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Sterling Bancorp (NYSE:STL)
Q2 2020 Earnings Call
Jul 23, 2020, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the Sterling Bancorp 2Q 2020 Conference Call. Today's conference is being recorded.

At this time, I would like to turn the call over to Mr. Jack Kopnisky, President and CEO. Please go ahead.

Jack L. Kopnisky -- President & Chief Executive Officer

Good morning, everyone, and welcome to our second quarter 2020 earnings call. Joining me on the call is Luis Massiani, our Chief Financial Officer and Bank President; and Rob Rowe, our Chief Credit Officer. On our website, you'll find the slides we're referencing in our presentation.

I'd like to first recognize the fantastic efforts of our extraordinary team. They have adjusted admirably through this extremely difficult operating environment and continue to perform at an outstanding level during a particularly challenging period for the banking industry and the broader economy.

Our company's culture emphasizes change and adaptation, traits that have served us well in these times. Our colleagues have consistently gone above and beyond for our clients and each other.

For the second quarter of 2020, we reported adjusted EPS of $0.29 and grew our tangible book value per share 6.2% to $13.17 from $12.83 last quarter. We continue to build our allowance for credit losses given the downward revisions to economic forecasts, though our conservative assumptions last quarter reduced requiring provisioning for this quarter.

We are particularly encouraged by our ability to grow tangible equity and tangible book value per share in the face of this challenging economic environment.

We continue to service our existing clients and grow our business in targeted loan portfolios. In addition to the $650 million in PPP balances we originated this quarter, our commercial portfolios grew $85 million over last quarter, spread across several portfolios.

While we continue to see meaningful new business opportunities, current volumes are approximately 50% of historic production, which is reflected in our updated loan growth outlook. Portfolios that grew this quarter are likely to be future drivers of growth, including traditional C&I, CRE, affordable housing and public sector finance.

We are shifting capital away from national transaction-based businesses that do not provide opportunities for full relationships and that are not meeting our targeted risk adjusted returns in current market conditions.

Deposit growth was also strong, core deposits were up nearly 6% over last quarter despite a 2% drag from seasonal run-off in the municipal portfolio. We are optimistic we can continue to exhibit solid deposit growth in the current environment, driven by our commercial and business banking teams.

We are augmenting our traditional growth channels through technology-enabled banking initiatives, including the direct banking product we launched last year and our recently announced banking-as-a-service program. We view these as efficient ways to grow and diversify our funding sources, fee income and total revenue.

The pandemic has accelerated client adoption of technology and validated our investment in digital banking platforms. The accelerated adoption of technology will also enable us to perform more efficiently in the future as we reevaluate our real estate footprint and leverage automated processes that have been tested and enhanced over recent months.

We are pleased with our pre-tax, pre-provision net revenue performance, although we experienced pressure in several businesses related to the pandemic.

Net interest income excluding accretion income was $206 million, an increase of $2 million over the prior quarter. Fee income was lower than expected due to lower transaction volumes and deposit fees, wealth management, factoring receivable volumes and other loan commissions.

We expect these volumes will rebound as the economy recovers and customer activity resumes and we have started to see positive trends in volumes over the past 60 days.

Regarding expenses, we incurred $3.8 million in expenses to support our colleagues at the outset of the pandemic that should not repeat in the third quarter. Among those expenses was a $1.5 million charitable contribution via the Sterling Foundation that supported communities affected by the pandemic. We also had costs of $9.8 million to exit FHLB borrowings and $1.5 million of OREO expenses to exit properties held on our balance sheet.

We maintained our core net interest margin flat to last quarter at 305 basis points, despite recognizing lower short=term interest rates in the early part of the quarter. Our team did an outstanding job in lowering the funding costs which were down 35 basis points, well exceeding the 10 to 15 basis points quarterly reductions we were expecting to achieve this quarter, and we ended the quarter on an upward trajectory for the core net interest margin in the month of June.

We continue to believe we can achieve a total cost of funding liabilities of 35 basis points to 40 basis points, if not lower in the current interest rate environment, which should help support net interest margin near current levels.

We anticipate generating positive operating leverage through the remainder of the year, as repricing of liabilities outpaces pressure on asset yields, transaction activity and volumes begin normalizing, and we focus on efficiency initiatives and growing our most profitable businesses. This progress should be evident in the third quarter, where we expect each component of core PPNR to improve.

Moving on to credit. We added another $39 million to our allowance for credit losses this quarter, taking the allowance to portfolio loans to a 164 basis points, as deterioration in the macro outlook increased our estimate of losses.

Our CECL model assumes the unemployment rate averages in excess of 9% through full year 2021 with GDP not reaching breakeven until early 2021.

Aside from the adjustments related to the macro outlook, credit performance was generally reflective of our expectations as of last quarter. NPLs were effectively flat for last quarter. The increase in charge-offs to $17.6 million or 32 basis points of loans annualized reflects our effort to quickly resolve these credits we moved to nonaccrual late last quarter.

