credit card balances declined in the quarter due to lower spend activity. Turning to slide seven. Average deposits increased 11.2% on a linked-quarter basis and grew 16.8% year-over-year. Average non-interest-bearing deposits increased 30.1% year-over-year, driven by corporate and commercial banking, consumer and business banking, and wealth management and investment services. Turning to slide eight. While the net charge-off ratio was relatively stable on a linked-quarter basis, non-performing assets increased 24% sequentially, reflecting increased economic stress. The non-performing assets to loans plus other real estate owned ratio totaled 0.38% at June 30th, compared with 0.30% at March 31st.
We have taken a proactive approach in evaluating credit quality across the entire commercial loan portfolio and considered risk rating changes in the evaluation of our allowance for credit losses. Our loan loss provision was $1.7 billion in the second quarter, inclusive of $437 million of net charge-offs and a reserve build of $1.3 billion. The increase in the reserve was related to changes in risk ratings and deterioration in economic conditions, driven by the impact of COVID-19 on the U.S. and global economies, and our expectation that credit losses and non-performing assets will increase from current levels. The increase in the allowance for credit loss is considered our best estimate of the impact of slower economic growth and elevated unemployment, partially offset by the benefits of government stimulus programs as of June 30th.
While estimates are based on many quantitative factors and qualitative judgments, our base case outlook assumes an unemployment rate of 13%-14% for the second quarter, declining to 9.0% in the fourth quarter of 2020 and to 7.8% by the fourth quarter of 2021. Slide nine highlights our key underwriting metrics and exposures to certain at-risk segments, given the current environment. We have a strong relationship-based credit culture at U.S. Bank, supported by cash flow-based lending that considers sensitivity to stress, proactive management and portfolio diversification, which allows us to support growth throughout the economic cycle and produces consistent results. Slide 10 provides an earnings summary. In the second quarter of 2020, we reported $0.41 per share. These results were adversely affected by the current economic environment and the related impact to consumer and business spend, and the expected increases in credit losses. Turning to Slide 11.
Net interest income on a fully taxable equivalent basis of $3.2 billion was essentially flat compared with the first quarter, in line with our expectations, as the impact of lower interest rates was partially offset by deposit and funding mix and loan growth. As expected, the net interest margin declined by 29 basis points compared with the first quarter. The lower margin reflected lower rates and a flatter yield curve, as well as higher cash balance of being maintained for liquidity to accommodate customer demand. While loan mix put pressure on the net interest margin, the earning asset impact was mostly offset by beneficial shifts in deposit and funding mix. Slide 12 highlights trends in non-interest income. Strength in mortgage banking and commercial product revenue more than offset declines in the payment revenues.
Mortgage banking revenue benefited from higher mortgage production and stronger gain on sale margins, partially offset by the net impact of change in fair value of mortgage servicing rights and related hedging activity. Commercial product revenue reflected higher corporate bond issuance fees and trading revenue. Slide 13 provides information about our payment services businesses, including exposures to impacted industries. Payments revenues was pressured by the impact of COVID-related shutdowns and reduced economic activity in the quarter. However, consumer sales trends improved throughout the quarter, and that trajectory has continued in early July. Credit and debit card revenue declined 22.2% year-over-year, and merchant processing services revenue declined 34.2% year-over-year. Both categories performing somewhat better than what we had expected. Corporate payment products revenue declined 39.5% year-over-year, in line with our expectations as business spending continues to reflect cautious sentiment. Turning to slide 14.
Non-interest expense was essentially flat on a linked-quarter basis, in line with our expectations. Second quarter expense reflected an increase in revenue-related costs for mortgage and capital markets production and expense related to COVID-19 situation. During the quarter, we incurred incremental COVID-19-related costs of approximately $66 million. These expenses consisted of about $30 million related to increasing liabilities for potential future delivery claims related to the airline industry and other merchants, and about $50 million related to premium pay for frontline workers and costs tied to providing a safe working environment for our employees. We expect these incremental COVID expenses to begin to dissipate in the second half of the year. Slide 15 highlights our capital position. At June 30th, our Common Equity Tier 1 capital ratio, calculated in accordance with transitional regulatory capital requirements related to the Current Expected Credit Loss methodology implementation, was 9.0% at June 30th.
