Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Banner Corp (NASDAQ:BANR)
Q2 2020 Earnings Call
Jul 23, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Banner Corporation's Second Quarter 2020 Conference Call and Webcast. [Operator Instructions]

I would now like to turn the conference over to Mark Grescovich, President and CEO. Please go ahead.

Mark J. Grescovich -- President, Chief Executive Officer

Thank you, Kate, and good morning, everyone. I would also like to welcome you to the Second Quarter 2020 Earnings Call for Banner Corporation. As is customary, joining me on the call today is Rick Barton, our Chief Credit Officer; joe Rice, our Chief Commercial Credit Officer; Peter Conner, our Chief Financial Officer; and Rich Arnold, our Head of Investor Relations. Rich, would you please read our forward-looking safe harbor statement?

Rich Arnold -- Investor Relations

Sure, Mark. Good morning. Our presentation today discusses banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about Banner's general outlook for economic and other conditions.

We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available in the earnings press release that was released yesterday and our recently filed Form 10-Q for the quarter ended March 31, 2020.

Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations. Mark?

Mark J. Grescovich -- President, Chief Executive Officer

Thank you, Rich. It has certainly been an interesting first half of 2020, and I hope you and your families are well as we all battle the COVID virus and its effects on our communities and the economy. Today, we will cover four primary items with you. First, I will provide you a high-level comment on the quarter. Second, the actions Banner continues to take to support all our stakeholders, including our Banner team, our clients, our communities and our shareholders.

Third, Rick Barton will provide comments on the current status of our loan portfolio and accommodations we have made to assist our clients. Finally, Peter Conner will provide more detail on our operating performance for the quarter and the continued build of our loan loss reserve associated with the estimated economic impact of the COVID virus on our clients and capital actions taken in the quarter, consistent with our long-standing strategic priority of having a moderate risk profile.

I want to begin by thanking all of my 2,100 colleagues in our company that are working extremely hard to assist our clients and communities during these difficult times. Banner has lived our core values, summed up as doing the right thing for 130 years. It is critically important that we continue to do the right thing for our clients, our communities, our colleagues, our company and our shareholders to provide a consistent and reliable source of commerce and capital through all economic cycles and change events. I am pleased to report that is exactly what we are doing. I'm very proud of the entire Banner team that are living our core values.

Now let me turn to an overview of the second quarter performance. As announced, Banner Corporation reported a net profit available to common shareholders of $23.5 million or $0.67 per diluted share for the quarter ended June 30, 2020. This compared to a net profit to common shareholders of $0.47 per share for the first quarter of 2020 and $1.14 per share in the second quarter of 2019. This quarter's earnings were impacted by a number of items, including the allowance for credit losses billed based on the estimated impact of the COVID virus on the economy, strong mortgage banking revenue and a net change in the fair value of financial instruments. Peter will discuss these items in more detail shortly.

Directing your attention to pre-tax pre provision earnings, and excluding the impact of merger and acquisition expenses, COVID expenses, gains and losses on the sale of securities and changes in fair value of financial instruments, earnings were $57.9 million for the second quarter 2020 compared to $53.1 million in the second quarter of 2019, an increase of 9%. This measure, I believe, is helpful for illustrating the core earnings power of Banner. Second quarter 2020 revenue from core operations increased 6% to $147.3 million compared to $139.4 million in the second quarter of 2019. We benefited from a larger and improved earning asset mix, a good net interest margin and good mortgage banking fee revenue. Overall, this resulted in a return on average assets of 0.68% for the second quarter of 2020.

Once again, our core performance this quarter reflects continued execution on our super community bank strategy, that is growing new client relationships, adding to our core funding position by growing core deposits and promoting client loyalty and advocacy through our responsive service model. To that point, our core deposits increased 34% compared to June 30, 2019. Noninterest-bearing deposits increased 44% from one year ago and represent 44% of total deposits. Further, we continued our strong organic generation of new client relationships again this quarter.

Reflective of this solid performance coupled with our strong tangible common equity ratio, we issued a dividend of $0.41 per share in the quarter. Also, in light of the uncertainty of the future economic climate. We have continued the suspension of our share repurchases. While we have limited operations in our branches, our workforce has been mobilized with nearly 60% working effectively remotely. And the remainder available for in-person meetings by appointment, working our drive-throughs, ensuring our ATMs remain accessible and functioning and others performing operational duties.

We have also created special programs for employees deemed worksite essential, and we are providing additional paid time off for exposure or sickness. To provide support for our clients, we have made available several assistance programs. These include wave penalties for early IRA distributions up to $100,000 And COD withdraws up to $25,000 and increased daily limits on mobile check deposits and ATM withdrawals. Further, Banner has provided SBA payroll protection funds, totaling $1.12 billion for 8,665 clients and provided deferred payments or waived interest on 3,314 loans totaling $1.1 billion. Finally, we have made significant contributions to local and regional nonprofits and provided financial support for emergency and basic needs in our footprint.

