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Cadence Bancorporation (NYSE:CADE)
Q1 2020 Earnings Call
Apr 29, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Cadence Bancorporation 2020 First Quarter Earnings Conference Call. All participants will be in listen-only mode. The comments are subject to the forward-looking statement disclaimer which can be found in the press release and on Page 2 of the financial results presentation. Both of those documents can be located in the Investor Relations section at cadencebancorporation.com. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Paul Murphy, Chairman and CEO. Please go ahead.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Well, good morning, and thank you all for joining our first quarter earnings call. With me today are Valerie Toalson, Sam Tortorici, Hank Holmes, and David Black. First, I would like to talk about a few positives. We had another good quarter of operating results as measured by our adjusted pre-tax pre-provision net income which, excluding the noncash goodwill impairment, was $93 million for the quarter. This is right at 2.11% return on average assets in the quarter. So, PTPP was down 2% in dollars-linked quarter but flat at 2.11%. So, a good quarter there.

The loan loss reserve doubled in the first quarter and ended up at $245 million or 1.83%. The increases are attributable to CECL and to COVID. Our capital ratios are strong, our tangible book value increased nicely from $14.65 at the end of the year to $15.65 at the end of the first quarter, 6.7% increase in linked quarter.

Also, during the quarter, we locked down a $261 million gain on the termination of our interest rate collar which we established back in February of 2019. In the first two months of the year, our collar increased by over 100%, and we locked that in which contributed to the nice increase in tangible book value during the quarter. We had another strong quarter of good expense management. Adjusted noninterest expenses declined $5 million or 5% linked quarter. This was primarily attributable to a significant reduction in the incentive accrual. Our adjusted efficiency ratio at the end of the first quarter was 49.9%. We're down a 100 basis points compared to the fourth quarter.

We continue to have a lot of success in our deposit base and overall funding cost. Specifically, total cost of funds were 1.05% at quarter-end and total cost of deposits 0.96%. These represent declines of 18 basis points quarter-over-quarter for each metric. The declines largely neutralized the impact of the declining rates on our earning assets. So, quarter-end NIM was 3.80%, a decline of 9 basis points, but really attributable to lower accretion. Excluding the impact of lower accretion, NIM would have increased 2 basis points.

I'll now highlight, I would point out that we announced a noncash goodwill impairment of $413 million net of tax. This is, of course, tied to the current value of our acquisitions. As you know, this impairment does not affect tangible capital or liquidity.

We made the decision to reduce our quarterly dividend to a $0.05 per share this time. We believe this is a prudent step and consistent with our historical conservative approach to capital management. Loan-to-deposit at quarter-end were 93%. So really liquidity and capital look good.

Prior to COVID, our classified assets had crested, and we have good visibility to seeing some reductions in classified assets coming up in the next few quarters. At this point, we expect to be dealing with credit stress resulting from COVID for a meaningful period of time, and that will be our primary focus.

Again, our extremely experienced team, many of whom have been through tough down cycles in the past, and we are focused on risk management like never before. Clearly, we'll experience some stress, but fortunately, our capital ratios and liquidity are strong, and we're prepared to manage through it.

From an operational standpoint, let me touch base on a few relevant facts. And first, I'm pleased to report that at this point, none of our Cadence bankers are known to be positive for COVID. 1,100 of our 1,800 bankers are working from home, and this transition has been much more manageable than I would have expected. In a very compressed period of time, we've worked proactively to ensure the safety of our customers and our employees and we maintain business continuity with our mobile capabilities and quite honestly, a lot of hard work and phone calls by all of our employees.

Our branches are open. The clients can come and see a banker mostly by appointment, customers are using alternative channels like never before. our transaction volumes have stayed constant. Our call centers had a few spikes here and there, but really very manageable. And of course, as you expect, the website and other forms of interacting with the bank are -- had increased significantly, flow in our online product.

We have seen a surge of SBA applications, over 1,700 applications, $1 billion in approvals, and a full pipeline moving forward tomorrow morning. Special thanks to our Cadence bankers who are working really nice in weekends to get these PPP loans funded. It has certainly been a large amount of volume.

So, I'll probably take a moment and talk about some of the higher risk parts of the portfolio, as I know that's of interest to investors. And let's start with our restaurant portfolio which is found on Page 24. As many of you will remember, this portfolio peaked at $1.25 billion, and we've been reducing it over the last couple of years. Our restaurant portfolio stood at $1.082 billion at quarter-end, up slightly linked quarter due to some line draws primarily.

And so, let me just hit a few of the major segments. Our Limited Service portfolio includes QSR and Fast Casual. It's up $737 million, 73% percent of the portfolio. So, QSR consists of large multi-unit franchisees, nationally recognized brands.

We have a lot of really big, big companies that bank with us. Our clients account for over 7,500 units. It's geographically diverse and really QSR, these days especially, is focused on off-premise. So, off-premise would be primarily drive-in but also delivery and pickup. So off-premise for this portfolio accounts for 70% of the revenue previously and so that means they're best positioned to deal with the quarantine restrictions.