Our Common Equity Tier 1 capital ratio, reflecting the full implementation of the Current Expected Credit Loss accounting methodology, was 8.7%. I'll now provide some forward-looking guidance. For the third quarter of 2020, we expect fully taxable equivalent net interest income to be relatively flat compared to the second quarter. We expect mortgage revenue to continue to be strong on a year-over-year basis in the third quarter, but it is likely to decline compared with the second quarter, reflecting slower refinancing activity for the industry. Payments revenue is likely to be adversely affected through the remainder of the year on a year-over-year basis due to reduced consumer and business spending activity. However, we expect continued gradual improvement in sales volumes. We expect non-interest expenses to be relatively stable compared to the second quarter.
Future levels of reserve build will depend on a number of factors, including changes in the outlook for credit quality, reflecting both economic conditions and portfolio performance, and any beneficial offset from government stimulus. We will continue to assess the adequacy of the allowance for credit losses as credit conditions change. For the full year 2020, we expect our taxable equivalent tax rate to be approximately 15%. I'll hand it back to Andy for closing remarks.
Thanks, Terry. I'll end my remarks on slide 16, which highlights a few of the recent actions we've taken as a company to help support our customers, communities, and employees. We are operating in uncertain times, not only for the economy, but for our society in general. I am confident that together we can make lasting and impactful changes that will leave us all better on the other side of these trying times. We are well-positioned for near-term challenges, and we continue to manage this company with a long-term lens and focus on maximizing shareholder value. Our capital and liquidity positions are strong, and our unique business model remains a differentiator for us. I would highlight three things that will continue to support our ability to deliver industry-leading returns through the cycle. First, as our second quarter results indicate, our diversified business mix reduces revenue and earnings volatility.
In this quarter, it allowed us to deliver good revenue growth even against a challenging interest rate backdrop and an industry-wide slowdown in consumer spending activity. Second, our time-tested credit underwriting discipline puts us in a strong position to navigate through an economic downturn while setting us up to return to prudent and consistent growth in a more favorable economic environment. Third, our culture remains the foundation which informs not only what we do at U.S. Bank, but how we do it. I couldn't be more proud of our employees who've come together to support our customers and communities, and they face significant economic and social disruption. I want to take this opportunity to thank them for all their hard work and resiliency. We'll now open up the call for Q&A.
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Scott Siefers with Piper Sandler.
Morning, Scott.
Morning, guys.
Hey, thank you for taking the question. Let's see, I guess, Terry, a question for you just on, you gave the NII expectation for the third quarter. I wonder if you could talk a little bit about the sort of the puts and takes, meaning balance sheet growth and where you'd see the margin projecting from here?
Yeah. From a loan perspective, again, we would expect that we'll see year-over-year growth, but on a linked-quarter basis, clearly it's going to be down. We're going to continue to see paydowns associated with those defensive draws that we had at the end of the first quarter and early second quarter. That'll put downward pressure on a linked-quarter basis. PPP will actually probably help from a growth standpoint as we think about the second quarter. It does start to dissipate in third and fourth quarter simply because of the loan forgiveness program. On the consumer side, auto lending has generally been weak in April and May, but it's gotten stronger in June. We believe that's going to be a bright spot as we think about the third quarter.
Overall, consumer lending is likely to be down simply because consumer spending has been down. That's kind of the puts and takes if you think about loan growth. Margin, we believe, is going to be relatively stable. It'll be helped a little bit by PPP. Impacted a little bit. There'll be a little bit of pressure on the yield curve side of the equation, but relatively stable to the second quarter.
Just given the absolute level of interest rates, do fee waivers start to become an issue in the money market area? If I recall correctly from the last time rates were this low, I think those show up in trust fees. If they're something you guys are thinking about, where would they show up, and what's kind of the impact you guys would see?
Yeah. I think the impact would be probably similar to what we saw last time given, but it'll may be a little bit more simply because of growth. It will show up in trust and investment management fees because that's where our money market fund revenue gets recognized.
