Welcome to Wintrust Financial Corporation's second quarter and year-to-date 2020 earnings conference call. Following a review of the results by Edward Wehmer, Founder and Chief Executive Officer, and David Dykstra, Vice Chairman and Chief Operating Officer, there will be a formal question-and-answer session. During the course of today's call, Wintrust management may make statements that constitute projections, expectations, beliefs, or similar forward-looking statements. Actual results could differ materially from the results anticipated or projected in any such forward-looking statements. The company's forward-looking assumptions that could cause the actual results to differ materially from the information discussed during this call are detailed in our earnings press release and in the company's most recent Form 10-K, and any subsequent filings on file with the SEC. Also, our remarks may reference certain non-GAAP financial measures.
Our earnings press release and slide presentation include a reconciliation of each non-GAAP financial measure to the nearest comparable GAAP financial measure. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Mr. Edward Wehmer.
Thank you very much, and welcome to our second quarter earnings call. Pardon me. With me, as always, are Dave Dykstra, our vice chairman and chief operating officer, Dave Stoehr, our CFO, Kate Boege, general counsel, Tim Crane, president of Wintrust, and Rich Murphy, vice chairman and chief lending officer. We'll have the same format as usual. I'm talking funny because I had a tooth removed. It's not because I have a mask on or anything. I'm going to give some general comments regarding our results, turn it over to Dave Dykstra for a detailed analysis of other income, other expense, and taxes. Back to me for some summary comments and thoughts about the future, and then I'll raise questions. In my 45 years of being associated with the bank industry, I thought I'd seen it all. How stupid of me to be arrogant enough to think that.
The COVID pandemic, the resulting unprecedented government economic intervention, interest rates falling to basically nothing, remote work environment for pretty much the entire staff, the implementation of FASB's latest and greatest pronouncement on how to determine loan loss provisioning, surely made life interesting. Add that, a dose of social unrest, and a presidential election, we've got a very spicy pot of chili we're working in. All we need are locusts and earthquakes or floods to make this somewhat biblical. It is times like this when our high-tech, high-touch, relationship-based distribution model, our consistent and conservative approach to credit and liquidity, and diversified asset base actually shine. Add to this our strategic agility born out of our structure and culture, we look forward to whatever the current environment throws at us. Sticking to the basics have never been more important.
On our results for the quarter, our quarter can be summarized in a couple of bullet points. Great asset and deposit growth spearheaded by over 11,000 PPP loans totaling $3.4 billion, the resulting halo effect. Even better mortgage results despite approximately $15 million of one-time expenses. First would be the $7.4 million MSR valuation adjustment. You have to wonder how low they can go now. We've really written them down to basically nothing. Rates move up, we have a beach ball underwater there. $7.3 million in conditional contingent consideration. A contingent consideration as a result of us buying a mortgage company a number of years ago and setting up a liability for the contingent consideration. With the strong mortgage market, they're outperforming, and we owe them more money.
That number is a one-time because we basically have projected out where we think they're going to be for the duration of the contingent period. That's close to $15 million of one-timers associated with mortgage. Outsized provision expense of $135 million despite consistent traditional credit metrics. The loan modification curve has peaked and appears to be decreasing. Increasing net interest margin in a low rate environment. Excess liquidity. Increased NII due to overall asset growth. A net overhead ratio of 0.93%. Lots of ins and outs here, $5 million of one-time conversion expense related to a reacquisition expense related to our DP conversion. Dave Dykstra will take you through this in detail momentarily. Pre-tax, pre-provision, pre-MSR earnings were $173.1 million, up approximately $23 million, including the one-time expenses previously referenced.
We completed our preferred stock offering, which added $278.4 million new capital to support growth, taking advantage of dislocations that may occur in the market and anything else that may come along. The earnings front, we had $21.7 million of earnings, down 66%, diluted earnings per share of $0.34, down 67%. Talk about the pre-tax, pre-provision, pre-MSR numbers. Net interest margin dropped 39 basis points due to the low interest rate environment and excess liquidity. The other numbers come out accordingly. Margin really got clobbered, down 39 basis points this quarter due to that rate environment going to basically zero and excess overnight liquidity held on our balance sheet. Overnight liquidity total of $4 billion, up $2 billion from Q1. This results in overall liquidity portfolio duration, 1.7 years compared to 6.1 years at June 30, 2019.
We did bulk up on liquidity at the beginning of the crisis. I believe the prudent thing to do, as we did not know if and when there'd be any available funding for the PPP loans. Things have settled down a bit. We'll be returning some of the excess liquidity in Q3, knowing that there are alternatives for PPP funding, which we have not taken advantage of to date, allows to de-lever our balance sheet a bit for the time being. To date, in the third quarter, we de-levered to the extent of about $1 billion. This money is basically held at a zero spread. It should help the margin going forward. There's some movement on the deposit side through these rates. Approximately $133 billion of CD deposits that currently average rate about 1.6%, are scheduled to mature and be repriced in the next six months.
In July and August, an additional 1.3 billion promotional accounts at 2.23% will also reprice. We expect the majority of PPP loans to be forgiven in the third and fourth quarters of this year, based on surveys we did with our PPP borrowers. If Congress approves automatic forgiveness of loans under $150,000, it should expedite the processes. Two-thirds of our outstanding loans will be covered by this mandate. This will help the margin and the net interest income in the short term. As will be discussed momentarily, our commercial and CRE pipelines remain strong, as does our momentum in the niche businesses, specifically premium finance and leasing. We still expect the margin, notwithstanding the effect of PPP loans, to settle in the 2.7%-2.8% range when the dust clears, assuming no round 2 of PPP stimulus. Net interest income should also increase. Other income and other expense.
