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Cadence Bancorporation (NYSE:CADE)
Q2 2020 Earnings Call
Jul 22, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Cadence Bancorporation Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. The comments are subject to the forward-looking statements disclaimer, which can be found in the press release and on Page 2 on 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 & Chief Executive Officer

Well, good morning, and thank you all for joining us for our second quarter 2020 earnings conference call. Joining me today on the call, as usual, are Valerie, Sam, Hank and David.

I'm going to kick this off with an overview of our operating results. Of course we're going to talk at length about credit, some of our latest observations from the ongoing COVID-19 stress. David Black is going to go into some detail with you on the work that's been done during the quarter around assessing risk and the conclusions from those efforts. Valerie is going to cover the financials in more detail and then we'll have some concluding remarks.

Let's start with our pre-tax pre-provision net revenue for the quarter totaled $95 million, which is up modestly from $93 million last quarter. The key drivers of this solid operating results are mainly NIM performance and really continued cost discipline.

Our pre provision pre-tax ROA ended the quarter at 2.06%, down 5 basis points linked-quarter, and pretty good on a comparable basis. We ended the quarter with the NIM at 3.51%. It's down 29 basis points, but when you consider the PPP impact, the lower rate environment all banks are dealing with, the decline was largely offset by our continued repositioning of our deposit base and hedging. As we previously reported, we terminated our highly effective net interest rate collar in the first quarter and locked in a $261 million gain we'll realize over the next several years.

So all things considered, I feel like we're managing NIM relatively well. Valerie is going to speak in more detail about loan yields and the impact of PPP on NIM in the quarter. But overall, we're pleased with our execution here.

Turning to expense management; adjusted expenses were down $5.1 million linked-quarter. This allowed our efficiency ratio to improve to 47.9%, nearly 200 basis point improvement over the first quarter. This is aided by some reductions in compensation and just good overall expense control. We expect our efficiency ratio to remain attractive as the management team is very focused on expense management and will be so in the coming quarters.

With respect to loan growth, the vast majority of the loan growth or 2% for the quarter was the $1 billion in PPP loans. If you take out the PPP loans, our portfolio would have declined by $725 million linked-quarter. This is partially by design as we're reducing energy and restaurant, but we're also seeing borrowers proactively paying down loans.

We've seen several borrowers who repaid defensive revolver draws from the first quarter, which is a healthy data point. And then last, just overall, there is lower loan demand, there is less expansion planning and there is a lot of COIVD caution out there.

Another positive for the quarter is our liquidity position, it has strengthen nicely. Our loan-to-deposit ratio ended the quarter at 85%, down from 92% last quarter. The deposit growth and deposit mix was really incredible, a very strong point for the quarter.

Portfolio grew 11% in the second quarter, non-interest bearing increased $1.3 billion now 32% of the mix, up 500 basis points linked-quarter. Just -- I wouldn't have thought that achievable, and not all of that will stay clearly, because we know some of that's PPP, but we have seen a lot of new accounts.

So deposit cost declined 50 basis points linked quarter and total funding costs declined 46 basis points. So these things really helped us offset the lower loan yields and supported our attractive NIM.

So next let's turn to capital. I mean, capital remains strong at Cadence and despite a challenging credit environment we'll talk about more in a moment, but the Bank is really, I think, well positioned to manage the pandemic. Our tangible capital equity ratio remains over 10% and despite the material increase in our provision this quarter, three of our four primary capital ratios increased from last quarter. So, as a result of our solid capital base, the Board approved a $0.05 dividend payable August 7th to the holders July 31st.

Let's talk more about credit. So, as it was mentioned at the outset, we took a thoughtful and clear headed view and really a diligent approach to credit this quarter. As a reminder, we've got a very seasoned team bankers. We've been through stress like this before; maybe not like this, but have certainly been through many cycles before and so we're reviewing our credits with a critical eye and then we've deployed extensive internal and external resources to just really dig deep and be sure we understand where we are situated.

So, a result of all these efforts led us to a provision of $159 million for the quarter and that I think is a reflection of the reality of the environment and some exhaustive credit work.

So reserves have now increased over 50% in the past quarter. Net charge-offs have been in the mid-$30 million range for the last three quarters, roughly 94 basis points annualized for the second quarter. So, non-performers were up $65 million or 35 basis points, similar to what we saw in the first quarter. But over the last two quarters, we've expanded our reserve by over $250 million and that brings our ending reserve to 2.71%.

So let's talk now about some of the portfolios which are most impacted restaurant and energy. First, restaurant now stands at right at $1 billion. Excluding $141 million of PPP loans, the portfolio would have declined $78 million linked-quarter. As many of you will recall, from having studied us, 68% of this portfolio is to quick service restaurants. The vast majority of those are backed by the top 5 strong brands; we call them Taco Bell, Pizza Hut, KFC, Burger King and Wendy's.

QSR comp sales for the second quarter across these franchises were down in April, but showed nice improvement in May and June, and in many cases, have recovered to prior year comps. So the overall QSR space has remained relatively healthy and Pizza has been, Pizza -- by the way, roughly 11% of our portfolio has been positively impacted and we're seeing some sales there quarter over quarter that are up low teens year-over-year basis. So, yeah, so year-over-year.

Full service concepts; casual and family dining trends continue to be challenge and we're facing some really tough year-over-year comp sales there. This portfolio now stands at a $191 million, down from $214 million linked quarter and it's still roughly 20% of our portfolio, down just a touch as a percentage. So while we do see some improvements later in the quarter we're just very clear and very real about the caution on this part of the portfolio with quarantine restrictions being mixed in different parts of the country that this would be the highest risk portion of the business I think.