On Slides 14 and 15 of our presentation, we provide an update on COVID impacted portfolios we highlighted last quarter and provide incremental detail on the portfolios that comprise the bulk of deferrals. We have deferred principal and interest on 8% or $1.7 billion of loans. Deferrals are most commonly for 90 days with an additional 90-day deferral period at our option. Over the past 45 days, we have received few new requests for deferral and are actively working with all borrowers as their initial deferral periods began expiring in late July and August.

I want to detail our current view of each of the impacted portfolios next. First, we are comfortable with our traditional C&I portfolio, which is generally well secured on a borrowing base and we have seen low request for payment modifications with the exception of a relatively small franchise finance portfolio whose underlying business fundamentals has held up relatively well over the past quarter and will improve as the economy opens.

Secondly, our national commercial finance portfolio has also performed at or better than expected. The equipment finance portfolio was more highly impacted by the downturn initially, particularly in the transportation and construction sectors, but we are starting to see a pickup in shipping and general transportation volumes. We have seen relatively low volumes of deferrals in our other national portfolios.

Lastly, commercial and multifamily real estate is performing as expected and we anticipate that our relatively low loan-to-values of approximately 50% across the entire portfolio will provide substantial support to the long-term performance of these assets. We're working through the higher impacted sectors of hospitality, retail and office, where we will continue to work with borrowers and in providing working capital relief, given our strong collateral position and debt service coverage prior to the pandemic.

Multi-family is performing well in our loan-to-values and debt service coverage. That portfolio also provides a strong degree of credit protection.

We will be pragmatic about each loan portfolio and we'll take aggressive action to recognize and resolve issues directly and expeditiously.

I noted at the outset of my prepared remarks that we were able to grow our tangible book value per share over the last quarter and strengthened our capital ratios. Our TCE ratio increased 8 basis points to 8.82%, and our Tier 1 leverage at the holding company increased 10 basis points to 9.51%. We continue to be on a self-imposed pause of our share repurchase plan. We expect we will continue to grow both our capital ratios and tangible book value per share through the remainder of the year.

On Page 16, we update our outlook for the year. We continue to be comfortable with our net interest margin and core expense outlooks for the year. We reduced our fee income expectation in given some of the near-term headwinds caused by the pandemic and expect loan growth to come at the lower end of our previous guide at $500 million of growth for the year. We also expect to incur a lower tax rate through the remainder of the year.

There are still many unknowns in the economy given the potential lasting effects from the pandemic. We will continue to be aggressive with our operating model to address the financial impacts.

Our primary focus in this environment is twofold. First, to produce strong earnings streams driven by revenue gains that enable us to build capital; and secondly, to recognize and resolve credit issues early with strong levels of reserve and capital.

Now, let's open up the line for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] We will now go to our first question that comes from Casey Haire with Jefferies. Please go ahead.

Casey Haire -- Jefferies -- Analyst

Yes, thanks. Good morning, guys.

Jack L. Kopnisky -- President & Chief Executive Officer

Good morning.

Casey Haire -- Jefferies -- Analyst

Couple of questions on the credit quality front. The deferrals, it sounds like they have slowed. We have seen from peers some decent cure rates. Just some color that you can provide as these deferrals hit their 90-day terms based on your conversations with them what -- how you expect that to trend in another three months and your appetite to extend another 90 days?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Sure. So, I think consistent what we've talked about in the first quarter Casey. I think that from an appetite perspective, we're going to continue to work with borrowers where we see that there is a long-term viability to the business and where we think that there is a good opportunity to have a full relationship in the long-term.

And -- but our strategy is going to be the same, which is we're not going to provide extensions or new referrals that just anybody who ask for it. So, one of the reasons again -- and as a reminder in the first quarter, we had some migration credit -- is that the strategy has been identified, who have long-term viability, work with those borrowers. That's where the appetite is.

And then if we don't see that there is a long-term viability to it, then we decide to move the -- exit the relationship, move in a different direction. So, the appetite remains the same.

Now, from where -- the early feedback and Jack alluded to in his remarks, late July and August is when the majority of that, those initial 90-day period start coming due. So, we're going to know a lot more in the next 30 days to 45 days. With that said, early feedback across several portfolios like equipment finance, like franchise finance is pretty good and we are -- we feel good that there is going to be a substantial amount of those initial deferrals that are going to move to some form of either full payment or some modified payment stream are going to be in cash flowing again. Is it 40%, 50%, 60%? We don't know yet. But we feel very good that the early feedback in many of those sectors is quite positive.

Places where you're going to see the majority of the, I'll call them reextension, is hotel margins. The entirety of our portfolio and hotel margin is pretty much concentrated in the New York area. That industry is not back yet. So, you're going to see extensions there. You're also going to see extensions in CRE retail.

So, those are the two sectors where we see the majority of the extensions happening or kind of recurring for the second 90 days. And on aggregate, you're talking of approximately $300 million to $400 million or so of P&I deferrals that you see in those, and the payment deferrals that you see in those two sectors.

So, those are the two places that we're focusing on the most, and that is not to say that in others, you are not going to have a fair amount of risk potential [Phonetic] as well, but those are the places where you go, those two sectors where you see the most amount of additional 90-day periods going forward.

