Heritage Financial (NASDAQ:HFWA) Q1 2020 Earnings Call

0:01 I'm here.

0:04 Thank you, Brian. Okay, so the hosted speakers, you are in the main conference and everyone else is in listen mode right now.

0:13 Okay, perfect. Thank you, Daniel. Welcome, everybody who called in. This is Jeff Deuel, CEO of Heritage Financial. We're very sorry for the mix-up on the phone call. Apparently, we asked for a hosted call and got a general call. Fortunately, in... Today's environment, we're all a lot more flexible than we used to be, so hopefully you had some time to work on your emails while we got straightened out on our end. I'm going to jump into our presentation, and then we will open up for questions at the end. With me in the room are Don Hinson, our Chief Financial Officer, Dave Sperling, our Chief Credit Officer, and Brian McDonald, our Chief Operating Officer, is on by extension She's at one of our remote locations this morning. Our earnings release went out this morning pre-market and hopefully you have had the opportunity to review it prior to the call.

1:12 Please refer to the forward-looking statements in the press release. Well, it goes without saying this has been a heck of a quarter for our country, our communities, and the banking industry. We started out the first two months of the quarter seeing some nice growth in our pipeline. some positive progress with credit quality as a result of our active portfolio management. We also successfully launched our new Heritage Direct Treasury Management Platform. Obviously, things quickly changed as the C-19 pandemic accelerated. Our pipeline began to decrease and the management team dusted off our pandemic plan. In Washington and Oregon, we have been operating in stay-at-home status since the third week in March. Our robust regional economy is in a self-induced coma, and although we have managed to flatten the curve, we expect the revival of our economy to take some time. Fortunately, Washington and Oregon are talking about a staged approach to a restart.

2:14 As an essential service, we continue to operate the bank with very little interruption to our customers. Early in March, we opted to close our branch lobbies to most customer traffic and operate through our drive-through facilities. All but nine of our 62 locations have drive-through capabilities, which made the transition that much easier. This move served to keep both employees and customers safe. We continue to operate in this manner and we are now just beginning to plan for a phased approach to reopening some lobbies in the next couple of months. We were also able to quickly implement a remote work environment for many employees.

3:00 Approximately 60% of our employees now have remote capabilities, and we have about 325 who are fully remote at this time. It is important to note that even with the lobbies closed and people working remotely, we continue to add deposit relationships and make select new loans. In parallel with securing our lobbies and our people, We launched a loan modification program for all loan types to provide relief to our customers and we also began a review of our underwriting parameters in light of the new conditions. After that, we became completely absorbed in the SBA PPP program and getting the stimulus money to customers who needed it.

3:45 Fortunately, we have seen good success with our PPP program. and at this point we believe we have served the needs of our customer base. Even though we expect the banking industry will experience credit quality deterioration as a result of the C-19 impact, we believe Heritage will outperform the industry median similar to our experience in the last downturn. Our longstanding culture is focused on conservative underwriting, active portfolio management, and avoidance of loan concentrations, which will pay off for us by keeping credit losses at manageable levels.

4:30 We will cover all of this in more detail as we move to Don Hinson, who will take a few minutes to cover our financial results, including color on our corporate operating metrics, our core operating metrics, with some specific comments about credit quality and CECL. Don Hinson Thank you, Jeff.

4:50 A reported diluted earnings per share for Q1 was $0.33, which is down from $0.47 in Q4 2019. The decrease in earnings was due mostly to an increased provision for credit losses. The unfavorable impact to earnings was partially offset by a much lower effective tax rate in Q1. This was due to a combination of factors including lower pre-tax income while increasing tax-exempt income instruments and a $1 million discreet item due to the CARES Act allowing us to carry back an acquired bank net operating loss to 2013. Our stable net interest margin also helped earnings this quarter. The net interest margin expanded to 4.06% compared to 4.02% in the fourth quarter of 2019.