Dave'll cover in detail, but needless to say, our mortgage company hit the cover off the ball. $2.2 billion in production, over $102 million in gross income, almost double the previous quarter. Margins were strong in this business. Only negatives were the $7.4 million MSR valuation, downward MSR valuation adjustment, the $7.3 million contingent consideration expense. As I said earlier, the latter is ironically a good thing because we expect above normal credit mortgage volumes for the foreseeable future. Pardon me. Wealth management fees were down over $3 million due to market fluctuations. Most fees are based on the prior quarter end asset levels. Assets under administration at 6/30 actually grew $2.9 billion quarter versus quarter. Expect a rebound in fee income in quarter three, barring any other wild gyrations or other things we don't anticipate in the market. On to the provision.
Provision for the quarter totaled $135.1 million, versus $53 million in Q1 and $25 million in Q2. A low CECL. Approximately 20% of that provision can be attributed to portfolio changes, the majority of which are the result of loan modifications. The remainder of the provision relates to economic factors used in our models. All traditional credit metrics stayed relatively constant, and charge-offs totaled $15.4 million or 20 basis points. $9.2 million of those charge-offs related to credits that had specific reserves assigned in previous quarters. NPAs total $198.5 million or 0.39% of total assets, compared to $190 million or 0.4% on March 31st. The majority increase related to commercial premium finance loans. We'll discuss later. The ticket size of our premium finance loans was up a lot, and accordingly, the amount of non-performing commercial premium finance loans made up most of that increase.
You should know, however, that every one of those, or 99% of those, the losses are taken earlier, and we have confirmed return premiums cover the outstanding. Really kind of inflates our number, but a GAAP is a GAAP. Loan modifications for the quarter to $1.7 billion or 9.2% related loan totals. The growth curve related to loan mods flattened and is falling off so far in Q3. We included a lot of information on our exposure to select bank-impact industries and loan modification earnings release. Rather than regurgitate all that information to you now, we, that is Rich Murphy, our Chief Lending Officer, can handle inquiries in the Q&A. Total credit reserves on the core loan portfolio stood at 1.85% related to balances.
Premium finance loans carry a 14 basis point reserve, which is appropriate given $7 billion of the life portfolio, knock on wood, has never had a loss. Purchase loans carry 230 basis point reserve. Needless to say, in the old way of calculating reserves and provisions, our numbers would be nowhere close to the ones recorded. Not that we are naive enough to think that these extraordinary times will not result in elevated credit losses. I guess time will tell whether CECL is accurate or whether the industry will be subject to the whims and the quants and model makers. If one loses a girlfriend or has a hangover, you never know what they can do to the industry now based on these new models. Many of them were well reserved. Now we'll see what the future brings. The balance sheet side, great growth of $4.7 billion.
Loans grew $3.5 billion. We'll talk about that in a second. Average loans obviously were up higher than period end loans. Period end loans, I'm sorry, are higher than average loans, so we should be able to achieve the benefit of that going forward. Our loan-to-deposit ratio of 87.8% was in the high 70s when you deduct PPP loans. We have room for, we'll have plenty of liquidity and have room to invest that in our loans. We discussed our excess liquidity and the overall effect on liquidity management on margin earlier. Loan growth, not including the $3.4 billion of PPP loans, was driven by our premium finance portfolio. Commercial premium finance loans grew $535 million. It was driven by higher average ticket sizes. 38,400 was the average ticket size in this quarter, versus 31,500 in Q1 and 30.2 from a year ago.
This bodes well for future quarters. The life insurance portfolio also grew almost $180 million. Commercial real estate loans were basically flat for the quarter, while core commercial loans were down $502 million. Approximately $300 million of that decrease related to line usage returned to normal levels. At the end of the first quarter, we had 56% line usage. We went down to 45% at the end of the second quarter. Many clients drew on their lines in the first quarter to enhance their liquidity for that uncertain future. We estimate another $300 million ± of PPP proceeds were used to pay down other debt. Paying those amounts back would actually show growth for the quarter. Speaking of PPP loans, to date, we have 11,632 loans for $3.41 billion.
I could not be prouder of our team for satisfying all these clients and non-clients. They did a great service. We are currently working on landing portfolio relationships with over 450 new prospects who could not be served by our larger competitors. This represents 1.5 years of new business resulting from the halo effect of our people's good work. As a result, 90-day pipelines are very, very full. Deposits grew nicely in the quarter, as we mentioned. We completed our preferred offering, adding $278 million, $287 million, Tier 1 capital. Capital will support our growth, but also take advantage of any asset dislocations that may result from these uncertain times and provide a cushion for any unexpected contingencies that may arise. Estimated Tier 1 and Tier 2 capital ratios were 10.1% and 12.8%, respectively. I'll turn the call to Dave to provide some additional detail on other income and other expense.
All right, Ed. Thank you very much. Ed touched a little bit on some of the non-interest income and expense sections. I'll just give a little bit more detail. In the non-interest income section, our wealth management revenues decreased $3.3 million to $22.6 million in the second quarter, compared to $25.9 million in the first quarter of the year, and down 6% from the $24.1 million recorded in the year-ago quarter. The decline is impacted by the volatile equity valuations during the first half of the year, which impacts the pricing on a portion of our managed asset accounts and also due to some lower trading in the brokerage accounts. Given current market conditions, as Ed indicated, we would expect those revenues to rebound in the third quarter.
Mortgage banking revenue increased by a whopping 112%, or $54 million, to $102.3 million in the second quarter from the $48.3 million recorded in the prior quarter. Was also up a strong 174% from the $37.4 million recorded in the second quarter of last year. The company originated $2.2 billion of mortgage loans for sale in the second quarter. This compares to $1.2 million of originations in the first quarter of the year and also the second quarter of last year. Up $1 billion from last quarter and the year-ago quarter in production. The increase in the category's revenue from the prior quarter resulted primarily from that increased volume as well as expanding production margins, which led to an increase in production revenue of $44.1 million.