Okay. All right, perfect. Thank you guys very much.
Scott.
Your next question comes from the line of Matt O'Connor with Deutsche Bank.
Morning, Matt.
Good morning.
Good morning.
Just to clarify on the net interest income outlook of stable quarter-to-quarter, does that include some of the kind of benefit from PPP repaying or forbearing? If so, what are your assumptions on that in terms of the next couple of quarters?
Yeah. It includes all the puts and takes. Like I said, it'll reflect a decline on a linked quarter basis in terms of commercial loans because of the draws, but there will be some benefit associated with PPP. It includes essentially all the puts and takes associated with net interest income.
Okay. I am wondering on the PPP, it seems like your kind of approach was more granular or to go after kind of smaller, really the small businesses, if I just look at your total amount funded versus applications, and just wonder if you could talk to that approach and maybe give us some insight in terms of the cost that you've incurred to originate those loans.
Matt, this is Andy. We took the applications as they came in serving our customers and initially then ultimately outside of the bank. As you saw, we had over 101,000 applications and the average balance was in the $70,000. A lot of our customers are small business and we helped a lot of employees. The team did a great job. We started with a bit of a manual process and went to a much more automated process, certainly in the second round. It was just based on the request that came in and the priority was really time-based.
Okay. Just the cost to originate, was it just kind of moving resources from one part of the bank to another?
Yes, it was, Matt. We actually had individuals from throughout the entire company help us through this process, particularly the manual process that started and the technology as well. Yes, the entire Bank was supportive.
Okay. Thank you.
You bet. Mm-hmm.
Your next question comes from the line of Saul Martinez with UBS.
Hey, guys. Good morning.
Hey, good morning.
I wanted to drill down a little bit on your comments, Terry, on the payments business and sort of a gradual improvement there. I guess first of all, could you just give us a little bit of a sense for how much the consumer recovered and it seemed like in June the year-on-year declines in acquiring volumes and in card volumes had really lessened. Can you just give us a sense of what, say, the exit rates were in terms of volumes in those categories in June versus March? I guess as an adjunct to that, why wouldn't that suggest that at least sequentially you should see pretty sharp improvements in terms of the sequential growth and issuing and acquiring revenue versus, at least versus the second quarter.
Obviously year-on-year is tough, but versus the second quarter, it would seem to suggest that you could see a nice improvement sequentially. I just want to get your sense as to whether I'm thinking about that right.
Yeah. Saul, I think you're right on. I think when we end up looking at our payments business on a sequential basis we will see growth, particularly in the credit card and the merchant. The corporate payments, we would also expect growth, but maybe not at the same level simply because the sales volumes there are commercial spend or commercial customers are still fairly cautious. To kind of give you some perspective, at the end of or in April, we saw on the merchant side of the equation consumer spend was down almost between 50% and 55%, kind of in that ballpark.
Today, it's really back to spend levels that are closer to about 20%. That has come back really very nicely. The things that are going to continue to impact for a while is the mix associated with the airline industry and some of the entertainment. It has come back very nicely. Your point on sequential growth is right on. With respect to credit card, credit card we had said was down kind of in that 30% range in April. That has come back nicely as well. In terms of credit card it is still down. It's down around 10%-12%. We would expect that trajectory to continue so into the third quarter. Debit card revenue or sales, excuse me, actually have been pretty strong. The sales on the debit card side has been kind of up 10%-12%, kind of in that range.
While we wouldn't expect it to be maybe quite at that higher level in the third quarter, it is still, I think, going to be relatively strong. On the CPS side of the equation. CPS, again, the commercial spend has been pretty cautious. It was down kind of in the magnitude of 30%-35% in that April sort of timeframe. It's still down around somewhere between 25%-30%. We do expect it to get a little better than that in the third quarter for a couple of reasons. Simply because government spend tends to be strongest in the third quarter. Hopefully that gives you some insights or perspective.