5:38 Moving on to the balance sheet, net loan balances increased $73 million in Q1. Of that amount, $30 million was due to increases in utilization rates for offering lines of credits on C&I loans. Deposits increased $35 million in Q1, while maintaining the same percentage of non-maturity to total deposits of 88.6%. We continue to maintain very strong balance sheet liquidity. At quarter end, we maintain combined credit facilities at the Federal Home Loan Bank and Federal Reserve Bank of $972 million, and fund lines at other banks totaling $140 million. In addition, we have unpledged investment securities totaling $728 million and brokered deposits currently making up only five basis points of total deposits.

6:26 Our loan deposit ratio is 83.4%. We continue our longstanding strategy of operating with a balance sheet with a low leverage, which we believe will serve us well during our current economic situation. We have also been approved to use the Fed's PPP liquidity facility in conjunction with our PPP lending. Regarding credit quality, we had a significant decrease of 10.4 million or 23% in non-accrual loan balances in Q1. This improvement was due mostly from agricultural borrowing line of $6.8 million which exited the bank. This was part of the $20 million relationship discussed at length in the Q3 and Q4 earnings calls which we partially charged off in Q4. We still have $12.4 million in real estate loans related to that ag relationship, which we believe are well secured. These loans will stay on non-accrual status until we see a history of payments on those loans.

7:22 Additionally, we received payment in full on a commercial business relationship of $2.3 million, which was also on non-accrual status. Our net charge for Q1 was only $417,000. This is a decrease from $1.9 million in Q4 due to the recovery Q1 of $963,000. from that same ag relationship that was charged off in Q4. This recovery was offset by other commercial charge-offs of $1.2 million in Q1. Potential problem loans increased $14 million in Q1 due mostly to four loans downgraded to special mention as a result of C19 and eight loans downgraded to provide additional oversight. Potential problems decreased quarter-by-quarter without the C19 additions. We are carefully monitoring our exposure to high-risk industries during this pandemic.

8:10 Our commercial exposure to high-risk categories is relatively low and includes the following. Restaurants, 85 million, or 2.2% of the total portfolio. Hotels, 124 million, or 3.2% of the total portfolio. And recreation and entertainment, which includes bowling, fitness centers, and other amusement-related businesses, of 37 million, or about 1% of the total portfolio. In addition, we are monitoring all remaining loan types carefully. I'd like to turn now to COVID-19-related loan modifications. At the end of Q1, we had modified 136 commercial loans for a total of approximately $80 million, including a combination of interest-only deferrals on advertising term loans and full payment deferrals.

8:57 Almost all modifications were for 90 days. So as we went to quarter end through April 27, we modified 615 commercial loans for a total of approximately $350 million with approximately 60% interest only and 40% full payment deferrals. While consumer loan modifications in number are higher than on the commercial loan portfolio, the dollar amount of consumer loan modifications is less than 10% of commercial loan modifications. We are taking a conservative approach to risk rating and only leaving modified loans at their pre-pandemic risk rating if it is clear that the operating entity will quickly return to its pre-pandemic performance. As of March 31, we have downgraded 39 loans, totaling $36 million in response to pandemic-related issues. Most of our C-19 modifications are being downgraded to watch and are not included in potential loan numbers.

9:53 Our expectation for the next round of modifications is that we'll see deterioration of borrower sustainability and some downgrades of standard. Moving on to CECL, The total day one impact on allowance for credit losses was $5.5 million, $1.8 million for the allowance on loan balances, and $3.7 million for the allowance on unfunded commitments. This day one increase in the allowance for credit losses on loans was partially mitigated by approximately $1.9 million of previously allowance related to December 31 PCI loans that were reclassified to loan discounts to be accreted as part of the CECL implementation process. The provision for credit losses on loans in Q1 was $10 million, or a 26% increase from the post-Day 1 allowance for credit losses on loans.

10:45 This provision was partially offset by a $2 million reversal of allowance on unfunded commitments due to lower unfunded balances at the end of Q1. At the end of Q1, the allowance for credit losses on loans increased to 1.23% of total loans from 0.96% as of the end of Q4. As a result of this increase in the allowance and decrease in non-accrual loans, the allowance to non-accrual loans increased to 139% at the end of Q1 from 81% at the end of Q4. I'll quickly go over some CECL model assumptions we used. We used a late March Oxford economics models for the forecast. Due to the rapidly changing environment, we added additional expected losses to the allowance for certain at-risk industries such as restaurants, hotels, and recreation.