Capitalized mortgage servicing revenue also positively impacted the mortgage revenue as capitalized MSRs net of payoffs and pay down activity was approximately $9.3 million higher than the prior quarter. These positive revenue measures were offset by a negative MSR adjustment net of the hedging contracts during the second quarter of approximately $7.4 million compared to a negative MSR adjustment of $10.4 million in the prior quarter. The mix of loan volume originated for sale that was related to the refinance activity was approximately 70%, compared to 63% in the prior quarter. The refinance volume increased slightly during the quarter, and the pipeline is predominantly filled with refinance applications as of now. We expect to have another strong third quarter, as Ed indicated, as the continuation of that refinance activity is represented in a strong, committed pipeline as of this time.
However, production margins may compress a little bit from the recent lofty levels. They topped out over 4%. We expect them probably to drop back down into the 3% level, but we'll see what happens for the remainder of the quarter. Table 16 of our earnings release provides a detailed compilation of the components of the mortgage servicing revenue and MSR activity and levels. Other non-interest income totaled $14.7 million in the second quarter, down approximately $3.6 million from the $18.2 million recorded in the prior quarter. The lower revenue in this category was due to lower capital market activity from loan sales and syndications, a lower amount of card and merchant-based services due to a lower activity, card activity, and losses on investment partnerships.
These decreases were partially offset by $3.2 million of higher BOLI income, as BOLI investments supporting deferred compensation plans were positively impacted by equity market returns during the quarter. I should note, though, that the BOLI income in the second quarter resulted in a similar increase in compensation expense as the deferred compensation and BOLI investments move in tandem together. Turning to non-interest expense categories. Non-interest expenses totaled $259.4 million in the second quarter, up approximately $24.7 million, or 11%, from the $234.6 million recorded in the prior quarter. Relative to the prior quarter, there were three main factors that contributed to the increase. First, the company recorded approximately $6.9 million of additional contingent purchase price consideration related to the acquired mortgage banking operations. That's the difference between the contingent consideration expense in the first quarter and the second quarter at $6.9 million.
We incurred approximately $14.6 million of additional commissions and incentive compensations during this quarter relative to last quarter, primarily due to the mortgage business. Approximately $2.9 million of additional FDIC insurance assessments was recorded due to growth in the balance sheet and the impact of the PPP loans on our leverage ratio. If you add up those three items, they combine to $24.5 million of the $24.7 million increase. Essentially, all of the increase was related to those three items. With that being said, I'll talk about these and a few more items in a bit more detail. The salaries and employee benefit category increased by $17.4 million in the second quarter from the prior quarter this year.
The majority of the increase, as I mentioned, related to incentive compensation accruals, which were approximately $14.6 million higher than the prior quarter, with that change being largely driven by additional commissions on significantly higher mortgage loan production closed during the quarter. Additionally, salaries expense was up $5.8 million from the first quarter. The primary causes of that was related to $3 million of deferred compensation costs tied to the BOLI investment gains that I'd mentioned earlier. Additionally, the company incurred approximately $1.6 million of overtime and temporary help expense in the current quarter to support the significant mortgage volume being processed through the system and incurred approximately $2.6 million of elevated pay for COVID-related compensation matters. Offsetting these increases was a higher level of deferred salary costs recorded as significant loan volume during the quarter occurred primarily related to the PPP loan category.
Further offsetting the aforementioned increases in salary and incentive compensation expenses, the employee benefit expense was approximately $3 million lower in the current quarter than the prior quarter, primarily due to a reduction in employee insurance claims, as we're seeing that our employees are doing less discretionary doctor visits during the pandemic work from home time periods and social distancing time periods. Data processing expense increased approximately $2 million in the second quarter compared to the prior quarter, due primarily to a $4.5 million conversion charge related to the Countryside Bank acquisition versus $1.4 million of deconversion charges incurred in the prior quarter. Delta there of $3.1 million. I should note that all acquisition-related conversion and deconversion costs are behind us for all the completed acquisitions, and accordingly, the third quarter should be void of any such charges.
As I mentioned, FDIC insurance expense was up $2.9 million in the first quarter compared to the prior quarter. The increase was primarily due to increased assessment rates at our subsidiary banks as a result of balance sheet growth and lower leverage ratios. Relief was provided for FDIC insurance premiums related to increases in assets from PPP loans for the asset size component of the assessment, relief was not provided for the leverage ratio unless a bank utilized the Fed's PPPLF funding program. We did not need the PPPLF funding program to fund our PPP loans, we did not receive the FDIC insurance release on the leverage ratio component of the rate determination.
As unfair as that may seem relative to a bank that funded using the Fed's program, it is what it is, and our assessment rates were higher for that reason, and also due to other growth in the balance sheet. Professional fees increased to $7.7 million in the second quarter, compared to $6.7 million in the prior quarter. The professional fee categories averaged approximately $7.3 million over the last five quarters, it's in line with our average, and it relates to a variety of matters, such as legal services related to litigation, problem loan workout, consulting services, and legal services related to acquisitions. Advertising marketing expenses in the second quarter decreased by $3.2 million when compared to the first quarter of the year.
The decline was primarily related to a decline in sponsorship spendings, including our sponsorships of various Major and Minor League Baseball teams, which have not been active, as well as other summer event-related sponsorships which have been canceled due to the coronavirus pandemic. This expense category also had a lower level of mass media advertising costs as a result of reduced mass media spending, which was not incurred due to the cancellation of the Major League Baseball events and our related media surrounding those events. OREO expenses increased by approximately $1.1 million in the second quarter as the company recorded a gain of approximately $1.3 million on a sale of an OREO property during the prior quarter, and only a small OREO loss was recorded in the current quarter. Although this expense category increased, the total expense for the quarter was only approximately $237,000.