Let me now turn the call over to Rick to discuss trends in our loan portfolio and his comments on banner's credit quality. Rick?

Richard Barton -- Executive Vice President and Chief Credit Officer

Thanks, Mark. Since our first quarter call, Banner's bankers and credit risk managers have done a superb job of dealing with the colitis topic environment created by the COVID-19 pandemic. From handling the unprecedented volume of PPP loan request to managing stressed existing client relationships, their work has been focused and executed with calm precision. And on top of those challenges, they have participated in a series of deep dive loan portfolio reviews that have allowed us to gauge and measure the credit risk being created by the pandemic.

It is a humbling experience to work with them each and every day. With that said, the balance of my remarks this morning will include the usual recap of the company's credit metrics and loan portfolio and detail on our continuing response to COVID-19. When reviewing our second quarter credit metrics, it needs to be remembered that they have been helped by both the loan deferrals we have granted to many of our customers and the various fiscal stimulus programs enacted during the quarter. Delinquent loans in the second quarter decreased 31 basis points over the linked quarter and totaled 0.35% of total loans receivable. This compares to 0.4% as of June 30, 2019. This metric, in particular, has been the beneficiary of our deferrals and fiscal stimulus.

The company's level of adversely classified assets did spike during the quarter as we proactively downgraded loans in early impact sectors and many of the loans that were put into deferral. This is in keeping with our culture of prompt risk recognition. Our nonperforming assets decreased during the quarter from $46.1 to $39.9 million; which is reflective of the continued strong collection activity by our seasoned workout group. Nonperforming assets represents 0.28% of total assets as of June 30 and include $37.4 million of nonperforming loans and $2.4 million in REO and other owned assets at 03/31/2020, nonperforming assets were 0.36% of total assets.

The second quarter loan loss provision was $29.5 million compared to $21.7 million for the first quarter. The drivers behind this ACL provision were the already mentioned loan downgrades, $12.8 million, changes in the Moody's economic forecast we use in our CECL model $5.7 million and management-driven qualitative adjustments of $7.4 million. After the provision, the ACL reserve totals $156.4 million or 1.52% of total loans. Debt of PPP loans and loans held for sale, the reserve is 1.71% of all remaining loans. This compares to a reserve of 1.41% for the linked quarter.

The reserve for credit losses currently provides significant coverage of our nonperforming loans at 425%, up from 299% last quarter. Loan losses of $4.3 million during the quarter were partially offset by recoveries of $641,000. On an annualized basis, this equates to a loss rate of 16 basis points when PPP loans are excluded. The size and makeup of Banner loan portfolio changed a little during the second quarter of 2020 with PPP loans totaling $1.1 billion are excluded from total loans. Last quarter, we emphasized the pre pandemic rate risk profile of our portfolio that positioned us well for the emergence of a credit cycle.

There is no need to restate those comments this morning other than to note that our approach to credit management and underwriting remains unchanged except for requiring a COVID-19 analysis for all credit actions. The rest of my comments this morning will focus on Banner's response to the pandemic and provide details on higher risk portfolio segments. We have already discussed the PPP loans made, 90% of which were to existing clients. We are now preparing for the loan forget the stage of this program and our anticipation is that this will be successfully executed. In response to the pandemic, we granted payment relief on had yet to expire. Currently, the pace of new deferral requests is very modest.

However, we do expect further requests for new deferrals, given the current state of the pandemic and the slowing or reversal of phased reopening plans. That said, it is worth noting that as of June 30, we had only processed three requests for payment relief extensions. During the July, the extension requests have increased slightly and additional deferrals have been granted to 26 clients with loan balances totaling $32.7 million. And to clarify that as 26 clients have been given a second or renewal of their loan deferrals. In parallel with processing PP loan requests and payment relief actions, our bankers and cr completed the already mentioned portfolio reviews, covering 86% of our commercial and commercial real estate borrowing relationships.

These reviews focused on total client liquidity and cash burn rate, operating projections, including underlying business assumptions of our clients and current estimated collateral coverage. The reviews were designed to gauge both immediate and longer-term repayment risk. Deep dive portfolio reviews have been an integral part of general and problem loan credit management at Banner since 2010. They served us well during the great recession and have been an invaluable tool to us in achieving and maintaining a moderate risk credit portfolio.

Joel Rice, our Senior Commercial Credit Officer, who is on this call, has been an active participant since 2010 in all of these quarterly portfolio reviews providing keen credit insights and leadership. Because of the current uncertainty surrounding the pandemic, these reviews will be competed each quarter for the foreseeable future the reviews will be central to setting future ACL provisioning and troubled loan management and loss mitigation.