Our Full Service segment, is casual dining and family dining, is $214 million or 21% of the portfolio and we believe this is the most stressed segment of the portfolio. Weekly sales have dropped by 60% and even more in some cases. And they're just really impacted by the complete shutdown of dining rooms and having to rely solely on carryout and delivery. So, a big adjustment for their business models and their label models.

So, a few other observations about the portfolio are found in your slide deck, but I think it's informative to learn that $496 million or about half of the restaurant portfolio is rated into what we call strong national brands. These are YUM! Brands. These are Taco Bell, Kentucky Fried, Pizza Hut, also Wendy's and Burger King.

So, these are some of the most respected restaurant brands in the industry and their franchise owners are known for providing strong support to their franchisees, things like product innovation, media and advertising spending advice, operational direction, recruiting, just a host of things that these major operators are able to bring to their franchisees.

And so, it's our belief that as the industry restructures and reopens, it's reasonable to expect that these stronger brands will recover faster, especially in light of the fact that some of the weaker brands may not survive.

Client selectivity has always been a key ingredient in our restaurant portfolio. We back 20 of the top 40 restaurant franchisee companies in the country today. These 20 companies of $408 million, a 41% of our exposure, they have the size, the scale the experience. They have $12 billion in annual revenue. They have an average 350 stores per operator. So, the bigger larger operators we believe are better positioned to cope with this level of stress.

Another note of relevance, the portfolio is about $103 pizza QSR. And as it would not surprise you, pizza is shown to be the most resilient segment. Since, pre-crisis, it was already delivered heavily to take out and delivery and their same-store sales have really been pretty flat compared to prior year, so that's an accomplishment.

And then one other note -- portfolio characteristic worth mentioning is that about $110 million of the portfolio is comprised of publicly traded restaurant companies which have a compound market cap currently of about $1.5 billion.

So, we just want to mention a few of the factors that point to a well-positioned restaurant portfolio. And clearly, full understanding and recognition of the extraordinary risk and impact of the sudden shutdown of the economy. So, we're well aware that there's risk in the portfolio but we think that some of the steps that we're taking to help would be of interest to you as well.

Payment deferrals, about 44 of the 72 clients, 50% of the portfolio were asked for payment deferrals. We've had 10 clients draw on revolvers of roughly $46 million. The vast majority of our restaurant clients have sought PPP loans from their agent banks, and we've processed $147 million in PPP loans for clients, which we view as immediate credit support in the near term.

So, this is the most stressed segment at Cadence, but we think we have done a lot of things to mitigate much of the risk for the reasons outlined earlier.

On Page 27, let's turn to Energy and let me update you with a few facts there about our portfolio. First, Midstream is the largest part of our portfolio. It's about 63% of the total, $937 million of the funded balance. That's about 7% of the bankwide loans. Midstream companies typically have fee-based contracted cash flow with no direct commodity price exposure. The really important point that we haven't illustrated previously is that the average debt cap of this portfolio is rather conservative at 39%. Of our borrowers, the average outstanding is $12.3 million.

In this portfolio, over time, we've experienced really great credit results. We've had charge-offs of less than $5 million or $2.2 billion in loans originated. Our team is known as one of the top teams in the Midstream space. We lead or agent over 30% of this portfolio. And, of course, we're continuing to stress test the portfolio for a world with lower oil prices. And I would just say that, so far, we feel pretty good about where we are and a key factor being the lower debt relative to the equity. It's just a major credit plus from my point of view.

Turning to E&P, this is now 2.5% of the bank overall. Recall that this is a portfolio that has down significantly from 2015. We peaked at about $591 million with 38 borrowers -- actually back in late 2014, I should say. And so, today, we have 23 borrowers and $337 million outstanding. We have one borrower just under $20 million that is nonperforming.

Hedging provides a great deal of comfort for our borrowers and for our banks at this point in the cycle. And we talk a lot among ourselves about the duration risk being a key variable. So, in other words, the hedging gives people protection to get through this period, but if prices stay low longer, that would mean more stress for the portfolio over time.

The last part of energy is oilfield services. It's just over $200 million, so about 1.5% of the bank total. And as we've reported previously, we shy away from growing sense of companies -- the majority of this portfolio is more production oriented, which, yes, there will be some shutdowns, but over time, production is, in my view, likely to resume.

So, we wanted to also touch base about hospitality and just CRE more broadly. But the hospitality slide is Slide 31. And so, before I touch on that, our commercial real estate book is approximately $3 billion in assets. We've got $7.5 million nonperformers, 25 basis points. This has been a very solid credit-performing portfolio over a long period of time. Tim Williamson and his team in Houston have had zero charge-offs, zero nonperformers, zero substandard. It's just really been pristine. And the State Bank legacy portfolio has also produced great credit metrics.