11:35 We also reviewed the impact of the Federal Reserve Bank's 2020 severely stressed scenario, which calls for increased U.S. unemployment rates, severe global recession, and elevated stress on corporate debt markets and CRE. Although we did not use this scenario in our final CECL calculation, our allowance as of March 31 was the equivalent of using a 60% likelihood of the Fed's severely stressed scenario and a 40% likelihood of the late March Oxford economics forecast. We will continue to monitor the forecasts and economic conditions based on what has occurred post-quarter end. We are likely to have elevated provisions for the remainder of 2020. Moving on to net interest margin, we had an increase of four beeps in the NEM Q1.

12:23 This occurred primarily due to a change in the mix on earning assets, higher percentage of loans and lower percentage in overnight interest earning deposits. Loan yields did not decrease as much as might have been expected due to some recapture of previously reversed interest on non-accrual loans and the funding of higher earning commercial construction loans during the quarter. As previously expected, cost of total deposits began to decrease in Q1, dropping two basis points to 37 basis points in Q1. Although we didn't experience NIM compression in Q1 due to 150 basis points rate cuts in March, I expect significant downward pressure in NIM starting in Q2. This pressure is expected to be partially mitigated this year by the yields on the PPP loans.

13:11 Non-interest expense increased 1.3 million from Q4 levels due mostly to increases in comp and benefits and marketing expenses. Both of these expense categories tend to jump in Q1 from the prior Q4. Comparing year over year, our overhead ratio improved to 2.70% in Q1 from 2.79% in Q1 2019. We do expect overall expense levels to increase in Q2 and Q3 due mostly to increased costs associated with the implementation of our new treasury management system and the completion of our usage of the credit for our quarterly FDIC premiums. And finally, moving on to capital, we remain well capitalized for all regulatory capital ratios.

13:53 Further, our TCE ratio remains strong at 10.2% at the end of Q1.

13:59 During Q1, we repurchased 796,000 shares, completing one repurchase plan and starting another one on March 12th. On March 18th, we suspended our buyback program until we better understand the impact of the current economic situation on our long-term capital levels. Yesterday, the board declared a 20-cent dividend, which is unchanged from the prior quarter. Although we have no plans to cut or cease our dividends at this time, we will be monitoring on a quarterly basis our capital position and ability to pay future dividends. Bryan McDonald will now have an update on loan production and PPP status.

14:33 Thanks, Don. As Jeff mentioned in his opening remarks, we saw good momentum in the commercial loan pipeline and production levels in January and February, before being heavily impacted in early March by C-19, which then caused us and our customers to shift our focus. For the quarter, our commercial teams closed $167 million in new loan commitments, very similar to the volume closed in the first quarter of 2019. The commercial loan pipeline ended the first quarter at $506 million, up 30% compared to the fourth quarter, and up 13% compared to the first quarter of 2019. Subsequent to quarter end, we have seen many customers put capital projects, expansion plans, and bank transitions on hold, and we are now anticipating the actual loan volume closed from this pipeline will be much lower.

15:27 Gross loans increased $84 million during the first quarter, a 9% annual rate due to lower levels of prepayment and payoff activity and a higher utilization rate on operating lines of credit. The utilization rate on our commercial loans increased by 6% during the quarter, contributing $30 million to the growth. And loan prepayments and payoffs were $68 million lower than what we experienced in the fourth quarter. Subsequent to quarter end, the utilization rate has trended down to levels more in line with utilization rates we have been experiencing over the last few years. Consumer production during the first quarter was $47 million, the same as the fourth quarter of 2019, and up from $40 million closed in the first quarter of 2019.

16:16 Moving on to interest rates. Our first quarter interest rate for new commercial loans was 4.24%. a decrease of 19 basis points from 4.43% last quarter. In addition, the average first quarter rate for all new loans was 4.46% up one basis point from 4.45% last quarter. The Mortgage Department closed 26 million of new loans in the first quarter of 2020 compared to 52 million last quarter and 22 million in the first quarter of 2019. The mortgage pipeline ended the quarter at $54 million versus $15 million last quarter and $27 million in the first quarter of 2019.