Turning to energy; recall that we improved the mix of the portfolio over the last several years. We peaked at about 18% of loans five years ago. We're now just under 11%. We now have a bigger increase in midstream and a lower allocation to E&P. We -- the portfolio commitments declined to $188 million or a little over 8% during the quarter. The reductions are driven by combination of things, but it's really required amortizations and deleveraging versus just -- and consolidation that's just happening in the industry.

So while we see, in the business, a number of bankruptcies really throughout the industry we have not had any Cadence clients declare bankruptcy in the first six month of the year. It is our plan and our expectation that this portfolio will decline by 15% to 20% through between now and the end of 2021. This again will be from scheduled amortization, consolidation, some refinancings that we think are likely to happen.

So overall, we have relative confidence in the health of this portfolio for a number of reasons. And first, our portfolio, our energy portfolio is far different than any other Bank. We're 62% midstream, I'm not aware of anyone that is anywhere close to that allocation and we're pleased with this, by the way. So midstream companies, as we've talked about in the past, are typically contracting cash flow businesses. They are not directly tied to the commodity prices. They are impacted, there is no denial there.

But a key point we've made before is the low leverage. So debt-to-cap of the portfolio at the end of the second quarter is 37%, down from 39% at the first quarter. So these midstream companies have gone from very well capitalized, very low leverage, nicely profitable, to some interruptions, we've had some shut in production early in the quarter and stress; we're not suggesting there is no stress.

But what we see now as the quarter rolls forward is that most all of the production that was shutting down has either come back on or are scheduled to do so quickly. And really the stress in the borrower covenants has been minimal. So we're pleased with the progress there.

Let's talk about our E&P, we just finished the spring borrowing base redetermination process. I'd say it went relatively well from our perspective. We saw borrowing bases decline between 10% and 40%. We have, of course, seen some improvement in commodity prices but commitments are down $58 million, 13.5% linked quarter. So many of our borrowers are actively hedging and overall we feel OK about these results. I'd say in general E&P feels a good -- bit better than it did even just a quarter ago.

So continued high degree of scrutiny and high degree of focus on that portfolio. And lastly, energy services would have decreased about $39 million were it not for the PPP loans and I would summarize it saying that the trends are somewhat similar to E&P where we're seeing stress but manageable and we think this portfolio is one that would take a bit longer to recover.

So let me now turn the call over to David to give some context on credit migration, David.

David F. Black -- Executive Vice President

Thanks, Paul. Good morning, everyone. I'm going to walk through credit migration for the quarter, discuss the drivers of our 2Q provision, give an update on loan modifications and highlight some of the tangible actions we've taken related to credit over the past year.

As Paul previewed, we did see significant migration in the second quarter. But as we get into the details, you'll see that it was in sectors where stress was anticipated those aspects of the economy most acutely impacted by COVID-19.

Over the course of the quarter, given the rapidly evolving environment, we can now get some very intense and critical credit work both through our normal processes and through in-depth incremental reviews. Therefore, we believe this migration is a realistic reflection of the elevated risk in a very challenging macro environment.

Criticized loans increased from the prior quarter, about $334 million to just over a $1 billion or 7.4% of total loans. Approximately two-thirds of this increase was driven by restaurant and two-thirds of the restaurant migration was in the non-QSR space as on-premise-dependent, family and casual sectors have been much more severely impacted by the economic shutdown. 34% of the restaurant portfolio excluding PPP is now criticized, which is consistent with prior expectations of stress in this line of business. The majority of the remainder of the increase in criticized loans was driven by energy, and more specifically, E&P. CRE also contributed $48 million to this increase in criticized which was almost exclusively hospitality.

General C&I actually offset some of this negative migration, reducing by $78 million due to several upgrades to pass in the quarter. Classified loans reflected similar trends, increasing $178 million from the prior quarter ending at $557 million or 4.1% of total loans. This migration was, again, primarily related to restaurant and energy sectors.

Non-accruals increased $65 million from the first quarter to $224 million. The linked-quarter increase was primarily due to energy, restaurant and healthcare. The majority of our non-accruals are comprised of seven relationships with greater than $10 million of exposure, representing 60% of total NPLs.

While a significant linked-quarter movement at 1.6% of total loans, still a very manageable number, given our capital and reserve levels. Net charge-offs were $33 million or 94 basis points annualized and all material charge-offs in the quarter were all non-accrual and rated substandard or doubtful going into the quarter,

While still elevated relative to our long-term expectations, the amount of charge-offs was in line with the prior three quarters. Provision in the second quarter was $159 million, producing an ending reserve to total loans of 2.71%, up from 1.83% in the first quarter. The provision in the quarter was significantly impacted by Moody's baseline economic forecast, including assumptions for depressed oil prices and a meaningful negative shift in the outlook for commercial real estate.

Additionally, management used qualitative and environmental factors to overlay portfolio specific assumptions, most notably for restaurant, energy and commercial real estate. Collectively, the forecast model and these assumptions drove approximately 60% of the provision for the quarter. Other factors included charge-offs, specific reserves on impaired credits, and general negative grade migration impacting the quantitative output.

Also think it's important to point out the allowance for credit losses as a percent of NPLs improved on a linked-quarter basis from 1.54 times to 1.65 times. COVID related loan modifications as of 6/30 totaled $2.4 billion or 18.2% of the portfolio. $1.5 billion of these mods were in C&I with the largest dollars at $707 million in general C&I given the size of that segment and the highest percentage in restaurant with 40% or $462 million of that portfolio being modified.

On the other end of the spectrum, only 4% of our midstream credits have been modified. Commercial real estate had $570 million in modifications with the highest percentage in hospitality at 61%, representing loans of a $155 million.

Only 6% or $48 million of our multifamily portfolio, our largest commercial real estate portfolio has been modified. Over 20% of our modifications have made a payment post their modification date. In the quarter, we also completed our fourth iteration of borrower level COVID survey work. With $11.2 billion of total commitments included in our scope, the polling penetration was higher and we're tracking potential impact in a very granular fashion.