The miscellaneous expense category totaled $24.9 million in the second quarter, compared to $21.3 million in the first quarter, an increase of $3.6 million. This increase was caused by the aforementioned $6.9 million of additional contingent consideration related to the previously acquired mortgage banking operations. The increase is a result of higher anticipated contingent purchase price payments, resulting from both current volume closed so far in 2020, as well as forecasts of revenues out through the end of the respective earn-out periods for our previous mortgage banking acquisitions. Offsetting that charge was a lower level of travel and entertainment expense and a variety of other smaller fluctuations. Without the contingent consideration accrual, the miscellaneous expense category would have actually declined during the quarter. As Ed mentioned, we think we have taken care of the contingent consideration based upon current mortgage volume projections.
Other than the expense categories I just discussed, all other expense categories were down on an aggregate basis by approximately $169,000 from the first quarter. As Ed mentioned, the net overhead ratio stood at 0.93%, which is down 40 basis points from the 1.33% recorded in the first quarter, aided by the growth on the balance sheet and a strong mortgage quarter. On a year-to-date basis, the overhead ratio was 1.12%, again, aided by the balance sheet growth and the mortgage results. With that, I'll talk about the tax rate just briefly, as I'm sure somebody will have a question on that. We generally think of the tax rate as being in the 26%-27% range. This quarter was at 29.46%, really the result of the increased FDIC insurance expense, which is not fully tax-deductible.
That caused an increase in the rate because of the increased expense and because of the lower pre-tax earning numbers due to the provision adjustment. The denominator was smaller, and the numerator was a little bit bigger because of the disallowed FDIC insurance expense. With that, I'll wrap up my remarks and turn it back over to Ed.
Thank you, Dave. Interesting times, as they say, but we're well prepared for whatever comes our way. Our capital levels are robust. Forgiveness of PPP loans should accelerate recognition of fees, we're prepared for round two if and when the government ever approves. The halo effect from that effort should provide additional core loan and deposit growth. Our loan pipelines, as mentioned, remain very strong. Commercial premium finance should continue to still benefit from that hard market we're now in. Tailwinds in the mortgage business should allow for above-normal business for the rest of the year. Credit metrics remain strong. Reserves are at their highest level in company history. As I said earlier, and that may even have to lead the current situation, we credit unscathed, but as of now, we don't see it. We're prepared if it turns.
First loss is your best loss. We'll continue to our practice of culling our loan portfolio to really identify cracks and deal with issues. Historically, we've operated at credit metrics that have been a fraction of peer group due to our conservative lending practices, product mix, and our diversified portfolio. We expect that to continue. Loan deferrals, which were below peer metrics to begin with, are declining. Managing liquidity to optimize earnings both now and in the future while retaining adequate levels to accommodate an uncertain future. We believe that there will be dislocations that result from the current state of the world. I don't believe the acquisition market will open up until some of the uncertainty goes away. We always say that we take what the market gives us. Right now, it's given us organic growth opportunities.
Our goal is to prudently grow through this period in time, as the zero interest rate environment will not provide much opportunity to grow the margin. We'll continue to prepare our balance sheet for higher rates. I don't know about you, but to me, it feels like the 1970s all over again. Not that I'm going to be breaking out my old bell-bottoms or disco records anytime soon, but it appears that higher interest rates are in our future based on the level of activity of the government printing presses. We're preparing for that. We're trying to optimize earnings. We'll keep the balance sheet ready for higher rates. Probability of them going lower is certainly diminished by the zero rate environment, and the opportunity of them to go higher, if Mr. Keynes is true, we should be there. With that, I'm going to turn over and ask you.
You'll always be considered our best efforts, and we appreciate your support. Now time for questions.
Certainly. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Chris McGratty from KBW. Your question, please.
Hey, good morning, everybody.
Hi, Chris.
Hey. Ed or Dave, the outlook for net interest income. I totally appreciate there's a lot of moving parts with the PPP. I guess the first question is, was there any of the $91 million fees that you booked in Q2? How should we think about the cadence of that $91 million?
Yeah. The approach we took on this, which we think is the right way to do it under GAAP, is we're doing a level yield method on the PPP loan fees. We did a survey of all of our customers and got input from them as to when they thought they would submit their application and what sort of forgiveness level they thought they would have. Based upon those responses and based upon communications with our customers, we think that at least 80% of the loans would be forgiven, and we would get our funds from the SBA by the end of the year. The rest, we would assume would go out over the remainder of the contractual terms of the loans at 20%.
We put that schedule together and we created a level yield chart, which we can adjust as time goes on here. As we know, the SBA could change the rules. They could go to this one-page form and have some of these smaller loans repaid much quicker, and they could potentially process them much quicker. We've gone on the assumption that 80% will be paid off by the end of the fourth quarter through the forgiveness process, and the rest would be projected forward. We have taken the fees and based upon that schedule. In the second quarter, we recognized approximately $25 million of the $91 million.
This represents two and a half months. Not a full three months.
Okay. $66 is the remainder. Is that right?
Yeah. The interesting thing is we continue to book loans. We're booking at probably an average of $1 million a day. We don't open the portal, but we are contacting customers who didn't take advantage of it, and we continue to book more of these loans as they're available. A little bit more. I think [Canam] will add materially to it, but there's still some more coming in.
Okay. I think, Ed, in your remarks, once we get through the next six months, correct me if I'm wrong, I think you said 270 to 280 basis points is kind of an exit margin for the business in this rate environment. Is that the right way to think about it once you get through it?