Yeah, no, that's super helpful. If I could squeeze another one in on fees. The deposit service charge is obviously down a lot. You commented about fee waivers related to customer, related to COVID. How do we think about that going forward? I don't know if you can quantify that or how do we-- or just give us a sense of how that, I think $133 million, how that could compare to maybe a more normalized level in the coming quarters.
Yeah. Similar sort of impacts as consumer spend and just activity has declined. You have the stimulus checks and all sorts of different things, just incidence levels related to NSF and fee waivers in terms of helping our customers has impacted the second quarter. On a sequential basis, we would expect that will come back nicely in the third quarter. On a year-over-year basis, it's still going to be down simply because consumer activity is down. Similar to merchant or credit card.
It'll take some time to get back to.
Yep
sort of a more normalized or what was a more normalized level, I guess.
Yes, that's right.
All right. Awesome. Thank you very much.
Yep, thank you.
Your next question comes from the line of Erika Najarian with Bank of America.
Hi.
Go ahead, Erika, starting.
My first question is on the reserve. This is a question that all your peers have been getting during this earning season. I always like to think in the CECL world that your reserve to loan ratio of 2.54% represents a cumulative loss rate for the recession that represents, let's say, two years. I guess the question here is that, is that your view? I guess it's another way of asking, are you done in terms of reserve building? Related to that, your peers have also talked about the base case, but that the base case tends to be one of, let's say, five or so different scenarios, and those scenarios are weighted.
I'm wondering if you could give us some insight in terms of, as you had built your reserve, how much weight that base case was taken into account versus perhaps other scenarios.
Let me take the first question. When we think about the reserving, you're absolutely right. You make your estimates at the end of any particular quarter based upon the information that you have available at that particular point in time. Certainly at June 30th, we believe that the reserve is appropriate for the cumulative losses that are there. We wouldn't expect future increases in the reserve. Again, that is going to be highly dependent upon what changes, either in terms of economic factors or if our credit quality changes differently than what we had expected. The important thing is that we're going to continue to assess the reserve every quarter based upon the information that we have available to us. You are right, theoretically, that is how CECL works, and that's how we're trying to apply it.
Coming to your second question, the information that I ended up giving you with respect to unemployment. Keep in mind, unemployment is an important factor, but there's like 200 different multiples that are a part of the modeling process. It's pretty complex because you got a lot of different types of portfolios, et cetera. Unemployment, the information I gave you was really the weighted average across many different multiple scenarios that we ended up looking at. You are right. When we look at this, we look at information from many sources in terms of things like unemployment, GDP, et cetera. We develop a base case, if you will, but then we look at multiple scenarios around that base case and weight it. The information that I gave you was weighted based upon those multiples.
It should give you some comparability when you think about that. Andy, anything to add?
No, you said it well.
Got it. My follow-up question is to Andy. Andy, I think what was particularly impressive about this quarter is your PPNR resiliency. Obviously the forward look would imply that this will continue. Terry just told us that we could be done in terms of reserve building. As we think about the future and as we think about a more difficult operating environment for banks, how are you thinking about inorganic growth strategies from here?
Erika, first, as you mentioned, I think our diversified revenue mix helps a lot, and this quarter probably represented it very well. We had some pressure on payments because of the spend activity that Terry talked about. Mortgage and commercial products hit it out of the park this quarter in terms of positives. The other part of a diversification is how much of our revenue comes from the balance sheet or net interest income, as well as fee revenue is sort of a mixed bag, 50/50 there. That really helps in environments like this, and different businesses do well in different economic cycles. As we think about the future, I think we are planning for a future that has continued low rates. It'll take a while for spend to get back to normal.
We're going to manage our expenses with that thought in mind, which is what we're doing today, and we're going to continue to invest in the businesses that have opportunity, as well as the digital initiatives I talked about. Those digital initiatives will offer not only the opportunity for our customers to connect with us in a virtual means, I think it'll also offer expense opportunities in the long run. Those are the ways we're thinking about it.
Just any thoughts on inorganic strategies, acquisitions?
Yeah.
I guess to say it more bluntly.