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, just to add a little more color on this too, we -- when we're granting deferrals, we're asking for updated financials, projections, things like that. We're not -- what we're not doing is we're not blanketing any deferrals, so that's one of the advantage of this -- the single point of contact structure we have with the teams. This is one-by-one and they have the -- the borrower has to justify the deferral based on their projections and all that. So, we're not -- we're not, say, in just the category. We're moving forward on that.

Second thing is, if we're -- we also are addressing those that don't have viability going forward. So, we're not going to sit back and watch things and wait and defer things until -- and hope and pray that something good is going to happen. If there is an issue, we're going to address it right up front and we're going -- we're going to take the -- one of the things we've learned over many-many-many years of doing this is, the sooner that you know your best outcome is, your soonest outcome when you take action on this.

So, we've tried to be aggressive and if there is an issue and there's not viability out there, they're moving forward and addressing this situation up front.

Casey Haire -- Jefferies -- Analyst

Great. Thanks for the color. That the retail CRE on Slide 14, that's obviously a big concern among many banks. What's -- what can you tell us about that bucket, $1.3 billion? Qualitatively, how much of it is -- is what you think is viable going forward to be it in an essential retailer versus stuff that you're worried about? Just a little color on the retail CRE bucket, which is a little bit bigger than most on that slide for you?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Well, we've discussed in the past, we do not have exposure to regional malls. So, from that perspective, that's a good thing. When you think about our CRE retail, its community-based. I mean, you could say its strips, but it really is a lot of community-based. I think about 80% of the portfolio, the borrower amount would be $10 million or less, OK.

So, it's really consistent with Sterling supporting its businesses and supporting stuff in the community. And so, we all could, I guess, conclude however we want to argue is pretty strong that after the pandemic that people who would go back to shopping in their community-based shopping centers, because that's what they've done for a long time. And that's not really where online is necessarily attacking. But certainly, to your point today, because of the pandemic, the tenants themselves are being challenged probably about 25% to 30% of them are having a hard time paying our borrowers. And so, that's why we see the deferral rate what it is.

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, and for the most part, these are also founded in essential businesses. So, the majority of all the retail are grocery stores, pharma's, banks, along the way. So, we're comfortable with the loan to values versus how people are paying now. And we would assume that that will get better over time. But we're pretty comfortable about the -- kind of the equity we have in those properties and the types of tenants they have in those properties.

Rob Rowe -- Chief Credit Officer

Yes, given the LTVs we have in the case, even in a scenario in which probability or default increases, locking in default when you have 50% or 55% LTVs, not to say that you're not going to lose some -- you're not going to have some charge-offs but the loss given default, given you have true equity, substantial equity under you, because again these are not large regional malls, these are not institutional kind of retail credits where you have mezzanine tranches and other sorts of kind of junior or capital stacks that create very little equity under you or true equity.

So, these are -- these are going to be -- this isn't in any scenario. We don't see this as a -- from one quarter to the next things going bad across a substantial chunk of the portfolio, because this is the likelihood of a lot of the owners. This is where they have their network.

So, this is going to be a longer drawn out. To the extent that some of these go bad, it will be a longer progression to that happening and we'll be able to kind of work our way through it over time. But the kind of anchor to all this is the fact that this is conservative low LTV and that gives you -- it'll give us options as to how we either work with the borrower or work out of these credits over time.

Casey Haire -- Jefferies -- Analyst

Very good. Last one for me, just the charge operates at 32 bps, and there was some migration. Should we expect charge-offs to sort of -- what's the near term charge-off outlook? Should we expect it to kind of hold us this level going forward or did you just do some clean up this quarter?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

We're going to be aggressive in cleaning up. So, there's still cleanup to do. We have -- whether obviously the NPLs or $250 million or so, particularly related to specific portfolio credit or no portfolios in residential mortgage in some smaller amounts of equipment loans. We're going to continue to address those very aggressively going forward.

So, you should anticipate that we will have charge-offs, but a vast majority of those are already covered with the reserves that we have and have been identified in our CECL modeling. And again, the position that we've talked about since the first quarter, which is the faster we get these things out of here and we get -- we focus on kind of the parts of the business that we want to long-term, the better it is. So, yes, you should anticipate that charged-off activity is going to continue in the third and fourth quarter.

Is it going to be 30 basis points or 40 basis points? Not a 100% sure yet. But, yes, we do -- we're going to continue to aggressively manage out of NPLs.

Rob Rowe -- Chief Credit Officer

Yes, one of the things that we all kind of forget in the last 10 years that credit quality has been so pristine that everybody is used to having charge-off levels of less than 20 basis points. Normalized charge-off ratio is based on, over many-many years is more than 20 basis point to 50 basis point range.

So, we don't think this is -- we think this is becoming more of a normalized environment where, you have certain risk and you have some [Technical Issues] and all that. So, that's -- I think that's the guidance for the future. This is more normal charge-off levels, this is an abnormal time, but that level of charge-offs are more normalized.

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

And we think about it, Casey, as more of a timing issue. So, that -- this is a good example we were talking about before. A substantial amount of the credit migration that you have seen had been driven by the equipment finance book, the small amounts equipment finance book and some of the residential components or residential mortgage. Those are all loans that we could have modified or deferred if we wanted to and essentially dealt with them later on in the year or early next.