And I know that was then and this is now, but I guess the point is that not that I would suggest there's no risk in this portfolio but a well-underwritten portfolio will be able to withstand stress perhaps better than others who are not able to turn in really pristine numbers as Tim and his team have done.

So now, turning to hospitality, $270 million in loans outstanding, 88 different borrowers. Cadence had zero hotel loans. This was an asset category that we shied away from. And so, since the merger with the legacy state, we've been tapping pretty hard on a break and tending to reduce that portfolio. But I will add, having said that, states portfolio was good, and a loan to value of 52% excluding SBA loans and many quality repeat borrowers. At this point, roughly 1/3 of these borrowers have asked for payment deferrals.

The next category I'll touch base on is residential mortgage. We have $2.6 billion in residential mortgages on our books. I view this is a very low risk and a very conservative -- conservatively underwritten portfolio. Our shop has always been a paper and it shows in our results. Our charge-offs over the last 8 years have been less than $500,000 on newly originated loans and that included hurricane Harvey, which was certainly a stress for the region.

We have had requests for deferrals of approximately 8% on this portfolio since COVID, and we would, as I said, expect us to do pretty well over time.

So, we hope that some of this additional detail is helpful for analyzing our portfolio as it relates to COVID-19, and I'm sure that in future periods we'll be doing more assessment and reporting to you more details and more understanding as we gain knowledge about how this is unfolding.

Quickly on 2020, what's our strategy? Well, we're cautiously and prudently beginning plans to return to work. I'll tell you, I for one can't wait to get back to the office. I'm just more productive there. Clearly, the process will take time and it will vary by state and we will -- we're not rushing to anything and safety and health of our bankers is of paramount importance.

In the meantime, we're tightening managing expenses and we're really just tirelessly, diligently working with clients to better understand their stress and to hopefully manage to do that constructively.

So, we're mindful of the well-being of our employees and our customers, and we will continue to provide updates on how we're supporting those communities along the way.

With that, let me turn the call over to Valerie. And then, after Q&A, I'll have some closing comments. Valerie?

Valerie C. Toalson -- Chief Financial Officer

Great. Thank you, Paul. As Paul noted, our pre-tax pre-provision earnings continue to be strong with our adjusted pre-tax pre-provision earnings at $93 million for the quarter, down only $1.9 million from the prior quarter due to lower accretion. As a percent of average assets, it was actually flat at 2.11% quarter-over-quarter, reflecting the consistent underlying earnings power even in a time of stress.

This strength combined with our robust capital position and an allowance for loan losses at 1.83%, which more than doubled from year-end, are important distinguishing factors for Cadence.

Adjusted net income for the first quarter of 2020 was $12.5 million with an adjusted EPS of $0.10 per share. This was down $39.4 million and $0.30 per share respectively from the prior quarter, primarily due to increased loan provisions, which were up $56 million from the prior quarter, reflecting the impact of COVID-19 as well as CECL implementation. The increase in loan provision in the quarter attributed $0.34 of the quarterly decline in EPS.

Additionally, we did record a noncash impairment in our goodwill of $443.7 million or $413 million after tax, amounting to $3.26 per share, reflecting all of the bank reporting unit goodwill. This impairment was attributable to several factors, including the volatility in our stock price, our trading value relative to peers, cash flow forecast in light of COVID-19, and higher discount rates and other variables given the environment.

While this impairment drove the quarter's $399 million reported net loss, it does not impact tangible equity, regulatory capital, cash or liquidity. Notably, our tangible book value of $2 billion increased 5.4% in the quarter, with tangible book value per share increasing to $15.65 per share and tangible common equity to tangible assets increasing to 11.5%.

Our capital ratios continued to be robust with CET1 of 11.4%, leverage ratio of 10.1%, Tier 1 risk-based of 11.4%, and total risk-based of 13.8%. Our liquidity is likewise robust, with our solid core deposit base, quality and highly liquid securities portfolio, minimal wholesale funding and significant alternative sources of available funding.

Our tangible book value increased in the quarter, in large part due to our previously reported termination of our $4 billion notional cover in early March. Given the market volatility, the collar had increased in value by over a 100% from year-end, and we opted to lock in that gain of $261 million, which will flow into interest income over the next four years, providing an estimated $1.63 per share over that time frame.

Also, importantly, with the collar terminated, Cadence's full asset sensitivity returns. And in a 100-basis point rate parallel shot scenario, it improves net interest income over 11%.

On the deposit front, we continue to be very pleased with our mix and ability to strategically reposition our deposit base. During the quarter, non-interest-bearing deposits-to-total deposits increased to 27%, up $126 million or 3% in the quarter. Total core deposits declined in the quarter by 4% of our net $636 million, as we focused aggressively on lowering our deposit costs.