Taking a step back, I wanted to touch on a myriad of recent risk actions taken by our team, most of which were embarked upon well before COVID. We've made enhancements to loan policy, particularly around leverage lending. We've adjusted hold limits to more conservative levels with an emphasis on higher loss given default exposures.

We've modified concentration limits to drive more asset diversification. We've meaningfully reduced loan segments with higher risk characteristics over the past year. Most notably, leveraged loans without a moderator is down $276 million or 33% decrease year-over-year, and we reduced Shared National Credit exposure by $143 million over the past year.

The team has expanded the scope and frequency of credit reporting to both management and the Board, including the implementation of enhanced stress testing. We also hired a new veteran leader for our special assets group and expanded senior resources dedicated to the special assets team.

Lastly, we engaged a highly regarded third-party with extensive expertise in energy in large C&I lending to perform a detailed loan level review of portfolios most impacted by COVID, specifically focused on all three segments of energy, restaurant, healthcare and hospitality. We conducted a buy a sample with an emphasis on larger exposures and adversely graded credits.

We believed an external review will be prudent given the current level of macro uncertainty. The exercise proved to be very constructive, provide incredible challenge, and ultimately confirming prior statements we've made regarding our team's experience, prudent risk culture and how we're appropriately grading our portfolio during this unprecedented time. In summary, we continue to see uncertainty, but we also see signs of customer resilience.

Provision and migration for the quarter were dramatic, but we believe a realistic reflection of elevated risk during this time of economic pressure and pandemic. We acknowledge there will undoubtedly be some level of continued stress in the quarters to come. But we will approach this stress with eyes wide open.

And now, I'll turn it over to Valerie.

Valerie C. Toalson -- Chief financial officer

Thank you, David. As Paul noted, our adjusted pre-tax pre-provision net revenue continues to be strong at $95 million, an increase of $2 million from last quarter, reflecting strength in our net interest income and expense management.

Our stable PPNR, our robust capital position and our allowance for credit losses at 2.71% all provide a solid foundation in this volatile environment. The second quarter adjusted net loss was $57 million or a negative $0.45 per share.

The loss was due to increased loan provisions which were up $75 million or 90% from the prior quarter to a $159 million in the second quarter. This provision actually brings our allowance, excluding the guaranteed PPP loans, to 2.93%.

A few comments on our balance sheet mix. Like a lot of other banks this quarter, we saw a massive influx of deposits in the quarter, up $1.6 billion with $1.3 billion of that in non-interest bearing.

At the same time, while we did fund a $1 billion in PPP loans, our core loans declined $725 million, primarily due to pay-downs of defensive draws that were taken late in the first quarter and other pay-downs really in both our stressed and non-stressed portfolios.

And the result of all of this was an excess of liquidity in the quarter, we did put some of it to work in securities, up $200 million in the quarter to $2.7 billion or 14% of total assets. However, cash balances still increased $1.3 billion quarter over quarter.

Looking ahead, with loan growth expected to be soft, we will put more of this liquidity to work in securities, but I do anticipate that we will maintain a somewhat elevated level of liquidity really until we get to a more normalized environment. With this balance sheet mix shift along with what was really a dramatic decline in LIBOR during the quarter, it negatively impacted our net interest margin.

NIM was 3.51% for the second quarter, down from 3.80% last quarter. The impact of the PPP loans attributed 11 basis points of the reduction and excess liquidity and lower accretion income attributed 4 basis points and 6 basis points of the decline, respectively. All the other fundamental NIM components netted to an 8 basis point decline, with the highly positive impacts of our lower deposit costs and increased hedge income significantly offsetting the impact of LIBOR and lower rates on our loans and securities.

Importantly, our total funding costs declined by 46 basis points from 97 basis points in the first quarter to 51 basis points this quarter. Our interest bearing deposit costs declined by 63 basis points from 1.28% in the first quarter to 65 basis points this quarter.

And our non-interest bearing deposits increased from 27% to 33% of total deposits. We've really been working pretty aggressively to bring our funding costs down and are very pleased with this progress -- really the progress we've made over the last several quarters.

Given time deposit maturities that are coming in the latter half of this year, we do expect interest bearing deposit costs to come down further. Although, certainly not at the pace they did this quarter, just given the new base level.

So while our net interest margin declined, our net interest income increased $1.3 million to $155 million in the second quarter. $1 million of the increase came from those core fundamentals, that combination of our lower funding cost and increased hedge income partially offset by lower core loan and securities income. The PPP loan income, cost of excess liquidity and lower accretion all combined for a net increase of $300,000 quarter-over-quarter.

Now PPP loan interest income was $4 million during the second quarter and total net deferred fees associated with these loans was just over $16 million at the end of June. These net fees are amortized over the remainder of the two-year life, but will be brought forward into earnings when the loans are forgiven. We currently anticipate the majority of these loans will be forgiven during the fourth quarter.

Non-interest income of $30 million was down $5.1 million from the prior quarter. This included a $2 million writedown of an alternative investment and it reflects declines in deposit service charges, card fees and loan fees, really resulting from the higher deposit balances from depressed consumer card activity and lower loan volumes.

Offsetting these declines were increases in investment advisory revenue, really largely driven by higher market values at quarter-end and increases in our mortgage loan fees just due to the active loan generation in the current rate environment. Non-interest expenses, they continue to reflect our long-standing expense management culture and resulted in a 200 basis points quarterly decline in our adjusted efficiency ratio to 47.9%.

Adjusted expenses declined $5.1 million in the quarter and included lower compensation expenses due to lower headcount declines in payroll taxes and increased deferred loan origination costs related to the PPP loans. Other smaller declines were across the board really, including things like employee travel and business development expenses.