But that is the type of the business that we're talking about where we're seeing that there isn't really a long-term viability to it. So, might as well just clean it up now rather than have to deal with it as a charge-off later on.

So, that's a perfect example of -- we think about more of the loss content and aggregate would be the same. And this is just a matter of how quickly you get it behind you, you reserve for it, get behind you and you -- again, you -- from a timing perspective, it's just how the charge-offs come off, but we're very confident that over a two year stretch, you're going to see that the credit quality from an annualized charge-off perspective on the cumulative basis is going to hold up very-very well.

Casey Haire -- Jefferies -- Analyst

Great. Thank you.

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

You got it.

Operator

Thank you. We will now go to our next caller. That is Alex Twerdahl with Piper Sandler. Please go ahead.

Alex Twerdahl -- Piper Sandler -- Analyst

Hey. Good morning, guys.

Jack L. Kopnisky -- President & Chief Executive Officer

Good morning, Alex.

Alex Twerdahl -- Piper Sandler -- Analyst

Yes, first off, I was just hoping as we look at the reserve here, can you remind us at $164 million, I think last quarter you kind of gave the adjustment for what the reserve could have been if you had excluded the purchase accounting adjustments or included the purchase accounting adjustments in the overall number?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Yes, there's still another -- from an absolute dollar amount, the $365 million of ECL that the fair value adjustments on those are still about $30 million, so $30 million to $35 million. So, the $365 million would be closer just under $400 million.

Alex Twerdahl -- Piper Sandler -- Analyst

Okay. That's helpful. And then how should we think about -- and sort of taking what you said in your last response to the net charge-off levels and as we think about the reserve builds versus higher charge-off levels, and I think your comment was that that a lot of the charge-offs are already incorporating the CECL model. How should we be thinking about the reserve from here in terms of building, some releasing and things like that in the context of CECL and the charge-offs, etc.?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Well, more so than the charge-offs I think that the reserve build is going to be driven near-term by the progression of the deferrals and in that we were talking about before, right? So, to the extent that we start seeing meaningful improvement in the sectors that we were talking about, the reserving requirements will essentially start coming down. And it might step with that, right?

So, we feel very good about credits that are able to continue to at a minimum, pay interest and stay current through this, right?

So, if you've identified a commercial real estate or C&I borrower that either has not requested a payment deferral or has essentially been able to continue to meet obligations and pay interest and so forth, then those are -- I mean those are credits that we feel very good about, because they've demonstrated that they didn't withstand a pretty significant and unforeseen impact of their business model.

So, the focus is on the deferrals. To the extent that you see deferral rates that stay level, they're decreasing, you're not going to see a large reserve build. To the extent that you see either deferrals that in the second go around, don't really come down or for whatever reason start increasing, which we don't think that will be the case, because as Rob alluded to in his prior response, we've seen a pretty substantial -- we really have seen a slowdown for the last 30 to 45 days in new client requests on that front. Then, we feel pretty good that again you should be able to maintain that reserve. We don't see that increasing and that means that the portfolio is holding up better than what the models are anticipating or what the models are estimating today.

So, kind of short -- is it more driven by charge-offs? No. Is it -- this is more driven by what we're seeing from the perspective of those deferrals and then once these -- kind of these deferral periods end, what happens from a migration of credit at that point? So, as a reminder, right now, for all these loans that are in deferral, you're not migrating them from a credit perspective.

So, that would be the bigger driver of where your reserve build is. If these modes and payment deferrals come off deferrals and they do not return to payment status in the third or fourth quarter, that would be a driver for getting reserves higher.

Alex Twerdahl -- Piper Sandler -- Analyst

Great. Thanks for that color. And then just a final question in the guidance, things like the margin and loan growth, are you including or what are your assumptions for PPP in terms of loan balances and how are you counting for the fees for PPP in terms of the amortization schedule?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

So, 80% -- so, there are three things there. First one, we only originated PPP loans through existing clients. So, we have -- we think pretty good visibility because through our commercial banking teams and business bankers, we've been able to reach out to a pretty much substantial majority of all of these folks to understand what their intentions are regarding prepayments or forgiveness new process.

So, we feel good that we have a good estimate of what the waterfall of forgiveness and payments is going to be. We think that by the end of the year, over close to 80% if not more, we'll have been fully forgiven. And you can -- we think that is going to be more weighted to the third quarter versus the fourth quarter.

So, from here to the end of the year, our $650 million of balances will be closer to about $150 million, call it $200 million if not lower. And then a good chunk of that, let's say, about two-thirds of that would be forgiven in the third quarter and then the remainder of it in the fourth quarter. So, you're only going to have a tail of about $150 million that goes into 2021.

Alex Twerdahl -- Piper Sandler -- Analyst

Okay. And are you amortizing the fees on a two-year schedule until they get repaid?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Yes. So, we are [Speech Overlap] yes, you got it.

Operator

Great. We will go next to David Bishop with D.A. Davidson. Please go ahead.

David Bishop -- D.A. Davidson -- Analyst

Hey, good morning, gentlemen.

Jack L. Kopnisky -- President & Chief Executive Officer

Good morning, David.