We were effective in decreasing nearly $1 billion in higher dollar cost -- or excuse me, on higher cost balances, $240 million of which was a collateral deposit related to our collar determination -- or collar termination, while offsetting that with over $0.5 billion in lower cost net core deposit growth.

And as a result, for the second quarter in a row, our total deposit cost came down 18 basis points to 96 basis points. And we expect further declines in the second quarter. Our core deposits make up 96% of total deposits, with brokered representing just 4%.

Our loan balances increased 3% or $334 million in the first quarter, with the growth coming primarily in March, as draws on existing lines of credit of approximately $450 million and modest new originations were partially offset by routine pay downs. Investment securities grew to $2.5 billion or 14% of total assets, adding $93 million in the quarter.

Our purchases over the past two quarters have been primarily in highly liquid agency mortgage bonds. Our municipal concentration, which is all investment grade, is less than 9% of the portfolio. On an average basis, our investment securities increased $394 million due primarily to the timing of the purchases in the fourth quarter, with the tax equivalent yield declining only 3 basis points in the quarter to $265 million. Our average interest-bearing deposits declined to $185 million, while average noninterest-bearing deposits increased $10 million from the prior quarter.

Due to the loan growth coming late in the quarter, our average loans declined $262 million. This mix shift combined with lower accretion and one less day in the quarter, led to total revenue down slightly to $188.5 million with net interest income decreasing $7.4 million and noninterest revenue increasing $1.2 million. The decline in net interest income included a $4.9 million decline in the accretion income and $1.4 million decline due to one less day in the quarter.

Focusing on net interest margin, the NIM of 3.8% was down 9 basis points in the quarter, solely due to an 11 basis points decline in accretion. All other NIM movements in the quarter netted a positive 2 basis points.

We were able to completely offset the impact of declining interest rates on our variable rate loans through our aggressive management of our cost of deposits and hedging activity.

Including hedging, originated loan yields of 5.10% decreased 15 basis points during the quarter, while we reflected an 18-basis-point improvement in our deposit costs. This is the second quarter in a row where we've had 18-basis-point reduction in our deposit cost, lowering our deposit cost by 27% over the last two quarters. Our first quarter originated loan and deposit betas were each 40%. Our hedging activities provided $7.9 million in interest income in the first quarter, up 23% from the prior quarter.

Note also that fee income from the Paycheck Protection Program will flow through net interest margin. So, we'll see that in the coming quarters. Based on secured funding so far, we currently estimate that that will be between $25 million and $30 million in fees alone, excluding any net spread of the loans themselves, for which -- for the most part are expected to be short term.

Noninterest income was relatively stable, up $1.2 million or 3.5% for the linked quarter. It included an increase of $2.6 million in securities gains and increases in service charges and credit-related fees as well. These were partially offset by declines in investment advisory revenue primarily due to declines of the market value and the impact of fourth quarter gains on loans sold.

Noninterest expenses were well-managed, reflected in our efficiency ratio of 49.7%. Our adjusted expenses declined $5.8 million in the quarter, largely in our compensation expenses as we lowered incentive comp and other employee accruals. Other smaller declines were really across the board, partially offset by an increase in FDIC insurance of $1.02 million, as the credits we received in the third and fourth quarters of last year were no longer in effect.

To summarize the CECL impact, we reported a Day-1 allowance of $75.8 million upon adoption, bringing our January 1, 2020 allowance for credit losses to $195.5 million. First quarter, we had net charge-offs of $33 million and loan provisions of $82.2 million. These charges resulted in an allowance of $245.2 million or 1.83% of loans at March 31. This was an increase of 105% or 91 basis points compared to December 31, 2019 numbers.

This doubling of our allowance reflected the Day-1 impact, of course, which we are opting to apply a two-year deferral into regulatory capital, as well as the impact of COVID-19 and lower oil prices reflected in the pandemic economic scenario that we used in our CECL modeling.

So, this has been really quite the quarter for the industry, and quite frankly for rest of the world. We are very confident in our balance sheet and earnings positioning as we navigate this environment.

We have a significant capital cushion, strong deposits and liquidity, meaningful inherent pre-tax pre-provision earnings power, a disciplined and lean expense base, a solid net interest margin that now has the locked-in gain from our caller as well as renewed full asset sensitivity, and importantly a resilient employee base that is demonstrating daily their flexibility and commitment to do whatever it takes to get the job done for our customers and for our shareholders.

Operator, I think we would like to open it up for questions now. Thank you.

Questions and Answers:

Operator

[Operator Instructions] And our first question today comes Jennifer Demba from SunTrust. Please go ahead with your question.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thank you. Good morning.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Hi, Jennifer.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thank you for going through all the greater isk portfolios, given the pandemic. Paul, are there any other loan buckets [Technical Issues] Cadence that maybe investors might not be thinking about that you're seeing greater risk and they could be very small exposures for you, but where you're seeing maybe higher deferral request than you might have guessed?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Jennifer, the only other category that comes to mind would be healthcare. As you know, we're roughly $500 million in loans outstanding there, about $150 million of those would be procedures that are on hold for the moment. So, I believe that that portfolio will be more V shaped. These are things that are being deferred and we'll have some pent-up demand.