Yeah. Thanks for being blunt. We will look at opportunities that come up. The only thing I'd say is, in this environment, Erika, there's a lot of uncertainty, and it's certainly not a clear vision in terms of the future, even for us. To look at someone else with that lens will be challenging. I do think opportunities will come up because of the stresses that are out there, and we'll take a look.
Okay. Thank you.
You bet.
Your next question comes from the line of Mike Mayo with Wells Fargo Securities.
Hey, Mike.
Good morning.
Hi. Look, you're one of the most conservative banks. I want to challenge some of your conservatism. On your base case, again, 9% unemployment by the end of this year. I know it's a lot of scenarios and it's a weighted average and all that. At least one of your peers was more conservative than that. I know that's the Fed base case. There's nothing crazy about it. It's just I thought why not be more conservative if you have the flexibility or when you take the weighted average of the different scenarios. I'm pushing back a little bit more.
This seems like peak reserve builds, and you said that. If your economic assumptions are wrong, then that won't be the case. Why not be more conservative there? Along those lines, your payments comment that it should improve sequentially kind of makes sense, but look, we just had a big increase in COVID cases, which leads to more deaths, which leads to some closing down, and how are you feeling about that progression?
Yeah. Maybe to address the first question, when you end up establishing the reserve, you have to establish what you believe is appropriate based upon the information that you have available to us. We use things like Moody's Analytics and other sources in order to kind of come up with that projection of what unemployment, as an example, looks like. You have to make sure that your reserve is appropriate based upon the information that you have. You can't build in tons of conservativism, so to speak, into it. Again, part of it is we'll have to kind of wait and see. On the payment side of the equation, in terms of COVID cases, based upon our estimates right now, I think that this go-around versus last go-around, I think that states are continuing to try to stay open to the best that they can.
I think you have different sort of health treatments and all sorts of different things that exist based upon better information or different information than what existed before. Quite honestly, we're going to find out. There's a lot of uncertainty, and it's too early to know.
I'd add on, Mike, I think you're right. Things are changing every day. The facts change daily, weekly, sometimes hourly. We're just going to continue to assess and manage the company given the changes that are out there, what Terry's telling you, what he's seeing right now. As he said, we get data every day, and we're going to continue to assess what we think is going to happen. We're running a lot of models. We're sharing with our board a lot of scenarios, including a much harsher scenario and understanding what would occur in that. You're right. There's a lot of unknown yet, and we are being conservative in the way we're approaching our financial modeling. One follow-up question. Look, your third slide of substance, it's slide number five, the digital engagement trends.
You're certainly putting that front and center. Can you bring us up to date, like to the moment, of what's happening with your digital engagement? What does that mean in terms of branches and national expansion and anything else? If you're putting this as your third slide in your earnings deck, I know it's always been important, but it seems like it's now being put on steroids in terms of the way you're highlighting this, which must mean some bigger part of the strategy.
Mike, it has always been important, but I do think the recent events and the customer behavior changes has even accelerated that further. You can see that in the numbers. Nearly 80% of transactions now occurring in a digital fashion. The branch activity as far as transactions is down a lot. On the sales side, I talked about the loan sales, but actually total sales on a digital platform have doubled versus a year ago. We do expect those digital investments, both do it yourself and do it together. In other words, co-browsing or virtual activity is going to continue to be important, not just for the consumer, but across many business lines. That investment that we're making is important on two fronts.
It's important to make sure we're giving the customer the best experience and connecting with them in the ways they choose to, and it's also offering efficiencies in the long run. As we talked about, we announced over a year ago that we expect to have 10%-15% fewer branches, and I would expect that number to increase in terms of the number of fewer branches that we have because of these changing customer behavior. Branches will still be important, but the number of them and the size of them will be fewer and less.
Any number on those branches, the updated number?
We don't have a number on it yet. We continue to assess, and as we think about the changes that are occurring and the closures that are out there, we'll continue to assess what we expect. I do expect it to be higher than the 10%-15%.
Okay. Thank you.
You bet.
Your next question comes from the line of David Long with Raymond James.
Morning, David.