I now would like to make some comments about those loan segments we have identified as having been most immediately impacted by the COVID-19 pandemic. The Hospitality segment is 2% of total loans, $166 million or 67% of this portfolio have been granted 90-day deferrals of which $43 million have not yet expired. As we expect the recovery horizon for hospitality will be measured in years, we do anticipate requests for both renewal and new payment relief.

The majority of this portfolio is nationally flagged for strong regional brands. PRE pandemic weighted debt service coverage and loan-to-value metrics of this portfolio were 2.5% and 50%, respectively, indicating that our clients do not need to return to historic norms to resume debt service. The Recreation & Leisure segment is 1.5% of total loans with a concentration of approximately 60% in fit is centers with most of those still closed. As of June 30, 2020, the $77 million or $0.59 in payment deferrals were granted in this segment of which, $5.6 million have not yet expired. Since quarter end, 20% of the original deferrals have been extended. This portfolio segment also had strong pre pandemic metrics with weighted average debt service coverage and loan-to-value ratios of 1.9% and 60%, respectively.

Health care exposure is 4% of the loan portfolio. Approximately $87 million or 18% and payment deferrals were granted in this segment through June 30, with $18 million of those deferrals yet to expire. Our portfolio reviews to date indicate that these clients will not require additional payment relief. Restaurant and food services exposure is 2.5% of our loan portfolio, of which 2/3 is commercial real estate secured. The portfolio is diversified by both geography and type, and there is limited franchise exposure. 65% are classified as full service restaurants, 10% has limited service and another 10% is drinking establishments. Banner initially provided payment deferrals of nearly $83 million or 36% of the segment and of those deferrals $12 million have yet to expire.

While most clients have reopened in some fashion, it is too early to assess their longer-term operating viability. Accordingly, it is reasonable to expect new or renewed deferrals in this loan segment. Our retail trade exposure that includes C&I as well as owner-occupied investor commercial real estate is nearly 11% of the portfolio. This portfolio is diversified across our footprint and includes no model exposure. Payment deferrals of nearly $257 million or 24.5% have been granted to this segment as of June 30, 2020. And of these deferrals, $142 million have yet to expire. With recent pandemic trends, we do expect deferral extensions in this portfolio, but it is too early to gauge at what level.

Before closing our remarks this morning, I would like to reiterate that we entered into the pandemic induced economic cycle with strong credit metrics and an established credit culture. This will continue to be a source of strength as we deal with the inevitable deterioration in credit quality and the emergence of loan losses as the pandemic continues.

With that, I will turn the microphone over to Peter Conner for his comments. Peter?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Thank you, Rick, and good morning, everybody. As discussed previously and as announced in our earnings release, we reported net income of $23.5 million or $0.67 per diluted share for the second quarter compared to $16.9 million or $0.47 per diluted share in the prior quarter. The $0.20 increase in per share earnings was driven by a combination of improved core earnings, positive fair value adjustments and an adjustment to the effective tax rate.

Core revenue, excluding gains and losses on securities and changes in the fair value of financial instruments carried at fair value increased $2 million in the prior quarter as a result of substantial core deposit growth, increased residential mortgage income and PPP loan income, while core expenses declined $6.6 million from the prior quarter due to increased capitalized on origination costs and lower provision expense for unfunded commitments. Loan loss provision expense increased $7.8 million due to additional reserve build driven by further deterioration in the economic outlook, negative loan risk rating migration along with coverage of net charge-offs recorded during the quarter. Turning to the balance sheet. Total loans increased $1.1 billion from the prior quarter end as a result of PPP loan originations.

Excluding PPP loans and held for sale loans, held for investment portfolio loans declined $124 million due in part to lower line utilization and lower commercial loan production along with prepayments on the one four residential mortgage portfolio. Held to sale loans increased by $76 million due to a large volume of residential mortgage loan originations produced in June carried over quarter end. Excluding the Altapacific acquisition and PPP loans, loans held for portfolio grew by 1% over the prior year quarter.

Ending core deposits increased $1.7 billion from prior quarter end due to a combination of new account growth, PPP loan proceeds and a continued increase in overall client deposit balance liquidity. Excluding the Altapacific acquisition, core deposits grew 30% over the prior year quarter. Time deposits decreased by $124 million due to a decrease in brokerage CDS, while retail CDs remain flat. FHLB borrowings declined $97 million as a result of deposit growth. On June 30, we closed on an offering of $100 million of subordinated notes that add to our regulatory capital position and to act as a source of strength to our bank subsidiary during a period of increased economic uncertainty.