Yeah, I think that's fair. Depends on where life goes, our loan pipelines are very strong. We got a lot of liquidity on the balance sheet right now put to use. I mean, at an 80% loan-to-deposit ratio, taking the PPP loans out, we have room to grow that side of it. We can shrink a little bit because we did bulk up on liquidity because back at the, if you remember, the end of the first quarter, who knew what was going on, and we felt it appropriate to have an oversized amount of liquidity just in case. We didn't know that the government was going to allow the PPP loan funding. The government's not your best counterparty. You can't trust them, rely on them for anything. We relied on ourselves there.
There are a lot of moving parts here, but we think that that's about the number we're going to come up with.
Okay. Just maybe a couple housekeeping, the FDIC insurance cost, Dave, does that gradually go back to where it was as these loans pay down? How does that work?
The reason we got dinged was not because of the size of the balance sheet, because they did allow you to exclude the PPP loans on the asset component of that calculation. Where we got dinged was our leverage ratio. If the leverage ratio increases, then our FDIC insurance rate would come down. As we make more money and the leverage ratio goes up, hopefully, then we could do that. If we downstream some capital into the banks, you could potentially reduce it. I would suspect that it would be a similar amount in the third quarter because the leverage ratio isn't going to shoot to the moon. Even if those PPP loans pay off from a leverage ratio perspective, they'll still be in our average assets. It'll just switch from a loan to liquidity.
Got it. Okay.
Yeah. What really happened was, remember back in March, nobody knew what was going on, and we made the decision to pull some dividends out because we hadn't done our capital offering yet, didn't know we'd be able to get one off. Cash at the holding company is king there. We did not jeopardize the banks. We did pull their capital levels down as they earn, as the PPP loans go up. Now that we have a lot of cash as a holding company, we very well could put some in and bring that level down. That's to be determined. We thought it was a prudent thing to do to bring cash out to have it at the holding company, because the cash is king at the holding company. If you don't have it starts a debt spiral. We didn't want that.
Got it. That'll stay steady, but that $7 million contingent number will come out, Dave, next quarter, right?
That's correct. Unless for some reason the mortgage market went way higher, because we're forecasting out over a few year period for these deals. We're making our best guess based upon talking to the business people, but I would think that that would not go higher. It could get tweaked a little up or down if volumes change a little bit. It's sort of like CECL. You're making your best guess right now based upon forecasts, and it is what it is. I can't imagine that we can actually handle much more volume than what we're doing right now. I think that should be a good number and not recur.
Great. Thank you.
Thank you. Our next question comes from the line of Jon Arfstrom from RBC Capital Markets. Your question please.
Hey, thanks. Good morning, guys.
Hey, Jon.
Hey. I wanted to ask about the reserve build, especially that $96 million in economic factors. I was curious if you guys were surprised by that amount, particularly relative to last quarter. When you think about your qualitative overlay, what would need to change for you guys to have another build in that economic factor?
I guess I'm a little surprised by the magnitude of it, but the models spit it out. If you look at it, the Moody's models, really, that they have, the economic factors that we use generally is the commercial real estate price index, which is the thing that drove most of that. Those projections were down quite a bit at the end of the second quarter versus the first quarter. The Baa credit spreads impact us, too, and those were a little bit wider. GDP impacts some of the factors as well as the Dow Jones. The big impact there was the commercial real estate price index impacting the macroeconomic factors.
If you saw the commercial real estate price index deteriorate further, it could be that we might have some additional expense, but it is sort of a line in the sand at June 30th. That's our portfolio, and that's the provision. Assuming conditions stay relatively stable going forward, you shouldn't have much more provision unless you grow your balance sheet. The reserves are out there, and we think we've got them marked pretty good. If for some reason the commercial real estate price index improves a little bit, the forecast for that improves a little bit, you could actually see some relief on that number. If that number gets substantially worse, then there might be a little bit more pain.
As Ed said, if you look at our charge-offs, you look at our past dues, you look at our NPAs, you look at the curve flattening and new deferral requests coming down, and actually the overall deferral requests declining. You don't get the feel right now that you're going to need to add to that reserve anymore, that the economy is getting worse. A little bit surprising to us, but 80% of that increase in the allowance was really related to GDP being worse in the second quarter and more importantly, the commercial real estate price index.
Yeah.
Those are the two big factors. Those are the ones we track. We do some qualitative overlays to it based on certain portfolio characteristics. That's what's driving the increase, and that's what you should sort of follow, I think.
Yeah. If you think about the other 20% is related to things happening with downgrades in the portfolio. Most of those downgrades occurred because of loan mods. Rich, you want to talk about where loan mods are? Because we see them going down and.
Yeah. No, I think that as we talked about in the last earnings call in the highly affected industries, we saw CMOD activity really come pretty aggressively during those first couple of weeks of April, particularly in the franchise space. We track that very closely. We follow it as a management team by segment. What we're seeing now, as we get through the first 90 days and now into the second 90 days, as those come off, we're seeing a fairly steep decline in the customers asking for that next round. That coupled with, as Dave pointed out, really new requests for deferrals are very slow. We're starting to see that CMOD % dropping off pretty dramatically.
As Ed also pointed out, those risk ratings that go with those CMODs, hopefully, that is a very good sign that those will be upgraded as cash flows improve. Certainly in the franchise portfolios we talked about last quarter, we're seeing material improvement in just overall level of cash flow and operating performance in that segment. We're mildly encouraged right now looking at that CMOD element.
Okay, good. That helps. It seems like it backs off quite a bit or much better for Q3. Dave, you backed us off a little bit on the mortgage banking margin, and I understand that, but what are you thinking on volumes? Sometimes it trails off in Q3, but it sounds like you've got such a pipeline of refinance that you're not suggesting that.