17:01 The growth in the pipeline is due to a spike in refinance activity caused by the drop in long-term rates. Refinances made up 70% of the pipeline at quarter end. Finally, I'd like to cover the bank's participation in offering loans under the SBA Paycheck Protection Program. At the end of the first quarter, we started preparing to launch our fulfillment of PPP loans after the President signed the CARES Act into law on March 27th. Our application package was made available to customers on Friday, April 3rd, and we went live processing applications on Monday, April 6th. We are very fortunate to have a very experienced SBA team here at Heritage, having been a preferred SBA 7a lender for many years.

17:47 This proved critical in designing the requirements and workflow for the PPP. In addition, we benefited from having internal IT capabilities to stand up a fulfillment and reporting system for SBAPP lending during the weekend of April 4th and 5th. The system allowed us to organize ourselves, see in real time our volumes at each process step, and shift work between several hundred staff members, many of whom were working remotely, and working extended hours. This allowed us to fulfill over 2,800 applications in the first phase of funding with an average loan amount of $244,000. Most important to us, we were able to process the full backlog of customer PPP applications received during the first round of funding, being left only with a small number of unprocessed applications when SBA funding was exhausted on the morning of April 16th.

18:42 These applications were fully processed when the second round of funding went live on Monday, April 27, and we continue to process new applications. We process PPP applications exclusively for our customers until we are current on our backlog and processing new applications within a few hours of receipt. After achieving this level of process efficiency, we opened up the process to known, prospective customers. We anticipate many new relationships will result from our ability to help them with their SBA PPP application. I'll now turn the call back to Jeff.

19:18 Thank you, Brian. We feel very good about our performance in light of the overlay of C-19. We have successfully and safely addressed the needs of our employees, customers, and the communities we serve. It was particularly important for us to be able to perform at a high level in support of PPP. As a result of adding IT development capability to the team two years ago, we were able to stand up an automated platform in a matter of days. We believe this capability provided us with a competitive advantage in our markets. While we have not seen notable deterioration in the loan portfolio, we expect to see stay-at-home actions continue to take its toll on the at-risk industries.

20:06 We will need to get beyond the PPP funding and the modification deferral period to fully begin to see the damage. We agree with others that businesses will suffer two shocks back to back, an immediate and in most cases total revenue shutdown that transitions to a recession with very slow revenue growth. This is a different set of parameters than we have ever seen before. and we are not sure how it will play out as the economic resuscitation gets underway in our footprint. We are pleased with our performance and progress in the first quarter despite the challenges from C-19 and a rapid decrease in interest rates. We believe Heritage is well positioned to navigate these challenges and we will continue to benefit from our core deposit franchise and conservative credit culture.

21:00 while maintaining our focus on net interest margin and expense management. Furthermore, the robust liquidity and capital position on our balance sheet provides us with a solid foundation to adjust the challenges and take advantage of opportunities. As I said earlier, we're pleased with our performance to date and immensely proud of our team for their performance during this difficult time. That is the conclusion of our prepared comments. So Daniel, maybe we can open up the line to answer questions. Absolutely. Ladies and gentlemen, if you'd like to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command.

21:49 If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, you may press 1 then 0 at this time. And one moment for the first question, please. and we do have a question from the line of Jeff Rulis. Your line is now open.

22:13 Good morning, Jeff. Thanks. Good morning, Jeff. To the margin, Don, how much did the interest recovery add to the 406 reported and what was core, I guess, if you quartered a quarter?

22:35 Jeff, I think it adds a couple beefs to that, so not a lot, but it did help some. But again, I think that, again, we didn't feel the impact of all the rate cuts until, you know, because it happened so late in March that we won't feel a lot of that until this quarter, and mostly on the loan side, obviously, because our cost of our loan rates will be.

23:08 Okay. So, you know, if it's 401,402 and you talked about, I think in the release about deposit lag pricing, that's more of a kind of a balance of the next couple quarters. So again, maybe an acceleration of some compression given the rate cuts didn't have a a lot of time to impact the quarters margin? Correct.