David Bishop -- D.A. Davidson -- Analyst

Looking at obviously multi-family recollection efforts remain in the news of the national media and local media. Just curious maybe you can update us what you're seeing in terms of the ability to collect across the different segments within multi-family?

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, generally our multi-family businesses in the boroughs of the city. So, we have very low macro, very low deferral levels on multi-family. We also have a low loan-to-values.

In the boroughs, we're seeing kind of in the 65% to 70% rent collection range is the feedback we're getting from this. So, folks who have continued to make current principal and interest payments out of that, so there's enough buffer in terms of cash flows out there. These are also, for the most part, rent controlled buildings, so there is some stability that way so the rents are lower than obviously market rents.

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

I would add that we did -- we have heard from our borrowers that the tenants are paid through improved through June and they expect it to improve some more in July if unemployment rates had come down.

David Bishop -- D.A. Davidson -- Analyst

Got it. And then just turning to the -- Jack, you noted in terms of the loan guidance, both -- it's going to be traditional CRE, traditional C&I or so maybe a migration maybe from the national platform. In terms of maybe just with the current performance here, any surprises here in the equipment finance and some of the other specialty finance portfolios that -- obviously, you don't purchase these expecting a pandemic, but just curious in terms of just the overall credit surprise, credit outlook and maybe just longer term holistic view for some of those businesses?

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, it's interesting. I -- the things that we thought would be problems going into this are the ones that are problems. We really have not been surprised by any of the portfolios, things like hotel or some of the small ticket equipment finance stuff, some of the hospitality-related restaurants and things like that, tourist-related things. We really have not been surprised about any of the categories. Kind of, given the situation, they're performing as we would have -- would have expected. The ones that have held up a little bit better.

The national commercial finance businesses outside of equipment have generally held up pretty well also. We have relatively low deferrals on everything outside of kind of the equipment space and maybe a little bit of ABL out there. But generally, the rest of it's held up pretty well. C&I, traditional C&Is held up extremely well.

In our book too, we tend to be a middle market C&I lender, maybe lower middle market. We don't have a big business banking concentration. My own personal view is that one of the bigger challenges is if you had kind of a micro business banking lending platforms with big portfolios, we do not.

So, those are longer tail kind of workouts out there. So, in the end, I don't think there's anything necessarily surprised us out there.

From a growth standpoint, there are sectors definitely on the C&I side, definitely in the public finance piece and I think as the country spends more money on infrastructure, public finance will continue to become bigger and bigger lending opportunity.

And the CRE side of it, there are going to be specific areas where we can land anything distribution, warehouse, frankly medical healthcare-related, certain types of those types of facilities will lend themselves to opportunities going forward.

But on the flip side of it, there are areas where we're just not going to get the right risk adjusted returns out of and have not for the last year or so, places like some sectors of equipment finance, some -- ABL is, in our view, mispriced right now. Mortgage warehouse is getting close of being mispriced as a result of the yields coming in in those areas.

Still good business and good opportunity, but there are sectors especially on the national basis where we have walked capital away from. So, long answer to your question. But -- one, I know there's no surprises; two, there are still some good opportunities going forward.

All that said, we are being more cautious. I mean, we want to lend, but the volumes are about half of what they have been in the past, in part because of demand, but in part because we're just be more cautious given the situation and the unknowns with the pandemic.

David Bishop -- D.A. Davidson -- Analyst

Great. Appreciate the color.

Jack L. Kopnisky -- President & Chief Executive Officer

Sure

Operator

Our next question will come from Collyn Gilbert with KBW. Please go ahead.

Collyn Gilbert -- KBW -- Analyst

Thanks. Good morning, guys.

Jack L. Kopnisky -- President & Chief Executive Officer

Good morning, Collyn.

Collyn Gilbert -- KBW -- Analyst

Just on the credit front. So, if you think about kind of your strategy here and how you've managed the book, obviously, right, the strategy here is to get aggressive early kind of differentiate between sort of transactional relationships versus not. And as you indicated, Jack, you guys have a pretty good handle on the book and it's performing as you would have expected, blah, blah, blah. What do you think the kind of the --

Jack L. Kopnisky -- President & Chief Executive Officer

I like your blah, blah, blah. Thank you.

Collyn Gilbert -- KBW -- Analyst

It's all good. It's very eloquent. What are you -- I mean, in terms of the trend here, I guess, on losses, right, so you've already identified that the LTVs on the core book are really low. I'm just trying to reconcile your aggressiveness early with the fact that we still really haven't seen stress yet in the overall economic environment from a loan credit loss standpoint.

So, and you indicated the normalized losses in the 20 to 50 basis points, I mean there you sitting with a book that's going to see peak losses more than to 1% or do you really not see that even being a possibility?

Jack L. Kopnisky -- President & Chief Executive Officer

Well, a couple of things. So, one, no one knows really what the future is. And until someone can tell me when the pandemic is going to be solved, the healthcare crisis is going to be solved, everybody -- every economist, accountant, consultant and investment banker, they're -- we're just trying to work our way through this thing. So, there is -- there is a big unknown out there for everyone. So, that's one.