So, we do see some stress there. But I feel like that's pretty manageable. And I don't know, Sam, would you add anything to that? I know you're close to that portfolio.

Samuel M. Tortorici -- President

Yes, Jennifer, that -- as you can imagine, ophthalmology, dental, urgent care, outsource clinical like anesthesia, radiology, all that has been kind of put on pause. And we do have some exposures in that space. Paul said it well, I do think we'll have V-curve kind of rebound on all of this, but I mean, because cataracts don't fix themselves. And so, I think that we've been -- this is stronger for clients, most of which have applied and been accepted for PPP funding, good private equity and SBIC backing. So, I think there's stress in the near term but not in the long term.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

One other question. For the charge-offs you had this quarter, can you just give us a little more detail on what those included for the general C&I portion of it?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Sure. David, would you take that one.

David F. Black -- Executive Vice President

Be happy to, Paul. Good morning, Jennifer. So, the $32 million in total charge-offs are 9.5 basis points on an annual basis was driven really by eight credits, one energy, three restaurant, and four general C&I. The general C&I -- the two largest of the general C&I on different sectors. They both had a consumer discretionary component to them. And as we came to the quarter-end, from an outlook perspective, I would say, the severity was definitely impacted by the more bearish macroeconomic outlook that influenced that charge-off total.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Okay. Thank you very much.

Operator

Our next question comes from Steven Alexopoulos from JPMorgan. Please go ahead with your question.

Steven Alexopoulos -- JPMorgan -- Analyst

Hey, good morning, everybody.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Good morning.

Steven Alexopoulos -- JPMorgan -- Analyst

I wanted to start on the dividend. So, if we look at capital levels are very strong. The reserve doubled over the prior quarter. What was the thought on reducing the dividend here, and why is $0.05 a share the right level?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Yes, Steven. Of course, we consider several different ways to approach it. As we mentioned in our comments, we've had historically a conservative approach to capital. There were times when people thought we should be aggressively buying shares back, and we were conservatively buying a few shares back. So, I think it's just more in line with being prudent and being conservative with respect to capital.

And credit stress is obvious. And there's a lot of numbers that I could have argued for, I could have argued to leave it where it is. I just felt like we wanted to make a reduction. It's a meaningful reduction to be conservative, but still pay at least some level of dividends.

So, I wish I could tell you there was a highly scientific answer to how we got to a $0.05, but it's not. It's just a judgment call.

Steven Alexopoulos -- JPMorgan -- Analyst

Okay. That's fair. Paul, on the criticized and classified loans, I was surprised we didn't see a more notable jump in the balances, particularly for segments such as restaurant. Is that because of the deferrals being provided?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Steven, no, I don't think so. I think that the COVID impact was really late in the quarter. And I think that we'll have to get more information about how the portfolios are doing to look at whether additional increases or -- I mean, the magnitude of the additional increases, obviously, we'll see some, but I think it's just too soon to recognize those at this point.

Steven Alexopoulos -- JPMorgan -- Analyst

Okay. And what was the balance of loans that you did provide deferrals on the quarter? What was the total?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

David, do you have a kind of a bankwide total there?

David F. Black -- Executive Vice President

I do. Steven, it was $1.2 billion or 1,134 loans that we provided deferrals on.

Steven Alexopoulos -- JPMorgan -- Analyst

Okay. Thanks. And then -- and finally, just on the energy portfolio, the reserve there, 1.6%, it seems very low. We have banks reporting energy reserves in the 5% to 10%-plus range. Do you have some color why is that reserve level sufficient particularly with CECL now live? Thanks.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Yes, the first thing is the Midstream portfolio. Again, as I mentioned in the comments, it's contracting cash flow. It's 39% loan to -- debt-to-cap. It's great performing historically. It's increased stress, but it's the vast majority of our portfolio and we think it will continue to do well. The E&P portion does have a higher reserve and we've got good hedging in place and one credit that's on the nonperforming list. I think it's appropriate for where we are today.

Steven Alexopoulos -- JPMorgan -- Analyst

Okay. Okay. Thanks for taking my questions.

Valerie C. Toalson -- Chief Financial Officer

Hey, Steve, this is Valerie. I might just add real briefly on that, really kind of on both of your questions on the criticizing classifieds as well as in the energy. When we went through our modeling on CECL, there is -- we did layer on both qualitative and environmental factors specifically to those sectors that you mentioned, really simply to kind of supplement the modeling. And the modeling we used was the pandemic modeling as of the end of March. So really the most up-to-date information that was available at that time.

As you know, everything changes day-to-day lately. So, things will certainly change as we go into the second quarter, yet to see how. But that was basically kind of the premise behind how we put this in a model and modeled that out.