Well, we don't necessarily have visibility to the end of the quarter, $2 billion ±, I think we probably will have another $2 billion quarter if the applications continue to come in at the level they are right now. If you look in our press release, we showed we have about $1.9 billion of loans that are locked in the pipeline. Some of those go beyond the 90 days. Some of them drag out. Based upon the pipeline we have there, people could walk away if rates went down. We could have people walk away. Given the pipeline we have and the applications that are coming in and the time it's taking to close them now, I think it's $2 billion ±. We didn't see many people walk away from their deals in the second quarter.
They just didn't want to get back in line. Even though rates fell a little bit, most people followed through and just closed on their mortgage. We'll have to see if that pull-through rate continues, but if it does, I would think, yes, plus or minus $2 billion again.
The applications have not slowed. Really, you kind of think about July and August is baked already. It's really September, those applications are still coming in at the same level, gives you a good feeling.
Yeah. Going to set up well for Q3.
Hey, Jon?
Yep.
You want to borrow my bell-bottoms or my disco records?
Hey, I still have all my teeth, Wehmer. We're going to just throw that back and forth here. I still have all my teeth.
Oh, boy.
Hope you're doing better, all right? I hope you feel better.
Thanks.
Yep.
Thank you. Our next question comes from the line of David Long from Raymond James. Your question, please.
Thanks. Hey, everyone.
Hey, David. You still have your bell-bottoms, don't you?
If you keep your clothes long enough, you'll use them again. Doesn't matter what type they are. The cycles do rotate. I guess I'm a hoarder, but yeah. I just wanted to see if I heard you correctly. Did you say in quarter to date in the third quarter that deleveraging has already been about $1 billion on the balance sheet?
Yes.
Okay. Got it. I didn't see it in the release, but did you guys disclose what the purchase loan marks you guys still have on the books are at this point?
Well, we have a reserve of, what I say, 2.3% against them.
No. Specific reserves, we didn't disclose that, but it's very small, David. I don't have the number in front of me, but it's very small.
Okay. You talked a little bit about the marketing dollars and the sponsorships. With Major League Baseball kicking in here, we think in a couple of days or tomorrow maybe with a couple of games, what type of increase are we expected to see here from the second quarter to third quarter from those sponsorships that you will be taking on?
My guess is about $2 million to $2.5 million. There's no tickets. It's just a sponsorship side of things. We hit October. If we're lucky enough to be in October, then you might have another half million to $1 million.
We're counting on the Sox playing the Cubs in the series, it may go up a little in October. Yeah. As I said, there aren't tickets. It'll probably bump up a little bit in the third quarter, but not like it was in prior years because you still don't have all the ticket costs.
Got it. Okay. All right. That's all I have for now. Thanks, guys.
Thanks, David.
Thank you. Our next question comes from the line of Nathan Race from Piper Sandler. Your question, please.
Yeah. Hi. Just a question on the excess liquidity build in the quarter. I'm curious to know how much of that you guys think is kind of transitory. I know almost two-thirds of that is tied to PPP and whatnot, but any sense just in terms of the other deposit growth that you had in the quarter, how much of that may stick around, and what are kind of your reinvestment plans with some of that excess liquidity as well going forward?
I'll give that to Tim Crane.
Yeah. I'll take the first part of that. For sure. In that we've seen ins and outs. Municipal deposits are up quite a bit. Obviously, to your point, there's probably $2.5 billion of PPP related deposits that remain on the balance sheet. I don't know exactly what to expect, I don't think it's going to go down a ton. We've seen good inflows. The press release references MaxSafe deposits up about a half a billion dollars in the quarter. I would expect sort of pretty flat, pre any PPP movements, or even up. Then Dave, with respect to utilizing some of the excess liquidity.
I'm really not excited about locking in these rates, 1.5% on mortgage backs. Our loan pipelines are very strong right now, and I think we're going to rely on those premium finances. Those are nine months full payout loans, so we're churning those every nine months, with $10,000 increase in average ticket sizes, picking up additional market share, that's going to help. The life insurance portfolio is doing very well. Our overall leasing portfolio, which is throughout the balance sheet, is over $2 billion now, shows no sign of letting up. The commercial side, again, with a total of $1.8 billion or $1.9 billion gross in the pipelines, coming down to about $1.3 billion in estimated draws on there. There are estimated success rates. That $1.3 billion of loans, it's a halo effect.
It's unbelievable what happened. They will bring probably another $1 billion of deposits in. If I had to guess, I'd say we're going to be flat on assets, maybe up a little bit in the third quarter. Loan-to-deposit ratios, PPP loans are forgiven, will start working their way up again. We may or may not do some mortgage backs just to make a little bit more money, but I'm more concerned about maintaining our gap position and now locking in these low rates. I truly believe that maybe not this year, maybe not next year, but with the amount of money in the economy right now and those printing presses continuing to hum, especially if phase 2 of the relief comes through. You go back in time, and those always result in higher rates.
Maybe the rest of the world won't, but inflation's got to kick in even with the rest of the world, so we'll see.
Yep. I would agree. Appreciate that commentary, Ed. Just thinking about core loan yields, maybe x the PPP program. Any sense in terms of how those came down in the quarter? I'm just, again, trying to isolate the impact apart from those lower yielding loans.
How they came down in the second quarter, or you're talking about what we're thinking about moving forward?
Yeah, no, I'm just trying to understand the magnitude of the decline in core loan yields outside of PPP in the second quarter.
Well, commercial and commercial real estate were probably down from April through June. Early in the quarter, they were probably 40-50 basis points higher than later in the quarter.
Okay. That's helpful. Appreciate all the color. Thank you.
Welcome.
Thank you. As a reminder, ladies and gentlemen, if you have a question at this time, please press star then one. Our next question comes from the line of David Chiaverini from Wedbush Securities. Your question, please.
Hi, thanks. A couple follow-up questions here. You mentioned about the Moody's model and the CRE price index projection being the main driver for the provision in the quarter. I was curious, are you able to share what that projection is? How much are commercial real estate prices expected to come down based on the Moody's model?