Once a sustained improvement in economic conditions has occurred, the additional current company liquidity will provide enhanced capital management optionality. Turning to the income statement. Net interest income remained even with the first quarter at $119 million as substantial growth in core deposits and PPP loan outstandings resulted in a 9.4% growth in average earning assets for the second quarter, offset by a 51 basis point decline in average earning asset yields. Compared to the prior quarter, loan yields decreased 50 basis points due to a combination of low-yielding PPP loan growth, declines in existing portfolio loan yields as a result of the decline in market index rates during the quarter, along with a lower contribution from acquired loan discount accretion.

Of the quarterly loan yield decline, PPP loans accounted for 15 basis points, lower loan accretion accounted for four basis points and the remaining 32 basis points was the result of loan repricing driven by the reduction in average market index rates compared to the first quarter. Security yields declined 24 basis points due to acceleration of prepayments on mortgage-backed securities. Total cost of loans declined 15 basis points to 31 basis points as a result of lower deposit costs and wholesale funding costs.

The total cost of deposits declined from 35 to 23 basis points in the second quarter due to declines in retail deposit costs and a larger mix of noninterest-bearing deposit balances. Brokered CDs accounted for two basis points of total deposit costs compared to four basis points in the prior quarter. The ratio of core deposits to total deposits increased 91% in the second quarter, up from 89% in the first quarter. The net interest margin declined 35 basis points to 3.9% on a tax equivalent basis. Of the total decline, the PPP program accounted for eight basis points, acquired loan accretion of three basis points and the increase in core deposit liquidity, not associated with the PPP program accounted for six basis points.

With respect to the margin outlook, we anticipate an increase in effective loan yields generated from the PPP program to begin having a positive effect at the end of this quarter and ramp-up in the fourth quarter commensurate with an increase in loan forgiveness activity, along with some corresponding outflow of deposit liquidity buildup we saw in the second quarter. Noninterest income increased $8.7 million from the prior quarter. Noninterest income, excluding losses on the sales of and changes in securities security at fair value increased $1.9 million. Deposit fees declined $2.3 million due to lower transaction volumes.

And fee waiver accommodations in response to the pandemic. Total mortgage banking increased significantly by $3.9 million due to an increase in residential mortgage gain on sale, driven by record volume and strong gain on sales spreads. The percentage of refinance volume increased to 58% of total volume, up from 46% in the prior quarter, with overall gain on sale spreads in the high 4% range, similar to the level in the first quarter. Within this line item, multifamily contributed less than $100,000 due to a decline in secondary market liquidity and reduced loan production in the second quarter.

Miscellaneous fee income decreased $1.1 million due to declines in SBA and swap fee income, along with lower gains on other real estate assets sold. Turning to expense, total noninterest expense declined by $5.6 million from the prior quarter. Excluding acquisition costs and pandemic specific operating cost, core noninterest expense declined $6.7 million. Salary and benefits expense increased $3.5 million due to normal merit-related salary increases, lower physician vacancy rates, overtime and mortgage commissions. The credit for capitalized loan origination costs increased by $5.3 million in the second quarter due to the PPP program and, to a lesser extent, a modest increase in normal portfolio loan production.

PPP originations represented $2.9 million of the total capitalized loan origination cost in the second quarter. Marketing and advertising expense declined $1.2 million as direct mail and marketing campaigns were curtailed in response to the pandemic. Provision expense for unfunded loan commitments declined $2.6 million due to a release in the unfunded commitment reserve driven by a shift in the mix of unfunded commitment balances by loan segment. Miscellaneous expense declined $1.2 million due to employee conference, travel and training costs. Acquisition costs declined to $800,000 from the prior quarter to $336,000 and COVID-related costs increased $1.9 million, principally comprised of premium pay for essential front line staff, remote work environment setup costs and community donations.

Finally, we are resuming efficiency initiatives that have been postponed due to the pandemic. Among these initiatives are the consolidation of the Islanders Bank charter in Cabana Bank in the first quarter of 2021, along with ongoing retail branch rationalization and completion of the streamlining of the commercial and small business delivery platforms over the next 18 months. We believe these initiatives align well with the recent acceleration in client acceptance of digital delivery channels and the percentage of workforce that will work remotely as a residual impact of the pandemic.

This concludes my prepared remarks. Mark?

Mark J. Grescovich -- President, Chief Executive Officer

Thank you, Rick and Peter, for your comments. That concludes our prepared remarks. And Kate, we will now open the call and welcome your questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Jeff Rulis of D.A. Davidson. Please go ahead.

Jeff Rulis -- D.A. Davidson -- Analyst

Thanks.

Richard Barton -- Executive Vice President and Chief Credit Officer

Thanks, good morning.

Jeff Rulis -- D.A. Davidson -- Analyst

I guess, first question could be for Rick on the deferrals. Just I think you're around 12% of loans on deferral as of six 30, I wanted to just clarify that the 62% of those deferrals that had expired, that's fully baked into that 12% number. Is that correct? As in those that perhaps did not reup that's reflective of the 12%?