Good morning, everyone. Going back to the Paycheck Protection Program, we talked a little bit about the expectations for forgiveness there. Do you have a timeline on where you think your $7+ billion in PPP loans may start to be forgiven?
Yeah. Well, we do expect that there's going to be some forgiveness that's going to take place as early as the third quarter, so there's going to be some runoff of the balances just because of that. I think the vast majority of it happens late third, fourth, and early first quarter in terms of timing. That's our expectation right now.
Got it. Okay. On the deposit side, obviously very good deposit growth there. How do you see the trajectory of that playing out, taking into consideration the PPP and all the liquidity that's built in now? How does that impact the size of the balance sheet through the rest of the year?
Yeah. Well, our expectation is that deposit growth is going to continue to be strong at least through the end of the year, if not into early next year. It's really highly correlated to the amount of liquidity that the Fed is continuing to pump into the system. The impacts from a balance sheet perspective is, I think certainly you have a funding benefit associated with that. The challenge is always trying to identify if you get the loan growth, great. If you don't, you're going to have to look for opportunities on the investment side of the equation. We do expect strong growth in deposits into the foreseeable future because of the Fed programs.
Got it. Thank you.
Thanks, David.
Your next question comes from the line of Ken Usdin with Jefferies.
Hi. Hey, guys. Hey, good morning. Just one question on the expense side. Obviously, much stronger than expected revenues, especially out of mortgage. Noting that you're talking about some of the COVID costs coming off and that even some of the, I would think, incentive-related cost type stuff like mortgage will be softer sequentially, you're still talking about flat-ish expenses sequentially. I was wondering if maybe you can kind of put that in context with some of the broader-reaching comments you just made about the future of the expense base in terms of why you'd only expect to see flat expenses sequentially. Thanks.
Yeah. On a sequential basis, I do think you're going to see revenue-related sort of expenses coming down a bit. You will see COVID-related expenses coming down. There's still going to be a fairly significant amount of PPP and costs associated with all sorts of things that will end up happening in the third quarter. The other thing that I think that ends up coming into play is just timing with respect to, for example, other loan expenses and when they end up getting recognized relative to the mortgage production that occurred. We recognize revenue in the quarter in which the application is taken and locked, but a lot of the expenses end up happening in the quarter that's following that simply because of the timing of closing loans and that sort of thing.
That's a big driver that ends up impacting the sequential growth from second to third quarter that you have to keep in mind.
Okay. A follow-up on the money market fee waivers. You had mentioned earlier that you would expect them to be larger than last time. Can you put that into numeric context for us? How much were you waiving either on an annual basis or at peak through the last cycle? How is the asset management complex differ in terms of mix today versus then? Thanks.
Yeah. In terms of the mix of the product that we end up offering, I think there's probably a more government or govvy-based sort of money market as opposed to prime-based. The prime-based declined fairly significantly. The overall, when you end up looking at assets under management, certainly we're at a higher level today than 10 years ago. That's the reason. I think that the rate of the fee waivers will be pretty similar, but just the assets under management in the wealth management space is higher. I'm trying to put my fingers on kind of what that looks like right now. We certainly can kind of get back to you, Ken.
Okay, thanks a lot. I'll follow up.
Terry, I think fee waivers, when they're implemented, will be somewhere in that $30 million a quarter range, plus or minus.
Yeah.
Your next question comes from the line of Vivek Juneja with JPMorgan.
Morning, Vivek.
Hi. Thanks. Thank you for taking the questions. A couple of ones. Firstly, on credit cards, can you give us the reserves to cards? Also, what are you seeing in terms of card customers where deferrals are coming off? Have you started to see deferrals come off? What's the reaction been in terms of customers paying the full amount or asking to extend the deferrals?
Thanks, Vivek. I'm going to ask Mark Runkel, our Chief Credit Officer, to respond to that. Mark?
The reserve ratio on the credit card was 10.14% at the end of June. That's question number 1. The second, in terms of those customers that have come off some of the programs that we've got in place, we've seen very strong payment performance to date. About 70% of those customers have started to make normal payments after those periods of time. We've seen a few of those, about 20% re-enroll. The rest has moved into delinquency. So far, so good on customer performance. Okay. That's great. Terry, if I may sneak in one for you. Other income, I know it had a lot of noise this quarter. What would you suggest as a run rate for us to use?