Steven Alexopoulos -- JPMorgan -- Analyst

Got it. Okay. Thanks, Valerie. Thanks, everyone.

Operator

Our next question comes from Brad Milsaps from Piper Sandler. Please go ahead with your question.

Brad Milsaps -- Piper Sandler -- Analyst

Hey. Good morning.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Good morning, Brad.

Valerie C. Toalson -- Chief Financial Officer

Good morning.

Brad Milsaps -- Piper Sandler -- Analyst

Valerie, I think you just touched on a little bit, but I was just curious kind of the assumptions you used in developing your CECL assumption. It sounds like you [Technical Issues] late March. Just kind of curious if that kind of was the most punitive sort of outlook kind of compared to maybe what you saw in early April? Just kind of any additional color there on kind of how you came up with the numbers you did in 1Q?

Valerie C. Toalson -- Chief Financial Officer

Yes, absolutely. So, you're right. We used the -- we're a Moody's customer. We use Moody's in our CECL analysis. And we used their pandemic scenario that was released the first week of April as of March 31. And so, that's what we used in the quantitative before we layer on qualitative and environmental. And it -- then we also ran one that was slightly better and two that were worse, really to kind of give us the borders and the guidelines around which we applied the environmental and qualitative.

But just for a couple of the assumptions that are included in that, it assumes, obviously, COVID impact 3 million to 8 million U.S. infections with the infections peaking in May, abating by July. It assumes fiscal stimulus in the second quarter, not this latest round, but it does assume that that was in place as of the end of March.

It assumes that GDP would be down by 18% in the second quarter, recovering a little bit to 11% in the third quarter, but slow growth, acceleration really beginning in late 2021. Likewise, on the unemployment, it assumes a peak of unemployment of 9% in the second quarter and then it's sustained at 6% to 7% until 2022, and no return to full employment until 2023.

It was a fairly drawn-out recovery scenario, so we believe that it's pretty conservative. And then like I said, we actually layered on some additional qualitatives and environmentals on top of that. And at 1.83% on an overall basis, feel pretty good at March 31, like I said before. Second quarter, we'll have a whole new set of assumptions, and we'll go from there. But we feel very good about where we were at the end of March.

Brad Milsaps -- Piper Sandler -- Analyst

Just curious, too, if you could disclose maybe what the reserve represents today kind of as a percentage of kind of what severely adverse stress tests from regulators would be in terms of overall charge-offs over the [Speech Overlap] --

Valerie C. Toalson -- Chief Financial Officer

Yes, we actually never had to do a DFAST test, just the timing of when it came over $10 billion and when that subsided. So, we don't really have that. What I will say is we've done obviously a number of stress tests internally, really kind of slicing it every which way you can. And that's what really gives us the comfort to say that kind of the things that Paul and I both mentioned in our comments is just with our capital, with our earnings -- underlying earnings abilities, we feel very comfortable in whatever this throws at us, at least as much as we can anticipate at this point in time. But, yes, we're -- we actively do stress tests. Got to be prepared for everything. And so, that's what we do.

Brad Milsaps -- Piper Sandler -- Analyst

Great. Thank you.

Operator

Our next question comes from Matt Olney from Stephens. Please go ahead with your question.

Matt Olney -- Stephens, Inc. -- Analyst

Yes. Thanks for taking my question. This is to Paul. I think, Paul, in your prepared remarks, I think you made some comments around credit that showed signs of stabilization in the first part of the quarter before the COVID-19 issues hit in March. Wonder if you could just kind of go back to that and just give us an indication of which industry, which sectors were showing signs of stabilization for March? Thanks.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Yes. Thanks, Matt. It was a couple of credits that David mentioned in his comments. Credits that had shown an improved operating results, building GAAP cash. One company was in early phases of -- under letter of intent to be sold and COVID-19 comes along, and their business models goes inside out overnight. And they go from on the watch list for upgrade to on the charge-off list in pretty short period of time. So, that's -- they're two examples.

And then just more broadly, if you just look at economic activity, first quarter was off to a great start for the Cadence Bank portfolio, and we see a number of companies that were on the watch list for upgrades and much fewer on the watch list for downgrade. So, credit trends, I believe that things had crested and we were seeing broad-based improvement prior to COVID-19.

Matt Olney -- Stephens, Inc. -- Analyst

Okay. That's helpful. And then on the energy side, you mentioned the hedges give you some comfort near term in the E&P portfolio. Can you expand on this and what level of hedges do you have and when do these hedges start to roll off? Just trying to appreciate when that comfort would slow if these current commodity prices continue for a while?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Yes. So, we anticipated questions like this and really given a lot of thought to the best way to answer it. And it's a little bit of a hard question to answer. So, I can tell you that 90% of our borrowers have hedging for the next year. It drops in future years. But it's not just -- it's not a static hedging. In other words, people are putting on hedges now and they may take them off next quarter and apply the proceeds to reduce the debt.