Richard Barton -- Executive Vice President and Chief Credit Officer

Thanks for the question, Jeff. As we've gone through the deferral process, I've asked Jill Rice, our Senior Credit Officer for commercial loans to be the keeper of statistics as far as deferrals are concerned. So I would like to have her answer that question for you. Jill?

Rich Arnold -- Investor Relations

Thanks, Rick. Yes, the 12% was the original deferrals and then the remaining unexpired are net of that. We do expect that there will be increased extension requests coming in this quarter.

Jeff Rulis -- D.A. Davidson -- Analyst

Okay. Just trying to net that out, I guess, those that don't request extensions on net. In other word, maybe a simple way of asking, do you think that 12% is going to be the peak? And while you might get a handful of extension requests. You're still getting some that do not, therefore, the 12% comes down? Or maybe I'm missing the message.

Rich Arnold -- Investor Relations

No, absolutely. That's correct based on what we know today from R&D portfolio reviews, we would expect that number to come down. It will increase from the 3% to 4% that are currently unexpired by virtue of expire coming back in, but it will it's expected to be below that 12% original.

Jeff Rulis -- D.A. Davidson -- Analyst

Okay. And as Rick outlined, just in the higher risk, maybe hospitality and other those are the areas that you'd expect extension requests?

Rich Arnold -- Investor Relations

Absolutely, the extension request, hospitality, fitness centers, restaurants, retail trade. And really, it depends on the reopening of the economies in our Footprint and the level and trend of the virus, but those are the four primary areas we would expect to see extension requests come in at this point.

Mark J. Grescovich -- President, Chief Executive Officer

And Jeff, this is Mark. Let me just add to that, that recall that our policy that we put in place as we started the deferrals was a 90-day deferral. Right? So even though we may get some extensions, they're still not going past the 90 or the 180 days.

Rich Arnold -- Investor Relations

A question on the expense side. Peter, I think if you back out the COVID costs and merger costs, you get to about $87 million. And then if we think about the provision recapture, maybe not recurring and then what was the capitalized benefit from PPP? Was that in the I think it was $2.9 million, is that what you said?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes, that's right, Jeff. Yes, we that $2.9 million is a nonrecurring benefit to expense really tied specifically to the PPP program and the flurry of originations we did and originating the 8,600 PPP loans. So that piece you could assume will go away in future quarters.

Jeff Rulis -- D.A. Davidson -- Analyst

Okay. So that kind of gets me to about a $91 million base. Does that sound roughly correct.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. Yes, that's roughly correct. I think the other dynamic going forward is going to be a couple of things. One is the pace of just general portfolio originations for the rest of the book, which are really tied to the pace of economic reopening. And over time, we should see that volume of capitalized loan origination expenses on the existing portfolio continue to improve. As reopening occurs?

And then secondly, we as you might expect, a lot of our travel and conference and employee business development expenses have been muted in the remote work environment and some of the reopening the limits of travel and reopening. So we'd expect, again, as the economy reopens, you'll see some of that employee in travel and marketing expense begin to resume normal levels that we've seen in the past.

Jeff Rulis -- D.A. Davidson -- Analyst

Okay. Great. Maybe one last, while I got you, Peter, on the tax rate, was that kind of a higher than normal sort of tax-efficient investment? Or any thoughts on the tax rate.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. We there was a catch-up effect that really related to the tax-exempt revenues as a proportion of total revenues and capturing that in the quarter. Going forward, we expect the effective tax rate to resume more of a 20% flat rate going forward. So that would be our guidance going forward.

Operator

The next question is from Gordon McGuire at Stephens. Please go ahead.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Hi, good morning.

Gordon McGuire -- Stephens -- Analyst

Morning, Gordon Peter, I appreciate the commentary about resuming the efficiency initiatives, I guess, particularly with the consolidation of the subsidiaries. But I'm curious if you could give us a little more color around what that looks like in a COVID world. Maybe size up whether you think the magnitude of what you can do over the near-term is different from where you would have thought in January? Or just how that process takes place compared to what you would have thought heading into the year.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes, Gordon, it's Peter. So yes, I think to your question on how has our outlook changed on efficiency opportunities given the pandemic. I think one thing you'll see is that we're going to be able to be a bit more aggressive on branch rationalization than we would have assumed in January. We've all gotten a good lesson and client behavior and limited branch operation environment and been able to identify some additional locations that are represent opportunities for consolidation.

So I think we are going to be in a position to accelerate some of what we had contemplated would take perhaps longer in a shorter period of time with respect to our branch network. And then two, I think our employee expense, especially the travel-related costs and perhaps some of the business development related costs that used to tie to physical presence in travel in terms of meetings, client-facing activities and conferences. I think we'll see a reduction in that. Some of that will not come back, and we'll see a permanent run rate that's somewhat less than we've seen in the past. So I think we'll see some benefits there. And then we're also wrapping up. We've got we've discussed.