Yeah, if you kind of think about when I end up looking at the current run rate, just given the environment that we're in, Vivek, I would end up looking at second quarter as a pretty good estimate of what future quarters are going to look like, at least for a while.
Meaning at this $130 million that you had roughly?
Yes.
Yeah. Okay. Yeah. Okay, great. Thank you.
Your next question comes from the line of Gerard Cassidy with RBC.
Morning, Gerard.
Hi, Andy. How are you? Hi, Terry.
Andy.
We've seen some real crosscurrents in economic information. For example, the Empire State Manufacturing Index came out today positive, first time since February, in industrial production coming a little better today as well. On the other hand, the initial unemployment claims numbers remain very elevated. When you talk to your customers, I understand the restaurants and the leisure guys are still feeling a lot of pain, can you give us some color on what are your commercial customers telling you? What are they seeing?
Yeah. First, you're absolutely right. There are some mixed signals. I think the mixed signals is the competing factors of the stress in the economy from the shutdown offset by the stimulus that's occurring across many categories. Unemployment benefits, the stimulus checks, PPP, all those things. Those are competing forces, which makes modeling and projecting very difficult in this environment. I would say small businesses are struggling the most, for a lot of different reasons, principally because they have less cushion than the larger companies. The larger companies, as Terry mentioned, initially they were very defensive, drawing down in excess of $22 billion, but about two-thirds of that is paid back. While certain industries continue to be stressed, you're seeing other industries that are actually doing a little bit better in this environment. Small, challenged; middle and large, mixed.
Some doing well and some not so much. Terry, what would you add, or Mark?
No, go ahead.
No, I think that's well said. I think it's right.
Then as a follow-up, in the reserving and the provisioning you guys did this quarter, I know you mentioned there's a lot of moving parts, as you just touched on it, Andy. But how much would you say of the provisioning was allocated to specific credits that you're now starting to see obviously distressed, versus just building up the general reserves?
I'll have Mark kind of add to this, but certainly when we end up looking at net charge-offs and things like that, there just hasn't been a lot of movement, especially on the consumer side of the equation. We are starting to see non-performing assets on commercial starting to grow, as we talked about. It's still, what I would say, relatively early. I think the government stimulus programs and things like that have kind of, at least for some period of time, muted some of those underlying credit characteristics that you typically see. More of it or most of it is really driven based upon kind of our outlook when we think about the economic conditions going forward.
If you end up looking at kind of the split between products, it's probably more heavily weighted, 60-plus% of the reserve build really more focused on wholesale and commercial real estate as opposed to consumer at this particular point in time. Mark, what would you add?
The only other thing I might add is, you mentioned this in the early comments. We've gone through the portfolio very granular and downgraded the credits appropriately. We feel like all of that's been factored into the analysis and the allowance.
Thank you.
The bulk of the change is really the economic assumptions, as Terry noted.
I appreciate that. Thank you.
Hey, Ken, coming back to your question on fee waivers. The impact second to third quarter, so on a sequential basis of fee waivers, will be about $30 million in that ballpark.
Your final question comes from the line of David Smith with Autonomous.
Good morning. Thank you for taking the call.
Morning.
Just to clarify on the expense guidance. 3Q stable to 2Q relatively. Does that include the COVID expenses in 2Q?
It's total expenses. It's all-inclusive. Again, we'll see benefit of COVID coming down, but some of those production-type costs that I talked about earlier going up.
Thank you. Also, any particular color you could give on the jump in non-performing loans in commercial real estate?
Mark?
Yeah. I would just say they're really focused in on a couple of different industries that we've highlighted. One is on the commercial side is really heavily energy and the retail sector, and then on the commercial real estate is going to be some of the retail-related exposure as well. It's coming off a very low point, as you note. Those are the industries that have been most impacted to date.
All right. Thank you so much.
At this time, I would like to turn the call back over to management for any closing remarks.
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