23:38 Correct. Again, about almost a quarter of our loans are fully floating. So if you just think about that, 150 basis points. Now, some of them have floors in them, but even then, when they get rewritten each year on their anniversary, they're liable to get rewritten at lower rates. So even if they're on a floor now, that will change as the loan gets renewed.

24:03 Got it. To the credit side, the ag and C&I credits brought out of accrual, I think I recall those were somewhat one-off issues, but trying to see if there's any related hope that others here that are similar, or were they true singular credit issues?

24:26 I don't think that there's an overlay to all of those loans that's specific to the group. I think they're all individual issues. We are always working the portfolio. We talk about that all the time, Jeff. And I think that we're hopeful that we'll see progress much like we've already seen.

24:50 And on the, you mentioned some C&I downgrades. I don't know if you've got a percentage or just in broad terms, the group of those that have deferrals or PPP support. Any idea on that?

25:09 Well, there's clearly customers in the PPP program that we're happy to see participating. The deterioration that was related to COVID, which was a series of what I would characterize as larger loans, moving into the problem loan category are obviously larger got attention sooner and they're part of that category of at-risk loans, specifically most of it is hotels. And it was just an exercise on our part to start taking action on some of them sooner than later.

25:55 Great. And one last one if I could. what would be the, maybe for Don, the true up on that reserve to loans at 123 if you were to include credit marks additionally?

26:14 Jeff, I'm not quite understanding your question.

26:18 The acquired credit discounts that may be, so reserves to loans at 123, but did you have a an additional balance that would exceed that reserve level?

26:36 Well, I think we had $1.9 million that we switched over.

26:40 Okay. So that effectively went away?

26:42 Yeah, so it went from allowance basically into discounts. That's one reason why normally we see as the balances decrease, the accretion percentage goes down. overall to the impact on loan yields, and it stayed the same this quarter. And that's because we threw in another, that amount in the $1.9 million is now going to get accreted as opposed to being part of the allowance, which it was before.

27:11 Great. Okay. Thanks. I'll step back. Thanks, Jeff. And we have a question from the line of Mr. Matthew Clark. Your line is open.

27:21 Good morning, guys. Morning. Good morning. On the adjustment this quarter, using a late March forecast with things obviously deteriorating in April, I know that forecast was pretty dire, but is it fair to assume that we'll see some additional reserve build here in the second quarter before, maybe even the third too, but before you start to kind of use that reserve to realize the losses?

27:59 Yeah, I think that, this is Don, I think that we will continue to see that. Again, I expect a higher, higher reserves throughout this year. And I think that Q2 and probably Q3 will be probably, I'm guessing, the high points. Really depending on what happens, right? It's hard to predict right now what's going to happen long term and how long this is all going to go on for. But right now I would expect continued high levels of reserves per quarter over the next probably couple quarters at least.

28:30 Okay. And then on the higher risk exposures, the restaurants, hotels, recreation, entertainment, can you give us a sense for the underlying LTVs and debt service coverage ratios there and maybe average loan size and whether or not there's any other industries that you might be concerned about that others have talked about, like like health care, senior living facilities, schools, churches, things like that.

29:02 Yeah, this is Dave Sperling. The high-risk industries we've identified obviously include restaurants, hotels, as Jeff mentioned, recreation fitness centers, but we've also got on that list some dental or dental borrowers and also churches, if that answers your question.

29:27 How much in terms of exposure there for those two other categories?

29:31 The exposure on those other categories are fairly low. The largest exposures in hotels, restaurants behind that, and the hotel exposure was about, what was that, 119 million, I believe, and restaurants is about 84. Those are the predominant high-risk categories.

29:59 Okay, and the underlying LTVs and coverage ratios there, if you have them?

30:04 On the real estate side of things, our LTVs tend to be pretty conservative. Weighted average in the portfolio is about 55% to 60%.

30:16 Okay, and then just on the PPP side, program. Can you give a sense for the average loan size there? How much might still be in the pipeline? I'm not sure if you already mentioned that. And then how you might be modeling it, whether or not you're just assuming that most of it will come and go by the end of the third quarter, or do you feel like you're going to stick around longer?