For what we see today, I mean you're only good for what we see today, we don't believe that we're going to get anywhere close to the 1% charge-off ratios and things like that. We think that -- from what we see today and the cash flows with clients through a variety of the portfolios, our estimates are there -- so, for example, Collyn, I should ask you a question. I mean, in your model, you have about $200 million of reserve build in 2021. Right now, we don't see that for us. We don't see that kind of estimate.

But until the health crisis gets solved and the economic crisis, no one's going to be absolute, us included on this. The estimates we're giving you is what we see today. We are trying to be aggressive, do charge-offs. If people aren't going to make, we're addressing this now and taking the charge now and moving forward. We're working with the clients on the deferrals.

And as Luis said, as the deferrals turn and whether it's the end of the first round or the second round, we figure out that they're not going to make it, we're going to be aggressive about addressing that.

Rob Rowe -- Chief Credit Officer

And Collyn, part of the aggressiveness and part of the proactive working with our customers, as an example, in the hospitality space, all but one of those loans have guarantors. And those guarantors, many of them have significant net worth and significant liquidity. And so, we work with them and say, "Listen, you pay us interest maybe we'll give you something on the principal side to get you through the next year or so in the pandemic, because you have a good fundamental asset." They agree with that and there's a guarantee in place.

So, right, you don't -- there, you're not going to try to take a big loss on anything right away. There's no reason to from our perspective, or no reason for the borrower's perspective.

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, and I think that portfolio is a perfect example. It's probably our highest at-risk portfolio, that we have geared toward that are very-very liquid that we'll step up and have already stepped up to make payments.

There are a couple of properties that have reinvented themselves. They've used it for housing healthcare workers, and they have used it for some of the homeless shelters. There are some that are -- will be a challenge because they may want to walk away from this and we don't want them to walk away from this.

So, that sequence, that portfolio boils down to the borrower-by-borrower. And where we have supporting guarantors and liquidity, we feel very comfortable. So, our comments come from the accumulation of all that. We will have probably problems in that portfolio. I don't think that we have good loan to values, and we can repurpose some of that.

I think the majority of that portfolio will end up being OK because of the liquidity, the borrowers and the loan-to-values and the repurposing of those things. But being able to look into each client and each situation and being aggressive and being proactive with them, allows us to have -- make the comments that we've made.

Again, the giant asteroid on this is, tell me how long the economic crisis is going to last, and I'll tell you exactly what our charge-offs going to look like in 2021 and 2022 and beyond.

Collyn Gilbert -- KBW -- Analyst

Okay, that's great color, that's very hopeful. Shifting to the NIM. So, Luis, you've given guidance obviously on the NIM and where you think funding costs will go. Can you just talk about kind of how you're seeing the asset side trend over time and, again, kind of a longer-term structural thought on what -- where that NIM ultimately settles out or bottoms out?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Yes. sure. So, I think that positives and negatives are there, right. On the positive side, we have now felt the vast majority of the pain on the floating rate loans. And so, one of the good things that we saw is that the NIM associated with all of our one month -- our Prime one month and three months LIBOR-based portfolios. The asset yields in the month of June actually held in very nicely relative to what we were in April and May.

So, when you think about the asset-based lending portfolio, the warehouse lending portfolio, substantial chunks of traditional C&I, all of those you've seen a pretty steep decline in the late first quarter into the early part of the second quarter and now that has largely abated.

So, as long as one month LIBOR stays at, call it, 15 to 18 basis points where it's been hovering for the past kind of 30 days or 45 days or so, and that continues to progress over and stay stable for the course of the year, the credit spreads are staying or handing in or hanging very nicely in those portfolios. And so, therefore, we should have seen the vast majority of the near-term floating rate loan pressure already being kind of impacting asset yields. That's the positive side.

The negative side on the asset yields is that you're now going to be -- we're going to be in the same position that we were in 2013-2014 etc., where the fixed -- existing fixed rate book of loans, which today as, you know, call it, somewhere between a 3.75% to 4.5% yield on it. You'll see on our slide deck that we had loan origination yields in this quarter of about 3.5%.

So, you're going to start running into, as you see greater prepayment activity, as you see greater refi activity. The existing fixed rate book will run off at some kind of lower rates. The new book of business will come on at some lower rate than that existing book of business that runs off. But that is not something that impacts NIM quarter-to-quarter or even through the -- through the back half of this year. That's the longer term progression that we had been in kind of the two or three-year window of 2012 to 2015, where you just continue to get to that point where new origination yields are going to be 25 to 50 basis points lower than what the existing book of business rolls off on. So, a much longer-term impact to asset yields from that perspective.

So, we think that for the back half of this year, we're going to be at around 3.75% to 3.80% for earning asset yields. You're going to see that the cost of funds was about -- the spot cost of fund as of June 30 was about 12 basis points lower than the weighted average cost of funds. So, we already start the quarter with about 12 basis point difference for cost of funding. And that will continue to trend down, because we are still repricing deposits. We still have CDs that are maturing, we still have FHLB borrowings that are maturing. We get a full quarter of the senior note that we paid off now being off the books.