Turning to capital, as Paul mentioned, here in this quarter three of our key --- three of the four of our key capital ratios increased over really what were already strong capital levels. Given the balance sheet mix shifts, our risk weighted assets declined in the second quarter and at June 30, our common equity Tier 1 and Tier 1 ratios were up to 11.7%, and total capital was up to 14.3%.

The leverage ratio ended the quarter at 9.5% and our tangible common equity to tangible assets remained strong at 10.2%. These robust capital levels, our higher level of the allowance for loan losses, our significant balance sheet liquidity and meaningful pre-tax pre-provision earnings power all combined to provide a foundation of resiliency as we continue into this period of economic uncertainty.

This resilience also provides a sound backdrop for our employee base to confidently focus on serving our customers with the excellence we're known for. And for us to continue the focus on providing value for our shareholders.

With that, let me turn it back to the operator for your questions.

Questions and Answers:

Operator

Ladies and gentlemen, at this time we'll begin the question-and-answer period. [Operator Instructions] And our first question today comes from Jon Arfstrom RBC Capital Markets. Sir, please go ahead.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Good morning.

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

Good morning, Jon.

Valerie C. Toalson -- Chief financial officer

Good morning, Jon.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Hey. Just -- I think sort of to describe this a little bit, but it sounds like you did a lot deeper work on the portfolio this quarter compared to last, and maybe that makes sense. But just talk a little bit about what you guys learned about the book this port -- this time around.

Did you have any differences between some of your grading in the third party and just a little bit on your approach between now and when we talk again in mid-October in terms of, you know, is it another deep dive or do you feel like you've captured most of the pain or expected pain with what you did this quarter?

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

Yeah, thanks, Jon. I'll comment and I also invite David Black to offer his perspective here. So first, I mean this is the quarter in which the shutdown happened and the global pandemic impact was really significant. And so, we did a lot of work to be sure we understood that as best we could and we, again, invited a third party to come check our thinking, you know, bring some intellectual challenge to the equation.

And so, one of your question is that the third party differences were really none. I mean I think it's sort of a validation of our approach and what we hope is that we're being more cautious than we need to be, but we also are very realistic and practical that risk have changed significantly and we want to be aware, alert, and appropriate in our grading of the reality that we're in.

So for me, I feel really pretty good about the energy book overall, and I think the restaurant portfolio which we've said for several years now, is the highest risk part of the portfolio and where we will be scrubbing harder and harder going forward. And then, of course, always anything that's leverage lending is going to get scrutiny and so we, for some period now, have been pulling leverage down across the board.

So maybe in some ways the fact that we had some challenges last year and we intensified our work in this area is a bit of a plus for us. But I don't know Jon, hope I'm going to the heart of your question. I'll let David comment and then certainly follow-up from there.

David F. Black -- Executive Vice President

Sure. Thanks, Paul. Good morning, Jon. We -- in addition to bringing in the third party, we expanded the scope of the reviews that we've done internally. I think it's just only appropriate that we would focus on the sectors most impacted by the macro environment and the feedback from the third party was, as Paul referenced, was one of concurrence.

It was an independent validation that we're appropriately grading credit given all the uncertainty that we face. From an outlook perspective, it's a continuation of the disciplined risk controls that we've had in place and trying to assess and early identify problems.

With that, Paul, what would you add?

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

I would just point to Page 8 in our slide deck. Jon, we break out the provision, $93 million of that is largely Moody's driven from the economic outlook. You know, that's a big number for the quarter and so estimating provisions is something that is not simple, I guess, you would say and not precise. But again, our hope is that we're being more cautious than we need to be and I think we're also being very realistic. So did we answer your question, Jon, or do you want to follow-up on that?

Jon Arfstrom -- RBC Capital Markets -- Analyst

Yeah, that will help. And I guess what we're trying to get at is what might the third quarter look like from a provision point of view? And I know that's a challenge, but maybe one way to ask this is, can you talk a little bit about the loan modifications and some of the trends there. And then David, you mentioned the survey of your clients, talk a little bit about what you've learned there, because I think the key is to get back to profitability for you and I guess we're all trying to figure out how you're thinking about third quarter from a provision and a stress point of view? Thanks.

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

Yeah, I'll comment. I'd start -- I think it's reasonable to expect that the second quarter will be the peak for provisions. Have to put an [Indecipherable] and say it just depends on reopening. I mean we had such a dramatic period with the shutdown and now as we're reopening and activity is improving, there is, again, some -- reasonable to expect that it will be the peak. But I think provisions will be elevated for a period of time until we work through what does the new economy looks like and especially, how does it impact Restaurant and Energy? David?

David F. Black -- Executive Vice President

Sure, Jon. On the topic of deferrals, as we previewed, that number did increase from our previously disclosed number in April of $1.5 billion to $2.4 billion. I would note that these are across the board 90-day deferrals, and given that time frame, we've had a small amount of loans -- actually $146 million actually enter into their second deferral which is 6% of that total deferral population or 1% of total loans.

And so from a process perspective, there are incremental questions and documentation and scrutiny that we place upon that second deferral request.

But in the categories in which they are showing up, consistent with our prior conversations, it's -- in the commercial real estate world it's really centered in hospitality from a percentage standpoint, 61% of that portfolio of $155 million and really the number would be higher if -- in that particular asset class if it weren't for how much of a meaningful piece of that book of business is the construction, construction component.

Retail, office, multi-family all have some element of deferral to a much lesser extent in the retail space, you know matching tenant concessions and as well in office, but multi family is only -- we've only have $40 million of concessions there. And again, that's our largest commercial real estate book at 25% of the total commercial real estate exposure.

The C&I book is largest dollars or -- again in general C&I, with the high percentage in restaurant and that's consistent with what we saw from a migration in the quarter as well and also influenced our qualitative overlays with the provision.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Right, I'll step out of the queue, but anything on from your survey work.