Streamlining the commercial and small business platform in prior calls, and that's been going on all along. But we still have some efficiencies to capture that will manifest over the next 12 months on that side of business. And so those are it's a collection of initiatives that go on. You'll never see a stair-step in a big reduction in expense, but these will accrue over time to generate scale, we grow assets and continue to create operational efficiencies for the company on an incremental basis quarter-to-quarter.

Gordon McGuire -- Stephens -- Analyst

Okay. And then the time line for the consolidation of the banks, how you expect the merger charges to flow through over the next couple of quarters and then the progression of cost saves there.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. With respect to the Islanders merger that we announced last night, so that's plan that's scheduled to close in the first quarter of 2020. So both the closing integration and conversion activities will all happen on the same date. Since that bank is already part of the banner Family. We can close it that way. We anticipate $2 million of integration and conversion-related expense to consolidate that charter. And going forward, we anticipate about the same number, $2 million a year in expense efficiency saves on a fully annualized basis.

Gordon McGuire -- Stephens -- Analyst

Okay. So the merger costs should all occur when it's consolidated in the first quarter, and that's presumably when the savings would be flushed out as well?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. Yes. So you'll see most of the $2 million will post in the will close in and the efficiencies will be rendered beginning in the second quarter of 2021.

Gordon McGuire -- Stephens -- Analyst

And then the balance sheet, I saw had $340 million of equity securities that looked like they popped up toward the end of the quarter. What is that?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. We've continued to invest some of the excess liquidity in shorter duration securities, given the surge in deposit liquidity, we've taken the position that surge in deposit liquidity may not last long term. Some of it will, but some of it will roll off balance sheet. And a lot of it came from the fiscal stimulus programs, the PPP program itself in this general flight to quality and liquidity buildup across our client deposit base.

So we've taken the position of keeping that excess liquidity invested in short-term securities with the expectation that some of it. We'll roll back off balance sheet. So we don't want to take any duration risk that's excessive, assuming that some of that deposit liquidity will flow back out into the economy as the pace of reopening continues.

Gordon McGuire -- Stephens -- Analyst

I appreciate it. I'll step back.

Mark J. Grescovich -- President, Chief Executive Officer

Thank you.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Thank you, Gordon.

Operator

The next question is from Andrew Liesch of Piper Sandler. Please go ahead.

Andrew Liesch -- Piper Sandler -- Analyst

Morning, guys, thanks for taking the questions. Just sticking on the securities portfolio here. Just curious what you have been buying, I recognize you want to keep the portfolio pretty short here just given some liquidity needs and so is excess liquidity. I'll probably follow-up. But just curious what you have in mind.

Mark J. Grescovich -- President, Chief Executive Officer

Yes. Andrew, we've been buying a mix of we've got many markets investments fund that we've been putting the really short-term funds in that we expect that we would need from a week-to-week liquidity perspective, that's obviously got yields below 1%. And then the rest of it has been laddered into our more traditional mix in the portfolio of immune some CRA investments, some MBS, but in general, obviously, the yields we're getting today are below the average portfolio yield. So we've tried to keep it short, but also balance some duration with what's available out there, but it's I would characterize it as being shorter. The new investments are have a shorter duration in the legacy portfolio.

Andrew Liesch -- Piper Sandler -- Analyst

Okay. And then just curious how the mortgage business trending this quarter versus what the strong performance last quarter. Just any update on how refi in the purchase business is performing in your market.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. We've had a record year. We will have very close to a record year here coming up in the third quarter. Even before we end the year in mortgage. So we had a very strong first quarter. We had an even stronger second quarter. And obviously, some of the improvement has been due to the increased refinance demand that's now well north, it's almost 60% of the volume. But we've also seen resilience in the purchase volume as well. So in the spring, we've seen strength in purchase-related mortgage volume along with a big increase in refinance volume that follows the 10-year yield down.

We continue to see very strong pipelines going into the third quarter. Our general expectation is we have a fairly seasonal mortgage business normally that slows down in Q4 and Q1. And so at this stage, we would anticipate a reasonably strong Q3 and then a traditional slowdown as we get into the fourth quarter. And as the refinance line begins to ebb, we'll see some of the effects of that lower volume going into the second half of the year as well.

Andrew Liesch -- Piper Sandler -- Analyst

Great, thanks for taking my questions.

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Thank you, Andrew.

Operator

The next question is from Jackie Bohlen of KBW. Please go ahead.