And so, what I think is important for investors to understand is the spot price of crude sort of gets all depressed. But our borrowers are able to sell their production, their December of 20 production today at, I don't know, $28. I don't have the curve in front of me. But it's not the $12 that you see on the screen.

And so, between the forward curve and hedging and modest debt levels, our E&P portfolio overall is going to see additional stress. We get that. And that's why I did mention in my prepared comments, it's really a lot about the duration. So, what we know is that rig count has come way down, depletion is a real thing, decline curves will happen, and at some point, prices will improve and drilling activity will resume. You must be present to win.

So, I do understand that the demand disruption is significant and unprecedented. But working through this portfolio, the hedges give our borrowers and our bank really a lot of protection for the near term. So maybe part of the answer to your question is a year or so, I feel pretty good. If prices stay at $14 for three or four years, I mean that would be very challenging for the whole industry. So -- but I think hedging protection for the next year feels meaningful to me, but still stressed.

Matt Olney -- Stephens, Inc. -- Analyst

Got it. Okay. That's great. And then, I guess the last question from me is -- it would be for Valerie and around operating expenses. It looks like the 1Q results were below forecast. And I think I heard you mentioned there was some lower incentive comp in there and lower accruals elsewhere. How should we be thinking about the run rate more near term?

Valerie C. Toalson -- Chief Financial Officer

Yes. So, I would say that, yes, we -- adjusting for what we said at the end of the year, now I think that expenses will be pretty flat from the first quarter. That being said, if things start to get -- the overall economic environment gets even worse than what we've expected and projected, then we've got levers that we could take further actions and reduce even further. But right now, I'd say expect pretty flat expenses from the first quarter.

Matt Olney -- Stephens, Inc. -- Analyst

Thank you.

Operator

[Operator Instructions] Our next question comes from Jon Arfstrom from RBC Capital Markets. Please go ahead with your question.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Hey. Thanks. Good morning.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Good morning, Jon.

Valerie C. Toalson -- Chief Financial Officer

Good morning, Jon.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Hey. A few follow-ups here. One was on restaurants. One of the disclosures you had is that 50% of your outstandings had requested loan restructures. I'm curious if you have any view on the other 50%? Is that -- are they just with another bank or are they strong enough or they've given up hope? Can you give me your opinion on that?

Samuel M. Tortorici -- President

Yes. Hey, John. This is Sam. So, yes, I mean, I think really the answer is that there -- a lot of them have deep enough pockets, publicly traded, have the wherewithal to make it through. And so, yes, I think that's really it. What we're looking at is typically 90-day deferrals, and a lot of our restaurant customers have qualified for PPP funding either through us or through their agent bank.

And so, we're -- it's a large number of our clients, for sure. But, again, that kind of points back to Paul's earlier point that we bank 20 of the top 40 franchisees, major brand names, really strong franchise or support that are providing royalty, deferrals, required capex or expansion or remodel. The franchise also really coming in strong to support these guys.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. Good. And then just a little nuance on that, the full service and other is about 25% of the book. You kind of touched on it, but it feels like that's probably the last to recover. Maybe could you touch a little bit on the health or any statistics you have on that portion of the book?

Samuel M. Tortorici -- President

Yes. So, on the full service, it's really kind of broken down into two categories, Jon. One is casual dining. That would be in the neighborhood of Chipotle's, Applebee's, those sort of brands, full sit down, table service with alcohol. And then you've got the family dining, which is going to be the lower-priced point, things like Denny's and IHOP and Huddle House.

And we -- our view is that the casual dining space is going to probably be the most stressed because of -- they just have a higher cost model, higher labor model. And just with the significant drop in revenue and toggling to only takeout and delivery, we think that group is going to struggle the most.

In the family dining side, our borrowers are larger, stronger, ones of large -- publicly traded, well-capitalized company that even if the dining room is shut for a bit, we think that that group is going to rebound pretty nicely.

The other category is very small but it's kind of some niche sort of restaurant businesses. For example, in grocery store, sushi operation would be one and that's really has done quite well through this, given all the traffic in the grocery stores.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. Good. Just two more topics under the COVID. Paul, this one is for you, back on Steve's question on the dividend, I thought it was a good one. It's a little tougher, but your stocks at 6.5 and tangible book is over 15. And clearly, the market is saying something on expectations for credit. But at the same time, you have a very sophisticated board. Again, obviously, when you think about the dividend, maybe it's obvious that it was cut. But the fact that you didn't go to $0.01 or zero, might be saying something. I know you said it wasn't scientific, but can you just go back to that topic and maybe address it a little bit more in terms of capital and especially in light of the view of your stock price versus your tangible book?