30:49 Matt, John, you want to start, and then I'll follow you.

30:52 Sure. Again, through the through quarter end, or not through quarter end, for the first tranche that we got funded was $687 million. Average was $244 million. And again, the bulk of those were under $350 million, or between $350 million and $400 million. Again, I would say In fact, if you break it down further, under $100,000 was about 9.4%. $100,000 to $350,000 was $22.5%. Half of the loans in balance were between $350,000 and $2 million. And then about 18.5% were over $2 billion.

31:42 So those are the funded piece. And then we're still getting other items through our applications through that haven't necessarily been funded, but they've been approved. and we're up to around our applications right now that we think we will get through is about 885 million and then it drops the overall average though with including all of that down to about 220 so the loan size has been going down over time but that's because we're looking on to putting on probably another 200 in the second tranche as of right now. Brian, you want to add anything to that?

32:21 No, that's right on.

32:24 Okay. But is it fair to assume a 3% origination fee on average, not 5?

32:32 I think it's going to be higher than that, yeah, because, again, only, again, about half of it is, half of the loans are between the 350 and 2 to get to 3, and only about 19% is over 2 million. So it'll be between like 3 and 4 on average. Okay.

32:55 Got it. Okay. And then maybe just the spot rate on deposit costs at the end of March, if you have

33:08 it. It was lower. I think it was closer to 35 basis points towards the end spot rate. But we keep dropping the rates in this market.

33:23 Okay, and then just a good tax rate to use given the lower level of income going forward?

33:30 Well, you know, depending on our income levels, as far as the effective tax rate, if it's similar and we didn't have the discrete item, it'd be closer to 13%. But again, the effective tax rate itself will depend on the pre-tax income going forward. But because, again, our tax or perm tax items that are used for that calculation actually grew a little bit in Q1. Okay, great. Thank you. And we have a question from the line of Jackie Bullen. Your line is now open, please.

34:16 Good morning, Jackie. Good morning, everyone. Good morning. one quick follow up on the PPP in terms of the new customers. So that the additional roughly 200 million that you're processing through the second round, is that all new customers or did you have some that carried over from the first round? I just wanted to make sure that I was clear on that.

34:36 This is Brian. We had just the inflow. So stuff that maybe was taken, you know, after eight o'clock the night before one ran out and then we had you know a certain number of incomplete applications that hadn't been able to be processed so and then of course between the time it closed and the time the second round of funding opened we had additional customers that came and applied during that period of time so you know our daily flow the last few days has been you know maybe somewhere in the neighborhood of a hundred applications and and you know it's different day to day but it's it's more of a mix of prospects and customers versus you know of course all customers when we went into phase one so there is still customers in there along with prospective customers that we've been calling on.

35:33 Okay and in in terms of these new customers what do you think the likelihood is that you could bring and other pieces of their portfolio in both loans and deposits over to you after things begin to normalize again.

35:50 We're already seeing that. Jackie, we didn't go into it with a requirement around that, but we're seeing a number of customers be open to talking to us about other banking services as a result of doing the PPP Loan Forum. It's a little early. but we're already seeing customers being open to moving additional business to us.

36:17 Okay. And were you actively marketing these customers? Meaning were these prospective customers that you had been reaching out to in hopes of obtaining their business or were these just customers coming in looking for a loan?

36:32 They were predominantly prospects that our bankers had been calling on previously. So in many cases for many years, you know, everybody has their prospect list and actively calling. So as they finished up handling the needs of their existing customers, the applications they had in hand, they then turned their attention to, you know, to the prospects they had been calling on to see if we could help them with a PP plan.

37:04 Okay. Great. Thank you. That's a really good question. Just one last one and then I'll step back. In terms of the treasury management system, I have in my notes, I think from last quarter, that that's roughly a million dollars in added expenses in a year. First off, is that still an accurate number? And second, was any of that included in 1Q or will that all flow in in 2Q, realizing that that million is an annual number?