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

Sure. I think the intent there has largely been trying to get as forward-looking as we can with feedback from our clients and what they anticipate impacts will be for their individual business and I would say the takeaways really influence what sectors we gave environmental and qualitative overlay to from the provision. So the survey work has definitely influenced our view of potential impact on the various sectors that we have exposure to.

Operator

And ladies and gentlemen, our next question comes from Michael Rose from Raymond James. Please go ahead with your question.

Michael Rose -- Raymond James -- Analyst

Hey, good morning and thanks for -- thanks for taking my questions. Just as you guys have done this steep credit dive again this quarter, have you -- the loans that were -- that moved into criticized. I mean if they've been downgraded in terms of, have you taken specific marks against those loans proactively for potential loss content even if they're on deferral at this point.

I just want to try to get a sense for how proactive you've actually been and Paul, your comment about this could be the peak for provisions. If there is continued migration, it does sound like, it could be likely, it does sound like there could be continued reserve builds beyond what you did this quarter ex PPP, I calculate about 110 basis points. Is that kind of the way to think about? I think that's the question I was trying to get at, thanks.

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

Yes. So, Michael, I would say, again, I think it's reasonable to expect that this will be the peak quarter for provision and things are better in the third quarter than they were in the second, people are going back to work and were seem to be managing the pandemic better. So will there be some lagging effect for things -- information that comes in in the quarter? Entirely possible. So again, I come back to probably elevated level of provision but reasonable to expect second quarter is the peak. With respect to...

Valerie C. Toalson -- Chief financial officer

Michael, this Valerie -- go ahead Paul.

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

I'm sorry Valerie. Just -- so with respect to specific credits, yes, I mean the process does go through and we look at specific credits and what's going on and the COVID impact, and in many cases are specific provisions allocated to those credits, but there's also just a portfolio view element that goes to this.

And so, I'll pass it to Valerie.

Valerie C. Toalson -- Chief financial officer

Yeah. Yeah, no, that's part of what I was going to add. But then also just kind of referring back to that Slide 8, where we break out the portfolio changes and then the economic forecast.

To Paul's point on the provisioning, I mean I think we feel very comfortable that we've captured everything that we know today. We are hopeful that the decline in the economic forecasts, the magnitude of that was the greatest in the second quarter, but you know that folks at Moody's and their PhDs know that better than we do. And as the quarter rolls on, we'll see how that goes.

So that's always -- it falls as an asterisk in that. And then, like you said, on the portfolio changes, yeah, there will be. There will undoubtedly be some movement in that; some negative some positive as we go through just seeing the full impact of the pandemic on some of these borrowers. That's a lot of non-answer to your question, but those are really the moving parts that we're looking at, right.

Michael Rose -- Raymond James -- Analyst

Understood. And maybe, Paul, if we could talk about the midstream portfolio a little bit, we saw a portfolio sale last week at another bank that primarily is in the Gulf of Mexico. I think the majority of your assets would be in Texas. So there is a difference, but how can you give us confidence that you think that your midstream portfolio would hold up if stress continues. Obviously the rig count is down, there is lower drilling activity, etc., but can you help us feel a bit more comfortable about your midstream book at this point, just given the severity that we saw taken on that other sales? Thanks.

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

Yeah, sure. Thanks, Michael. So as I mentioned in my prepared remarks the midstream business -- our portfolio overall is really far different than most of the other banks, because of the midstream component. So it's contracted cash flow, it's low leverage, it's good operators with a good track record. Our charge-offs lifetime-to-date have been less than $3 million.

It's a very experienced team. We lead a number of major relationships to top midstream operators in the industry. We're pleased with the portfolio. We did have linked-quarter, two non-performers totaling $37 million. Both of those are paying in accordance with their terms. So there is stress in the portfolio, there is no denial of that.

But it's a good portfolio, it's going to perform well over time. And yes, I'm aware that some other banks have sold their portfolios far different mix than ours. And as you point out, our Texas portfolio, which is way different than the Gulf of Mexico. We had only one E&P borrower in the Gulf of Mexico and that was a credit that we took a charge on in the quarter. So, final resolution of that credit.

So, overall, there is -- the energy business is going to be around for a long period of time. We're managing our portfolio tightly. And we're managing it down a bit. Again, as I mentioned, we expect to see it through amortization and refinancing and industry consolidation we expect to see some reductions in that portfolio over the next 18 months. But, all in, covenant violations for the quarter as it relates to midstream were manageable. So we're going forward.

R.H. "Hank" Holmes, IV -- Executive Vice President

Paul, this is Hank. I like just to add to that, that we're also seeing the shut-ins come back online. We had two good months -- we had two months there where we saw pretty significant shut-ins, but we're seeing those come back online and that's kind of a green shoot that we're seeing for the midstream portfolio.

Michael Rose -- Raymond James -- Analyst

Okay. Maybe one final quick one for Valerie. Any sort of outlook that you might have for the core margin as we move into the third quarter? Thanks.

Valerie C. Toalson -- Chief financial officer

Yeah. Thanks, Michael. We feel pretty good about where our margin is today. When you kind of shake up the noise of the PPP and lower accretion and some of the excess liquidity, etc., really the core fundamental piece of it really just declined 8 basis points and that's with the significance to the LIBOR drop in the quarter.

So when we kind of look at where we are at June 30, we still have some room at our deposit costs. We've got about $1.3 billion of time deposits that mature over the latter half of the year. Those are coming off probably on an average of about 1.6%, coming back online at 60 basis points. So there is opportunity and we will see some of those deposit costs continue to come down in the quarter.

Likewise, some of the excess liquidity that we have, we're going to be putting to work in, as in securities. So those are both positive factors kind of for the core margin outlook. I guess the only caveat I would give that is if we continue to see meaningful loan pay downs as corporate borrowers just reduce debt, then that could offset that a little bit.