So, you're going to continue to see the liability side move in the right direction. So, we're guiding to 3% to 3.10%. In the month of June, we're slightly over that 3.10%. So, we feel pretty good that you're going to have the NIM stability to slightly increasing NIM for the second half of this year.

Collyn Gilbert -- KBW -- Analyst

Okay, that's great. Super helpful. And then just one last housekeeping question, so I just want to make sure the guide that you guys are giving in your opex on the slide, I know that that's our amortization expense. But I just want to make sure the cost, the amort expense related to the lease acquisition of Santander, is that back -- do we backed out of the opex guide as well?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Yes, that is correct.

Collyn Gilbert -- KBW -- Analyst

Okay. And what's that number again?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

It's about $3.5 million to $4 million a quarter roughly. So, if you go to the -- in our press release, there's a -- in the press release in the GAAP reconciliation tables in the back, you've got a full reconciliation of how that opex is calculated. You can see the -- but it's about $4 million on the lease of that.

Collyn Gilbert -- KBW -- Analyst

Okay. Okay. Got it. All right. That's it. All right. Thanks guys. I appreciate it.

Jack L. Kopnisky -- President & Chief Executive Officer

Thank you.

Collyn Gilbert -- KBW -- Analyst

Thanks, Collyn.

Operator

Thank you. We will next go to Matthew Breese with Stephens. Please go ahead.

Matthew Breese -- Stephens, Inc. -- Analyst

Hey, good morning.

Jack L. Kopnisky -- President & Chief Executive Officer

Good morning, Matt.

Matthew Breese -- Stephens, Inc. -- Analyst

Just practically speaking for the loans that go up for redeferral in late July and early August, if they don't cure, how are you going to handle those from a NPL or classified loan perspective? Should we expect those that don't cure to start moving into traditional non-performing asset quality buckets?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Not in the second go around. So, under the regulatory guidance and this, again depending and to the point that Jack and Rob made before, in each one of these cases, we're getting updated financials and business model projections and so forth. And so, to the extent that you continue to determine that this is a near-term or short-term impact because of the pandemic where the business has viability post this period, where you see the ability to put them back on some, on a current payment status after the second deferral, you would not migrate it.

Now, to the extent that -- so you have another 90-day window before that would happen, right, of essentially starting to migrate that credit down.

Realistically, what's going to happen realistically here is that you're going to -- I mean, now that we have the benefit of, well, call it, little bit more of a longer timeframe to being able to make that decision, which is very different than the first go around, where essentially everybody was in a mad dash and everybody was kind of losing it a little bit. Everybody was in a mad dash to get these deferrals approved and so forth. Then this go around you have the benefit of having a much more kind of educated decision to make based on the updated conversations with clients and the updated information that you're getting from clients as to how their businesses are doing.

So, you should start to see some migration of credit in the third quarter, but I don't think that you're going to see that holistically until the fourth quarter once the second go around the deferral period is over, which if you think about a loan that comes off that deferral in the month of August, if you have to extend it for another 90 days, that takes you into October. That's why I think that it's for the vast majority of these more of a fourth quarter event than a third quarter event. But you should start seeing some migration based on updated underwriting analyses that we will do in the second go around.

Matthew Breese -- Stephens, Inc. -- Analyst

Now, after that 180 days, we've learned from a number of your peers that it seems like you have a tremendous amount of flexibility to extend deferrals well into 2021, if they need it. Are you going to pursue that option at all or do you want to essentially wind down the deferral book and put them into work out categories by the end 2020?

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

By the end of 2020, you're going to wind this down and put them into deferral. The -- for the Type 2 again, Jack was alluding to, we're in the -- we do lower middle market. To the extent that -- lower middle market doesn't have access to capital markets financing. It doesn't have access to large committed lines of credit, right? To the extent that you have a lower middle market decline that has 180 days to 270 days of not being able to open and get back to some sense of normalcy, I don't think that that's a situation in which you don't have a credit that starts migrating.

These are not going to be borrowers that have that amount of financial flexibility to be able to withstand close to a year of not being back to normal activity, so that's not even a -- I don't know if that's necessarily a decision or an option that we're going to have, because you're going to see that at that point businesses will have to start moving more toward other forms of either bankruptcy or something like that. So, I don't think that that is -- I don't think that there is as much flexibility as you're alluding to, Matt.

Rob Rowe -- Chief Credit Officer

Yes, Matt, it's our understanding that we'll all revert back to the --

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Yes.

Rob Rowe -- Chief Credit Officer

-- traditional type of grading for those credits. The only place that banks will be given a latitude at this point could change would be on the residential side, right? And that could be up to a year. But, no, for the commercial side, that's not our expectation nor is it what we understand it to be today at all.

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, and that's not what we're planning. We're going to essentially get these things out of deferral and we've got to put them to work out we will.

Matthew Breese -- Stephens, Inc. -- Analyst

And right now, what percentage of deferrals are paying you something I/O or modified payment versus no payment. And is that a decent way to look at bucketing these into low-risk versus higher risk loans?