Jackie Bohlen -- KBW -- Analyst

Just so that I understand are you looking at it a combination of all of those items, are you looking at them more as cost reduction strategies or as something that will slow the pace of other growth?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes, Jackie, it's Peter. The I would characterize, we do have some offsetting investment infrastructure of the company that we've discussed previously. So there will be some, obviously, continuing investments in our digital banking platform, our mobile banking platform, some of the residual branch delivery platform in the form of automation and improved client experience solutions that will show some increase, but those will be offset by these other reductions we're discussing.

So we again, it's going to be, in the long term, a play around scale, where we as we continue to grow assets, we put the infrastructure in to add another $5 billion of assets with a much smaller increase in expense than we would have had otherwise. So I would characterize the efficiency initiatives are going to basically act as an offset to the other infrastructure investments we've been discussing that will enable continued revenue growth and scale for the company.

Louis J. Feldman -- RedChip Companies -- Analyst

Okay. That's very helpful. And I I could beat a horse here, but I just want to make sure that I understand on the deferrals. And I wanted to talk about it from a dollar value perspective rather than a percentage since I apologize, but I was a little unclear on the prior discussion. So if I look at that $1.1 billion, and you talked about $408 million that are not expired.

If I just do the math there, that tells me that roughly $700 million of those have expired. Number one, is that the proper way to think about it? And number two, when you talked about the three in June and the I think it was 26 in July for the $33 million, that leaves over $600 million in expired deferrals that have not requested a renewal again. Is that the right way to think of it?

Mark J. Grescovich -- President, Chief Executive Officer

Jackie, this is Jill. That's absolutely the right way to think about it.

Jackie Bohlen -- KBW -- Analyst

Okay. So the vast majority of your deferrals are now have returned to payment status?

Mark J. Grescovich -- President, Chief Executive Officer

Yes. They have returned to payment status or they are coming up on their first payment after the expiration. So they expired in July, and a few of them will have a few more days to make payments, but...

Jackie Bohlen -- KBW -- Analyst

Okay. Okay. Great. Sorry, just one last quick one. What could be average balance for PPP loans in the quarter?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. For the second quarter, Jackie.

Jackie Bohlen -- KBW -- Analyst

Yes. Yes. I believe it's about $750 million on average for the quarter.

Operator

[Operator Instructions]. The next question comes from David Feaster of Raymond James. Please go ahead.

David Feaster -- Raymond James -- Analyst

Hey, good morning everybody.

Richard Barton -- Executive Vice President and Chief Credit Officer

Good morning, David.

David Feaster -- Raymond James -- Analyst

I just wanted to follow-up on Jackie's question on the redeferrals and ultimately, the implications for the reserve build. I mean that the low level of redeferrals is tremendous. I'm really happy to see that. But I guess the reserve build came toward the low end of the range this quarter. And if we're looking at a continued low level of redeferrals, maybe it accelerates a little bit, but it still ultimately sounds like it's going to be pretty low. I guess, do you think most of the heavy lifting is largely done with the reserve build and that there might only be some modest build in the second half of the year as maybe you get some risk rating downgrades from redeferrals.

Richard Barton -- Executive Vice President and Chief Credit Officer

David, this is Rick Barton. Let me take the first swipe at answering your question, which is a good one. I think, as I mentioned in my comments, we've been pretty candid about risk recognition in the high-impact industries and those loans that are under deferral. And if we have made the judgment that they should be downgraded. We have already taken those downgrades rather than allowing the deferrals to run their course. Both Jill and myself have been at this for quite some time in our careers. And I think we are a good judge of credits that are going to have longer-term rather than just a short-term operating issue.

So we have identified and taken those downgrades as we've identified with the weaker loans in the portfolio. And it is safe to assume that as we go forward. And the course of the pandemic becomes more clear that has credits seek additional deferrals. Our new deferrals come in, which demonstrate operating weaknesses in the core business that there will be a continuing stream of adversely classified assets being identified. But to end of how I began, we feel based on what we know today that much of the heavy lifting in terms of adversely classifying loans has already been accomplished.

David Feaster -- Raymond James -- Analyst

Okay. That's extremely helpful. And then I just wanted to get your thoughts on organic growth going forward. Loans ex PPP, as you highlighted, were down. It seems like this was partially a function of declining C&I utilization, but I'm just curious as to what trends you're seeing. How much of the decline quarter-over-quarter was maybe strategic where you're tightening the credit box versus payoffs and pay downs, asset sales or simply even just limited less demand for new credit and just how your pipeline might be heading into the third quarter?

Rich Arnold -- Investor Relations

This is Jill, David. I'll start by saying that the loan growth, we would expect to continue to be flat in the near term. The pipelines are OK. But there's been less activity overall in the new loan book, any future growth guidance that we would be based on the economic recovery that we see in the market.