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Yes, Jon. So, yes, I think there are a couple of things there. I mean, our capital ratios are healthy, are comfortable. And our outlook on pre-tax pre-provision growth provides us a meaningful first line of defense so to speak from a kind of capital management standpoint. When I look at where we are, it seems like a prudent step. But I -- hopefully, we'll see more certainty around the future of all these businesses as people start to return to work and stability is introduced. And I would expect, in future periods, we would take a look at this for improving the dividend as we go forward.

But the amount of uncertainty out there is, it's hard to nail down. So, I think it's a conservative decision and in line with how we have historically approached to capital management.

Valerie C. Toalson -- Chief Financial Officer

Jon, this is Valerie. I would just add to that, you know, in addition to kind of the overall conservative approach, which is how we've always operated. Just, we're continuing to support our customers, continuing to provide lending. Obviously, all of that factors into it as well, that, as well as all the other factors that Paul mentioned.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Yes. Okay. I would actually view it more favorably. It's not criticism. It's the fact that it didn't go to zero or 1, that's [Speech Overlap]. But, yes.

Okay. And then, Hank, or Sam maybe, or Paul, but this is early, maybe you can't answer. But Georgia seems to have reopened. They're starting to reopen. And I think Texas is slated for Friday. I know it's very early, but what are you seeing and what kind of expectations do you have as things reopen, just bigger picture? Thanks.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Yes. I'll comment and invite others too, also. It feels like it's going to be well-managed. It's going to be thoughtfully done. There's going to be social distancing. I think that people are ready to begin somewhat of a semi-normal routine. And take Houston, for example. There've been, I don't remember exactly, like 95 deaths from COVID here out of 6.3 million people. Really the cases, the people that have died tend to have had other health issues and high frequency of those cases. So, I think there is a sense that it's manageable, and it's prudent, and people want to begin to resume a somewhat normal life albeit in a very protected manner.

So -- but Hank, I'm sorry, thought you were going to comment also.

R. Hank Holmes, IV -- Executive Vice President

I was going to let Sam take the floor and I was going to finish up. So, Sam, why don't you go ahead and comment?

Samuel M. Tortorici -- President

Sure. So, Jon, I think the story in Georgia has been kind of overblown in the national media. It's really been more of a very soft kind of reopening. And so, you're seeing some activity in restaurants, they're allowed to open. They're taking their time opening.

Our approach at Cadence is going to be a thoughtful, slow, phased-in approach, as we think about getting back to the office, getting back to work. And frankly, regardless of the state, I think this is all going to be a real interesting exercise in human behavior, because when you think about it, some people are just anxious.

The business owners want to get cranked back up. But people, some people are still just very fearful of being in any sort of crowd, even three or four people. And so, they can take a little bit of time, but gradually will -- each of our markets will get back to some semblance of normalcy. Although, I don't see that things like restaurants and retailers are going to be -- have hundreds of people in them over the next month or two.

R. Hank Holmes, IV -- Executive Vice President

Yes, I would echo those comments, and I would say that our workforce is -- they're ready to get back. They also are cautious. And as Paul mentioned, we have 1,100 folks working on VPN. A lot of our time right now is being spent with our clients and working through the PPP process and really guiding those clients. And in addition, just getting feedback on a weekly, daily basis to make sure that we can meet the needs of our clients. Our folks are active, and they're engaged. But I do think it's going to be cautious as we reengage.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. All right. Thanks, everyone.

Operator

And ladies and gentlemen, at this point, we will end today's question-and-answer session. I'd like to turn the conference call back over to Paul Murphy for any closing remarks.

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Great. So, thank you all for joining our call. And in closing, just a couple of thoughts I would leave you with. First off, we really have a good franchise. Our core earnings strength is good, and our capital ratios are solid. We have a diverse deposit base that's attractive. And our liquidity is a big positive for us.

So, we're in some really good markets and our team is fully committed, I can assure you.

So, we had some credit challenges last year, I get that, where banks had begun to see improvement. That was encouraging. And now this global pandemic is clearly a challenge. So, we, of course, foresee the foreseeable future is going to be a rough period. We're going to have some elevated provisions. And I'm not the type to give the let's go win one for the Gipper closing comments. But I will tell you that we truly have a great team. We've been through cycles like this before. We know what to do and we have the resources we need to manage through this period.

So, I believe that patient investors will be rewarded and I can promise you this team is working hard to do a good job for shareholders.

With that, we stand adjourned.

Operator

[Operator Closing Remarks]

Duration: 54 minutes

Call participants:

Paul B. Murphy, Jr. -- Chairman and Chief Executive Officer

Valerie C. Toalson -- Chief Financial Officer

Samuel M. Tortorici -- President

David F. Black -- Executive Vice President

R. Hank Holmes, IV -- Executive Vice President

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Steven Alexopoulos -- JPMorgan -- Analyst

Brad Milsaps -- Piper Sandler -- Analyst

Matt Olney -- Stephens, Inc. -- Analyst

Jon Arfstrom -- RBC Capital Markets -- Analyst

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