Well, what we had in there, the CRE price index would decline through the fourth quarter and recovers into 2021, but still would remain below what it was at the end of the first quarter. It declines down. It does go down. It's probably down, I think the commercial real estate price index was near 300 at the end of the first quarter, and depending on which Moody's model you look at, but the ones we were looking at is sort of if you look at baseline or even if you looked at the S1 model, they're coming down in the 240-250 range. Could be down 20% ish.
Great. That's helpful.
Recovering into 2021 is what they show.
Got it. Okay. That's helpful. Did I hear you right, given all the moving parts and the utilization rates coming down in the second quarter, but looking out to the third quarter for loan growth, did I hear you say, think of it as flattish, given the pay downs and runoff of the PPP will offset some of the growth and pipeline build you're seeing in the other categories?
Well, not with the same PPP, which we expect to come down substantially. We believe our core portfolio, the non-PPP portfolio, should grow nicely based upon all of our niche businesses doing well and our commercial pipeline, say commercial real estate pipelines, being very full. Yeah, we think PPP loans in the third and fourth quarter will be gone barring round two. I don't know where we're going to make up $3.3 billion in that period of time, but we'll manage our liquidity accordingly. We expect our core portfolio to continue to grow.
We also would expect, unless they do this SBA program quickly here and the SBA's got 90 days to turn around the forgiveness applications once they get them. They could turn them around in 30 days or 15 days or quicker, I suppose, but my guess is they're not going to work at lightning speed just because they'll have a lot of activity from every bank around the country that did these. Most likely you'll see most of that payoff occur in the fourth quarter. Probably through the third quarter, we'll have the PPP loans generally in place.
Got it. Thanks for that. The last one is more of a housekeeping question. You mentioned about how the FDIC assessment was elevated in the second quarter, and you expect that to be kind of stable in the third quarter. You mentioned about the tax rate, how it's normally 26%-27%, but because of the elevated FDIC assessment, that's where it was in this 29.5% range. As we think about the tax rate going forward, should we think about 29%-30%, given the elevated FDIC assessment, or how should we think about that?
I don't think so, because the denominator really is your pre-tax income, and our pre-tax income was so depressed because of the $135 million worth of provision. If we go back to the normalized provision, the denominator is going to get much larger, and it should bring that rate back down. I'd still say 26.5%-27% is probably a decent rate. It really sort of depends on the pre-tax income number. Because it was so depressed because of the elevated provision this quarter, that was the other reason for the increase in the rate.
Great. Thanks very much.
Thank you. Our next question comes from the line of Brock Vandervliet from UBS. Your question, please.
Oh, great. Good afternoon, guys.
Hey, Brock.
Hey. Given the wash of liquidity, I'm just wondering if you feel you have much scope to further reduce the CD component of your funding mix. It's not large on a percentage basis right now. I'm just kind of curious if you thought you could work it down further.
I think naturally, I think it'll come down. Just as we don't want to lock up these rates, other people don't either. I think it'll move in the money market and what. I don't think we'll lose the deposits. I think people just wait. Yeah, I think it's natural that CDs would come down a bit.
Okay. On the deferrals, what do you think the end game is there? You can obviously re-defer. Do you decide at some point to re-underwrite and modify some of those that, I believe under the CARES Act would not be considered a TDR if you did that. Just wanted to talk that through.
Well, I'll turn it over to Rich in a second, but on round one, we share the pain. We don't just hand them out like candy. We actually underwrite and look at them at that point in time and say, "Boy, you could do X, Y, and Z to save cash. Why come to us?" We put provisos out there to share the pain and enhance our position. The second time round, there's more pain. Murph, what do you think?
No, you hit the nail on the head. I think as we walk through time here, the first round, I think a lot of our peers were pretty much looking at that as just kind of a free pass. We looked at it. We certainly wanted to be there to help out our customers who were stressed. We also did, as Ed said, you wanted to really think about what other things could we do to make it a better structure in terms of additional collateral, personal guarantees, things like that. As we refer to it as rumble strips in terms of the deferral process. As we get into the second go-round, we're kind of looking to bump that up a little bit.
If somebody is looking for another 90 days deferral of principal or principal and interest, those requests are going to get a little bit more elevated. At that point in time, we also want to understand what is the game plan, back to your original question. How is the customer planning to get to the other side? That is the end game question. For a lot of our customers, as I talked about earlier, we're seeing those deferral rates coming down pretty dramatically. I think that as the economy has reopened, a number of our highly impacted industries have really seen a substantial improvement. As we get into this next phase, we'll really start to be able to see which of those industries within our portfolio still have some really long-term residual impact.
We're going to have to kind of one at a time walk through what is the end game for that situation. At this point in time, we're mildly encouraged that the people who are coming in for deferral requests, they're not interested in throwing in the towel. They see a path to being cash flow positive again, and so we're feeling okay right now.
I think our mantra is, we don't want to kick the can down the road and just have it explosion in a compost pile later. There's no way out. Our first loss, our best loss is work with the clients and figure it out that way. As Murph said, most of these guys see an end, and we do underwrite at that point in time. If we can do anything in terms of rewriting the loan and doing it that way, and it makes sense to do it, we do it. Most of them, they were underwritten properly in the first place. Their business hasn't changed that much to require that other than additional collateral or other things that will benefit us.
Great color. Rumble strips, like that analogy. Good job working those down. Thanks.
Thank you.
Thank you. Our next question comes from the line of Michael Young from SunTrust. Your question, please.
Thanks. A quick follow-up on kind of the first loss is best loss comment. Just what areas are you kind of more aggressive in just going ahead and moving problems out where you maybe see less opportunity for a recovery or a better market to kind of liquidate at this time? Maybe just any color there.