Mark J. Grescovich -- President, Chief Executive Officer

And let me just add, David, this is Mark, that as we dissect some of the loan portfolio, a bulk of the decrease in the loan portfolio has been the result of line utilization decreases. So as business as the economy has come to a grinding halt, obviously, working capital needs have diminished. So we would suspect that, that's going to continue for a period of time. So our projection is that we're going to have pretty much a flat balance sheet for a period of time.

David Feaster -- Raymond James -- Analyst

Okay. That's helpful. And then last one for me, and you touched on it a little bit. I'm just curious to get your thoughts on the overall expectations for the levels of forgiveness and maybe the timing of forgiveness, you touched on a little bit, but and then maybe just the overall fees, net of net of like the origination expenses that you would expect going forward?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes, David, it's Peter. Yes. So we based on the new guidelines from SBA, which have evolved, as you know, over the last couple of months and the forgiveness time lines that they've guided to, we think we'll see the bulk of our forgiveness in the fourth quarter of this year. We maybe see a bit of it begin at the end of the third quarter. So the bulk of the forgiveness paydowns will we anticipate impacting us in Q4 and spill into Q1 to a lesser extent. And then the as you saw, the mix of our PPP loans is fairly granular.

So the average loan processing fee on the entire portfolio is about 3.6%, which is roughly about $40 million on the entirety of the portfolio. So we would expect an acceleration of a portion of that $40 million really to show up beginning at the end of the third quarter, but into the fourth quarter. And then we do expect residual balance. At this point, it's challenging to predict client behavior, but we anticipate there will be a residual balance that will not be forgiven or paid down that will carry through its 24-month maturity. We're assuming around 20% or so, 15% to 20% of that balance will continue out through that remaining amortization period after the bulk if that forgiveness activity occurs.

David Feaster -- Raymond James -- Analyst

Okay. That's helpful. And that $40 million that you referenced, is that net of the expenses, like the net NII impact from the PPP coming through?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

That's a gross number, so you want to adjust for the deferral origination cost against that.

David Feaster -- Raymond James -- Analyst

Got it. Thanks guys.

Operator

The next question is from Tim Coffey of Janney. Please go ahead.

Tim Coffey -- Janney -- Analyst

Thanks, good morning everybody. Most of my questions have been answered, but I just want to make sure I understood kind of all the comments you've made. So if I look at the capitalized loan expenses, it seems like those might come back run a little bit below normal for the next couple of quarters, given the level of activity you're expecting from the loan portfolio. Would that be accurate?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Tim, it's Peter. I think you'd certainly take out the PPP component of the capitalized loan origination costs in Q3 to set a new baseline. So I would characterize part of that some of the activity we had, especially in the mortgage side and is likely to come back down a little bit. So I think it's it will be above what we saw in Q1, which was a very we had a relatively slow quarter of just traditional production as the pandemic became apparent. So it would be somewhere between the Q1 levels and somewhat below the PPP adjusted level that we had in the second quarter. So obviously, I'm not going to give you specifics, but I would guide it will be somewhere within those two brackets.

Operator

The next question is a follow from Jackie Bohlen of KBW. Please go ahead.

Jackie Bohlen -- KBW -- Analyst

Sorry, I'm having a conversation with myself. Mute. I just wanted to double check on what if you have the fees that were realized through to Q 2020, I'm assuming that you amortize some of that. And then obviously, there's the 1% interest that was earned. So I wanted to see what the impact to interest income was from those loans in the quarter?

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Yes. Jackie, it's Peter. So the for the second quarter, the PPP loans generated about 2.75% all in interest yield. So the amortization of the fees we did have against the coupon is about 2.75%. Against that average balance, I gave you earlier of about $750 million.

Jackie Bohlen -- KBW -- Analyst

Thank you.

Operator

Thank you. There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mark Grescovich for closing remarks.

Mark J. Grescovich -- President, Chief Executive Officer

Thank you, Kate, and thank you, everyone, for your questions. As I stated, we are very proud of the Banner team as we continue to do the right thing as we battle this pandemic and its effects on the economies, the communities and our own lives. Thank you for your interest in banner and for joining our call today. We look forward to reporting our results to you again in the future. Have a great day, everyone, and please stay safe.

Operator

[Operator Closing Remarks]

Duration: 60 minutes

Call participants:

Mark J. Grescovich -- President, Chief Executive Officer

Rich Arnold -- Investor Relations

Richard Barton -- Executive Vice President and Chief Credit Officer

Peter J. Conner -- Executive Vice President, Chief Financial Officer

Jeff Rulis -- D.A. Davidson -- Analyst

Gordon McGuire -- Stephens -- Analyst

Andrew Liesch -- Piper Sandler -- Analyst

Jackie Bohlen -- KBW -- Analyst

Louis J. Feldman -- RedChip Companies -- Analyst

David Feaster -- Raymond James -- Analyst

Tim Coffey -- Janney -- Analyst

More BANR analysis

All earnings call transcripts

AlphaStreet Logo