But overall, we feel pretty good about the level that we're at and the ability to make some -- hopefully, a little bit marginal improvements depending on what happens with the loan balances.

Michael Rose -- Raymond James -- Analyst

Alright. So may be flattish to maybe a few basis points higher is maybe the way to think about it?

Valerie C. Toalson -- Chief financial officer

I think that's fair.

Michael Rose -- Raymond James -- Analyst

All right, thanks for taking all my questions.

Operator

Your next question comes from Steven Alexopoulos from J.P. Morgan. Please go ahead with your question.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Hey, good morning, everybody.

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

Good morning Steve.

Valerie C. Toalson -- Chief financial officer

Good morning Steve.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Just, obviously to follow-up on credit. So if we look at criticized loans, they're very high, right, over 7%. Is that understated though because of all the deferrals and as these deferrals come due, should we expect a further increase in criticized loans?

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

Steven I'll comment. I don't think it's understated. I think quite the contrary. We really went through extensive effort to be sure we marked everything accordingly. When I look at the deferrals, our strategy the first time around is we were pretty lenient. I mean we really granted deferrals. And as David made reference to, this time around it's a different process.

And so I think we can better answer your question about deferrals probably 90 days from now once we kind of work back through this and see, well aright, we were lenient on deferrals the first time around, we're going to really look at it more closely and if someone would like to have a deferral, but they have cash and can pay, we're going to be sticking closer to the original terms of the loan of course with some flexibility still going forward. But, I would definitely say I don't think it's understated.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Okay.

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

David?

David F. Black -- Executive Vice President

Okay. I would concur. I think we certainly didn't downgrade something to criticized just because there was a deferral request and I don't think anybody in the industry has gone that far. But to the extent that we identified that there was stress underlying the request then -- and we felt criticize was a perfect grade, we moved it.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Then, how should we think about the migration now from criticized to non-accrual. Does this become a third quarter event?

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

I think it's reasonable to expect some migration there, the extent of it is hard to put your finger on at this point. It's case by case, you just have to look, I mean, we're seeing some green sprouts here and some reason to be optimistic, and some of these credits, the longer they're stressed, they'll deteriorate. We just don't have perfect visibility on that.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Yeah. So Paul, from a big picture view, I think this might be the fourth quarter in a row where you thought that the peak of credit problems were behind you. I think this goes back to actually 2Q19. What gives you confidence here? I mean is it only that you're seeing some states reopen, they are confident that credit issues are behind you, because we've heard that story for the last couple of quarters and then you put up another higher provision, right, and more migration. I'm trying to really understand what gives you confidence at this quarter, is it...?

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

Yeah, that's fair. I mean, while prior to COVID, our first quarter numbers would have shown nice improvement. And so I guess I would say with COVID being a major impact, we would have been there. So it's -- the track record is maybe not as bad as perhaps the reference.

So I mean, all I can tell you is, we've been thorough. We are not in denial. I hope we're being more cautious than we need to be. We've got a good underlying portfolio. We got a lot of good bankers. There is stress. COVID; COVID is a challenge, but I think we've captured it.

Steven Alexopoulos -- J.P. Morgan -- Analyst

I appreciate all the color. Thanks for taking my questions.

Operator

Our next question comes from Jennifer Demba from SunTrust. Please go ahead with your question.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thank you. Good morning. Paul, could you talk about loan severities you saw on some of your larger loan charge-offs this quarter. and also you mentioned before, it sounds like you're not interested in any kind of bulk sale, but can you give us some more color on that thought process? Thank you.

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

Yeah, sure Jennifer. So in the quarter, we really had three charge offs range from a $4 million or $5 million range to $10 million, $12 million range that make up for the $32 million in charge-offs for the quarter. So we do see some severity of loss in the restaurant portfolio went to energy credit.

As was mentioned, we've been through the spring borrowing base redetermination season now and we feel pretty good about that process and how things are positioned for the E&P portfolio. Gosh, I don't know, David, anything you would add to that?

David F. Black -- Executive Vice President

No, I would acknowledge that there were elements of higher loss given defaults experienced in the second quarter charge-offs relative to the characteristics that we see in the rest of the non-performing portfolio. But again at two of the three that Paul referenced, we're filing resolution on those credits and so don't have any incremental exposure on those.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

And your thoughts on the asset sale [Phonetic]?

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

Right. So never say never, but it's my belief that our portfolio is going to be well managed over a period of time and we've seen it come down. Our midstream portfolio, as was referenced, is performing nicely. So I'd say it's unlikely that we'll pursue that.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thanks a lot.

Operator

Our next question comes from Brady Gailey from KBW. Please go ahead with your question.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Thanks, good morning guys.

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

Good morning, Brady.

Valerie C. Toalson -- Chief financial officer

Good morning, Brady.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

When you look at deferrals, so I know as of June the 30th, there were $2.4 billion, maybe an update on where those are at today. It sounds like only $150 million have entered into the second deferral. Has there been a lot of deferrals that are now back paying. I'm just wondering if that deferral number is a lot lower as of today.

David F. Black -- Executive Vice President

Hey Brady, this is David. So 20% of that total population has had a payment post deferral. And as you mentioned, only a small percent or 6% of that total $2.4 billion has entered into a second deferral request. As Paul and I have both referenced, it is hard to gauge what the real activity will be through the remainder of the quarter in terms of the second request. Anecdotally, it feels like it's coming down fairly materially that we're not seeing the activity on the second request that we did on the first request.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Okay. And then, I hear you guys talking about 2Q hopefully is the peak provision. But as you look to the back half of the year, I know there's a lot of moving parts, but do you expect for cadence to be profitable in the back half of this year?