37:29 Yeah, and that, Jackie, that's gone up some. The implementation is going to be more than reasonable. I think we probably have another I think another million or million or million one left and we did about I think about 400,000 in Q1 so but that should be done by end of Q3 the remaining million or million one.

37:51 Jackie one of the issues we faced into was we launched in the first quarter and the first wave of customers were handled quite well actually and then C19 hit so what we had to do was shift our waves of customers to double up the next wave later in the year so that we could get past what we were dealing with the last eight weeks. So that just presented additional costs because we had to reset our arrangement with the vendor that's helping us through that process.

38:27 Okay. Okay, that's helpful. And that 400,000 number, is that an annualized number?

38:33 No, that was the number in Q1. And then, like I said, we'll have another $1.1 million, I think, left over the next two quarters.

38:43 Okay. So the $400,000 is not annualized, but the $1.1 million is?

38:50 $1.1 million is what's left to be spent over the next two quarters.

38:55 Oh, okay. Got it. Okay. Thank you. That's all.

39:03 Thank you. And we have a question from the line of Mr. Gordon McGuire. Your line is now open.

39:11 Morning, Gordon.

39:13 Morning. How are you guys?

39:15 We're better now that the phone system is working.

39:21 Don, I wanted to clarify a comment you made earlier. For modified loans, you You downgraded if you didn't feel like they could return to pre-COVID levels of performance. Is that correct?

39:42 Yeah, this is Dave. We had a bias towards taking credits to watch, but in those instances where the borrower and client was more likely to return quickly to pre-pandemic performance, we left those at their original risk ratings.

40:00 Okay, and do you have the ratio of watch loans at this point versus, I guess, March 31st versus December?

40:10 I don't have those numbers handy, but I know there was in the first quarter in March, there was kind of a spike in watch credits due to the downgrades that were a result of modifications.

40:24 Okay, but those did not flow into potential problem loans, so... I guess the 18 million or so COVID related potential problem loans, are those going to be able to be subject to modifications?

40:37 Those were kind of outliers. Those were some credits that the two predominant ones were destination hotels and they presented more risk than we thought a normal modification would present. So we did take those down to special mention and became TPLs.

40:59 Okay. Do you have the mix of modification or how much of the modifications you had were related to the higher risk portfolios that you identified?

41:14 As was mentioned earlier, there was kind of an even split between interest only on amortizing and full payment deferrals, but don't have to break out by industry. Okay.

41:29 and then Brian, I think I heard all new loan originations were up one basis point to 446. I guess what drove, what do you feel like drove that? Was it increased credit spreads or did the construction utilization drive that higher? Was that kind of abnormal?

41:48 You know, it just, most of the quarters production just pre-traded the big drop off in rates. So Don mentioned the Fed rates dropping, but Of course, you know, the federal home loan bank indexes that tend to mirror the jury rates, of course, higher. You know, we saw those fall off. So it was really the mix of loans and then just the fact that the quarter just didn't capture most of the downward rate movement we've seen.

42:16 Okay. And then last one for me is how you guys are thinking about funding the PPP loans that come on the balance sheet.

42:28 Well, as I mentioned, we're all signed up with the Fed to use their liquidity facility for that. We haven't started doing that yet. We haven't needed it. But for one thing, because we've got the loans out there and they go into the person's deposit account, but really not much has been spent yet because it all happened pretty recently. But as that money gets spent and we need the funds, we'll start to pledge those to that facility and take those funds from that facility. And as a reminder, that facility is at 35 basis points, but there are no non-recourse borrowings.

43:16 All right. I appreciate it. Thank you.

43:18 Thanks, Gordon. And there are no further questions at this time.

43:24 Thank you, Daniel. I think then we're ready to wrap up this quarter's earnings call. We thank you all for your time and your patience as we got our call underway. We appreciate your support and your interest in our ongoing performance. So we look forward to talking with many of you over the coming weeks. Thank you and goodbye. Ladies and gentlemen, this conference will be available for replay after 1 p.m. today through May 14th at midnight. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code 3443-789. Those numbers again are 866-207-1041 and the access code 3443-789. That does conclude our conference for today. Thank you for your participation and for using AT&T teleconference service.

44:17 You may now disconnect.