Yeah, I wouldn't say that there is an industry-specific issue there. I think that as we disclosed in the release, there are a number of highly impacted industries that, generally speaking, we're feeling pretty good about. One that we see and some of our peers as being particularly problematic or two would be energy and hospitality have been really highly impacted. For us, it's just not that many credits. We can look at those individually and try to figure out exactly what we're going to do. Neither of those portfolios do we feel like we have a whole lot of exposure from a loss perspective too, at this point in time. We're feeling okay. I think the one that is probably most interesting to me to see how it ultimately works out is the CRE retail portfolio.
I think that's the one that everybody has highlighted for this quarter amongst our peers. Certainly for us, we've done a pretty deep dive understanding what that portfolio looks like. We do think that there's a lot of room in that portfolio from an LTV and a debt service coverage perspective. We've got a lot of personal recourse in there, so we've got some handles to pull. In terms of just going in and doing a wholesale sale of chunks of the portfolio, we just don't see that right now. There are certainly loans within the portfolios that have shown more stress than others. Generally speaking, the borrowers want to work with us, and we want to work with them. I wouldn't say we're cutting and running on any segment of the portfolio right now.
Okay, maybe switching gears, more of a strategic question maybe for Ed. Over the last 6-12 months, you guys have been kind of growing the branch footprint with some infill opportunities and obviously doing some deposit specials. I assume most of that activity obviously has been curtailed or suspended indefinitely. Are there opportunities to kind of go the other way and cut some costs on physical distribution and infrastructure? What needs do you have on kind of the technology investment side in light of kind of the pandemic and new customer trends?
On the technology side, we are constantly upgrading our systems there under one of our main operating tenets, which is selling better products, selling better delivery systems, still in the service. That's going very well. I think we're very competitive there, but the market moves very quickly. We continue to make investments in the digital side of the equation. On the branch side of the equation, by the end of the year, we will have completed a full review of our smaller branches to make sure that we usually are one or two in market share in our branches as they're a period of time in terms of after a year and a half, they should be one or two in market share. Some have not achieved that.
We're going through a full review of those branches to see do we have the wrong people? Are they the wrong location? Some have been acquired. Should we close them? There are always opportunities there, and we always look at them, but maybe a little bit more forcibly this time by the end of the year. There may be some opportunities to relocate, close, or the other side is, you hate to say it, but if this remote working and distancing becomes the new norm, you need as many people in the branches as you used to have. It's another thing we'll be looking at through the end of the year, looking at more remote work. I'm amazed at how well remote work is done. In other words, we are reviewing all those expenses and just seeing how they grow. Tim, do you have a comment on that?
No, I think that's right. We're not giving up on the branch footprint by any stretch of the imagination. We're seeing clients want to use both our branches and the electronic services, which, as most banks point out, are up over the last 120 days or so. There's still places we'd like to be as well, and we think opportunities. I think it'll be a selective review.
Okay, last one for me. Just on the mortgage kind of comp expense or variable expense, looked like it was up about $6 million year-over-year. Volumes were obviously strong. How should we think about that going forward? Are we in kind of a higher variable comp environment for the rest of the year, just given production volumes or anything like that we should be baking into the model?
Yeah. If we did $2.2 billion this quarter, we do $2.2 billion next quarter. We paid based on quantity of loans closed, basically. Depending on the average ticket size, I would expect it to be similar. If you went back down to $1.2 billion, then we'd obviously lose more. We don't see that happening in the third quarter. My guess is with rates as low as they are, that we'll have probably a relatively strong fourth quarter too with this, because some of the closing dates, the locks are much longer now just because the system is so full that you can't close quite as fast as you used to. I would expect those numbers to stay elevated. It's fine for them to be elevated because you're making the revenue on the other side.
I would expect they wouldn't change dramatically in the third quarter based upon us expecting to have a similar production in the third quarter.
Okay, thanks.
Thank you. Our next question is a follow-up from the line of David Chiaverini from Wedbush Securities. Your question, please.
Hey, thanks for the follow-up. You mentioned about retail CRE and called that out. I was curious, in light of the Moody's forecast calling for the CRE price index to be down possibly, and of course, it's only a forecast and very well could not come true, but down 20%. Can you remind us what the LTVs are for the retail CRE portfolio as well as CRE overall?
Yeah. For the retail CRE, I don't have the CRE overall, but we did a pretty deep dive on our retail CRE and looked at 75% of the portfolio in great detail. The average LTV there was about 55.6%. Now, keeping in mind that's based on the most recent appraisal. It doesn't necessarily mean that that's what a current LTV is. It highlights, I think, the fact that there's room to move here. We typically have been pretty conservative over time. The other thing that I think is interesting in that analysis is that the average loan size is around $1.2 million. It kind of highlights again that, what we said in earlier calls, that we do try to be pretty granular in that space. We really don't have a lot of exposure to big box and to any regional malls.
Most of what we have is sort of the infill, in-community type stuff that has kind of been a bread and butter within our retail footprint.
Great. Thanks.
Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Ed Wehmer for any further remarks.
Thank you. I have one further remark. I've had a couple of emails like, "Ed, you only talk about higher interest rates." I'm saying long term. I don't think it's going to happen tomorrow or maybe in the next year, but I think it has to happen. I think that this is such a cyclical business, you have to learn from the past. Although, there are different wrinkles thrown at you. I think preparing for higher rates makes a lot of sense in my book, I'm not saying it's going to happen next year or this year, but you'd only do a bunch of five-year or seven-year deals at 1.5%, because I think it's got to happen eventually. I want to make that point clear. We've always been somewhat like salmon when it comes to that.
We talk about longer term, and it seems like we're swimming upstream, but it's always paid well and played off well for us. Thank you, everybody. If you have further questions, you know who to contact. Have a great week and stay healthy. Thanks.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.