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

Brady, I would say that I think that's a reasonable expectation that we could be profitable in the third and fourth quarter, yes.

Valerie C. Toalson -- Chief financial officer

Brady, I think if you -- I think that the thing that's still important here is just to remember that strength of our pre-tax pre-provision net revenue and the consistency that we've had in that and you know the stability of our margin and so forth and we feel very confident about really that underlying core earnings power. And so, as things migrate out of this environment, then that foundation is resilient and that really gives us our confidence.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Yeah, that's a great point, Valerie. And then lastly from me, just when you look at period end loans and if you strip out the growth related to PPP, I think period end loans were down a decent amount, maybe about 5% linked quarter and I know some of that was probably planned and strategic.

You guys run off some loans that you no longer want. But -- and I heard the comment sort of about how you're expecting loan growth to be kind of soft from here on now, but do you think that there is some continued kind of strategic loan shrinkage that could send loan balances down a decent amount from here?

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

I do, yes. I think we're going to see just overall slower loan demand, pre-payments from stronger borrowers and that'd be a period of time that we'll shrink loans before we begin to build them subsequently.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

So, how much do you think, how much shrinkage do you think will be there Paul? I mean are we talking down another 10%, another 20% until you kind of bottom out from a loan balance point of view?

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

I don't think 10% or 20%. I think perhaps it's more like in the 5% to 10% range.

Valerie C. Toalson -- Chief financial officer

Brady, one thing to keep in mind this quarter, we saw a tick up in loans in the first quarter really as there was customers that had defensive draws. We had about $450 million of that. We saw a lot of that pay back down this quarter. As you know people got a better sense of the environment. And so, that had a pretty meaningful impact on the decline this quarter. So just important to keep that in mind.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Great, thanks guys.

Operator

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

Matt Olney -- Stephens Inc. -- Analyst

Yeah, thanks for taking the question. I want to go back to the core earnings power that Valerie mentioned that the PPA -- PPNR with that $95 million in 2Q and it has maintained that over the last few quarters. Can you just talk about the puts and takes around maintaining that $95 million quarterly level over the next few quarters? Thanks.

Valerie C. Toalson -- Chief financial officer

Yes. Well, I think -- well, a couple of things that are really important there. One is our expense base and our ability to manage that. We continue to have levers that we can pull should we need to and keeping that expense base, you know the efficiency ratio at 48% we feel very confident keeping that in that range.

The other thing is on the margin. As I mentioned, I think that we've got a pretty stable environment right now. LIBOR can't go really any lower and we've got ability to bring down our deposit costs where there is an impact, obviously with the decline in the loans, but -- so we're putting that to work in securities and over time the environment will shift and we'll be making loans again. So, yeah, we feel very good about that.

Our non-interest income took a little bit -- we had a couple of million dollars write down, that's a one-time kind of item related really to the COVID environment and once business activity starts to resume and consumers are making card charges again, we expect that that will also rebound a little bit. So that's really the great foundation for us and something that shouldn't be overlooked.

Matt Olney -- Stephens Inc. -- Analyst

Okay, thanks. And going back to the discussion around the loan deferments, let me ask Brady's question in a different way, can you give us an idea of how much of the deferred borrowers have now seen their initial 90 days expire and you've completed the full review? We're just trying to understand what portion of the initial deferred balances are requesting the second deferral when you've completed that review?

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

David?

David F. Black -- Executive Vice President

Matt, I know the numerator to that question, I don't know the denominator, of what has rolled off. My sense is, relative to the $146 million that have entered the second phase, because our April number was at 1.5. It's a relatively small percentage that are making these second deferral request.

Matt Olney -- Stephens Inc. -- Analyst

Okay.

David F. Black -- Executive Vice President

And as we said, really I don't know that exact fraction.

Matt Olney -- Stephens Inc. -- Analyst

Got it.

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

And Matt, I might comment a little bit too there. What we're hearing from our borrowers and our surveys and actually reaching out on a regular basis is that the numbers that we've told you so far are going to be consistent through the quarter. We may see some upticks if we see a decline in our close -- our shut-ins or close-downs in the markets. But as far as the second phase coming and being as big as the first, I think David is right on point.

Matt Olney -- Stephens Inc. -- Analyst

Okay, thank you.

Operator

Our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead with your question.

Ken Zerbe -- Morgan Stanley -- Analyst

Great, thanks. I guess is there a way to break out how much of the reserve build came from the -- sort of that deeper dive credit review that you did versus just actual deterioration in the portfolio of the known sectors like restaurant and energy, stuff that you wouldn't have been surprised by in your deeper review?

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

Ken, I mean, just to -- really, it's all done [Speech Overlap].

Valerie C. Toalson -- Chief financial officer

Yeah. Sorry, go ahead Paul. Yeah, I was just going to say it's all intertwined. It's all part of the quarterly assessment of what our credits -- what our credits are.

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

That would have been my comment as well.

Ken Zerbe -- Morgan Stanley -- Analyst

Got it. Understood. So -- OK, so presumably as you have pointed out a few times on the call that, so next quarter you're not doing a deep review, you don't need to since you already did one. And hopefully, we should see less provision expense going forward.

Valerie C. Toalson -- Chief financial officer

Hey Ken, I don't think that that's really -- Ken, I'd just like to clarify that. I mean clearly we did a deep dive into our credit but that's, in this environment, is going to be an ongoing process. It's not -- I mean, we certainly added some layers but it's really relative to the environmental stress that we're seeing. So it's -- the credit valuation will be what the credit evaluation is, it really has nothing specifically to do with the extra layers that were taken on in this quarter.

Ken Zerbe -- Morgan Stanley -- Analyst

Got you. Understood. Okay. Yeah, as you can imagine, I'm just trying to make sure I understand the difference between just the existing, say, restaurant portfolio and as it deteriorates, you're going to build reserves against that, which is sort of normal versus trying to pull out this sort of extra credit review that you're doing that would imply that you're digging deeper into things. But I do understand how they're intertwined, sorry.

And just maybe my second question really quick. Following up on, I think it was that PPNR question about operating expenses. Valerie I think I did hear you say that you want to keep the efficiency ratio of 40% -- I think it was 48% but just if we think about dollar numbers, because obviously I guess there is a capitalized PPP expenses this quarter, there was lower incentive comp, lower marketing, etc. It seems like some of that though should probably reversed back to more of a higher level come 3Q? How are you thinking about dollar expenses heading into 3Q?

Valerie C. Toalson -- Chief financial officer

Yeah, now that's a good question and I think there is a correlation between the increased business activity that would drive some increased expenses, but it should also drive some increased revenue. And so, to that end that's where -- it may not be 48% it maybe 49%, 50% within the range, still very highly effective efficiency ratio.

From a dollar standpoint though, you're right, I mean as soon as -- I mean I used to travel a ton, I haven't left my home office in a long time. So, as soon as the business activity starts to evolve, there will be additional expenses there, but that's all in generating revenue. So I think it goes hand in hand.

Ken Zerbe -- Morgan Stanley -- Analyst

Okay, great. Thank you very much.

Operator

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

Brad Milsaps -- Piper Sandler & Co. -- Analyst

Hey, good morning guys.

Valerie C. Toalson -- Chief financial officer

Good morning, Brad.

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

Thanks for joining us, Brad.

Brad Milsaps -- Piper Sandler & Co. -- Analyst

Thanks. I was just curious, I think about 14% of the general C&I portfolio is in modification. Just curious if there was any kind of particular theme or sector within that portfolio that was driving that. And I think if I recall, State Bank had about $1 billion ABL book. Just kind of curious kind of how that's performing? Anything that would cause you concern there one way or the other?

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

David, would you comment on that?

David F. Black -- Executive Vice President

Sure, be happy to. Good morning, Brad. In terms of the general C&I, I would say that's relatively diverse across that entire portfolio, no meaningful concentrations in those modifications. The ABL book is continuing to perform really well. It has not been the driver of modifications or significant migration in the quarter. Very pleased with that line of business. And Hank anything to add in that in that line?

R.H. "Hank" Holmes, IV -- Executive Vice President

Yeah, I would definitely to echo that, David, and appreciate the comment. We have seen that portfolio come down. We had a change in leadership there and our -- and with the credits that they've originated and the ones they have in place, we feel good about the outlook in the ABL platform.

Brad Milsaps -- Piper Sandler & Co. -- Analyst

Great. And then just maybe two quick follow-ups. I think you commented in the deck that your restaurant, at least the QSR piece is about 80% or 85% of its maybe pre-pandemic revenue. I'm not sure what the measurement period is there. Is that a level where debt can start to be repaid at that kind of level of revenue or do you need to see further improvement?

Samuel M. Tortorici -- President

Hey Brad, this is Sam. Did you say the QSR was at 80% of prior year's comps?

Brad Milsaps -- Piper Sandler & Co. -- Analyst

I think that's what I read in your deck. I may have misread it but that's what I thought I saw.

Samuel M. Tortorici -- President

Got it. Well, actually our QSR which is almost 70% of the book has been by far the most resilient in the portfolio. We've looked -- just quickly run down some comps for you. Our QSR pizza exposure was up 10% in April, 22% in May, 15% in June. Popeye's was up 25% in April, 45% in May, 38% in June. And all the rest are also showing favorable year-over-year store sales. So while a lot of them had a bad April and certainly a bad March when the shutdown initially happened. They've rebounded really very well.

So I think on the QSR side, yes, we expect them -- that's where we had the fewest payment deferral request of course but I think we're going to be in pretty good shape there.

Brad Milsaps -- Piper Sandler & Co. -- Analyst

Okay, and then final question, Valerie. Just curious, what are the reinvestment rates on the new bond that you're buying, adding to the balance sheet at this point?

Valerie C. Toalson -- Chief financial officer

Yeah, you know it's below 2%. We're doing mostly mortgage backed. It's probably around 1.70%. We are doing some high-grade municipals and those of course have a little bit higher level, but probably around 1.70% is a decent number to assume.

Brad Milsaps -- Piper Sandler & Co. -- Analyst

Great, thank you.

Operator

And ladies and gentlemen, with that, we will conclude 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 & Chief Executive Officer

Okay. So thank you all for joining us. Just in wrapping up, I would close with saying that I really am honored to serve with the great team of bankers. We're really proud of the critical support that we provide to many of our clients with these PPP loans.

Certainly challenging times for the industry and for the world, but I have to tell you, I've got a lot of confidence in our deep relationships that we have with our clients and a lot of confidence in our bankers and the experienced team that we have who have a lot of experience managing through previous cycles and I like our strategy.

I like the markets that we're in and so despite of the challenges and navigating this difficult time, I think we're positioned to come out of this and really have a bright future. So we're at our post we're working hard to do a good job for shareholders and we thank you for your support.

With that, we stand adjourned.

Operator

[Operator Closing Remarks]

Duration: 66 minutes

Call participants:

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

David F. Black -- Executive Vice President

Valerie C. Toalson -- Chief financial officer

R.H. "Hank" Holmes, IV -- Executive Vice President

Samuel M. Tortorici -- President

Jon Arfstrom -- RBC Capital Markets -- Analyst

Michael Rose -- Raymond James -- Analyst

Steven Alexopoulos -- J.P. Morgan -- Analyst

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Matt Olney -- Stephens Inc. -- Analyst

Ken Zerbe -- Morgan Stanley -- Analyst

Brad Milsaps -- Piper Sandler & Co. -- Analyst

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