Jack L. Kopnisky -- President & Chief Executive Officer

Yes. So, the numbers that we've put in the press release those -- that represents the P&I deferrals, which is the vast majority of our deferrals. And again, to the extent that there's an interest only deferral or modified payment deferral, where the vast majority of the payment is being made, we feel good about those credits. And those were more of defensive modifications. It won't be the common deferral. It'd be defensive modifications that were done where we anticipate that the vast majority of all of those get back to some form of -- actually will get back to current payment status if they haven't already.

We have some components of the residential mortgages that are in P&I deferrals -- that are right now in the P&I deferral bucket. So, about 15% of that has continued to make payments. But on the commercial side of the house, those P&I deferrals are P&I deferrals at this point.

Matthew Breese -- Stephens, Inc. -- Analyst

Okay. And then going back to expenses, your bank in particular hasn't been shy about cutting branches, cutting physical office space. As you've gone through COVID and I'm sure there's been some illuminating moments in terms of what you can do digitally and work-from-home and all that, as you reassess the branch count and the branch network sits around 80 branches today, where might you take that in the out years and have you taken another look at that and could it -- could it come down substantially?

Jack L. Kopnisky -- President & Chief Executive Officer

Yes. We are going to continue to make investments in technology. And so, if you would, there's a kind of a trade-off in the amount of money that we're going to put into technology and digital. So, the partnerships we have with the Lloyds, Banking as a Service, the online banking side of this thing, being able to automate everything in the company, are the investments that we're making.

In a direct way, you kind of pay for that because through the downsizing of the physical distribution system. So, being able to have clients that demand for digital services as this period of time, as you said Matt, proved the point once and for all that clients want to do business digitally on the transaction part of it.

It's also proven once and for all that clients need advice and counsel from their relationship team. So, the -- the team strategy that we've had have worked incredibly well and the digital platform that we have has worked pretty well -- incredibly well.

So, the net answer to that is we'll continue to downsize the physical distribution, where our consumer banking teams are moving to more of a segment approach anyhow and they're doing a great job with that and -- but we'll continue to take real estate costs out and reallocate people costs from one kind of a bucket to an another bucket.

Matthew Breese -- Stephens, Inc. -- Analyst

And then last one from me -- [Speech Overlap] I'm sorry, Jack, go ahead.

Jack L. Kopnisky -- President & Chief Executive Officer

The net effect of that is we -- there's still room to take cost out of it.

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Matt had enough of your answers.

Jack L. Kopnisky -- President & Chief Executive Officer

I know, I know, I know. Go ahead. Go ahead.

Matthew Breese -- Stephens, Inc. -- Analyst

My apologies, that's not what I meant at all. In terms of the Moody's forecast, could you just give us an idea of how the updates kind of progressed for the quarter and if you've gotten any updates in July? I know as those move and the GDP unemployment, the length of the recession those factors change, it can really move the needle on the provision. Have you started to see more stability out of those forecasts and should that imply anything for the provision on our side?

Jack L. Kopnisky -- President & Chief Executive Officer

We have seen a lot more stability in the -- especially in these -- so through the second half of the second quarter, we thought we saw a substantially greater stability and kind of a orderly progression of what the Moody's folks were anticipating, particularly in their baseline scenarios, particularly related to the longer tail part of the assumptions where you have seen a substantial amount -- where the forecasts are now changing mostly is in the short part, right.

So, if you, kind of, call it the third, fourth quarter and early part of 2021, where there still is -- every time that one of these comes out, it's essentially based on whatever the latest and greatest numbers that are being touted from unemployment kind of coming back, not coming back. So, GDP and unemployment rate assumptions vary substantially from forecast-to-forecast on the short part of the forecast or kind of the near-term part of the forecast, but the longer ended tail assumptions of how the economy recovers.

And so, how long it takes and when you get to pre-COVID levels has stayed generally very consistent with each one of the new update that has come out.

Since the mid-April forecast that we used for the first quarter provisioning, we have been looking at the assumptions that have a, what I'll call, some sort of a modified Nike Swoosh type of recovery to it, which is a recovery that starts at the end of this year, but a recovery that takes a very long period of time to get back to pre-COVID levels. And so, as you see in our slide deck that we put there, we don't get back to pre-COVID levels until end of 2022, early part of 2023, which is slightly worse than we were in April, but it's only worse by about a quarter or two. So, it's -- that part is not extending out.

The longer ended tail kind of risk of assumptions getting worse has not been there in the latest go-arounds of the Moody's assumptions.

Matthew Breese -- Stephens, Inc. -- Analyst

Understood. Okay. And that implies provisioning -- reserve levels are adequate and provisioning should reflect growth and charge-offs, correct?

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, that is correct.

Matthew Breese -- Stephens, Inc. -- Analyst

Got it. Okay. That's all I had. Thank you.

Jack L. Kopnisky -- President & Chief Executive Officer

Appreciate it.

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Thank you.

Operator

Thank you. [Operator Instructions] We will take our next question from Steve Moss with B. Riley FBR. Please go ahead.

Steve Moss -- B. Riley FBR -- Analyst

Good morning, guys.

Jack L. Kopnisky -- President & Chief Executive Officer

Hi Steven.

Steve Moss -- B. Riley FBR -- Analyst

I want to follow-up on that -- just on the CECL modeling, kind of curious as to the sensitivity regarding your provision and reserve. Newer GDPs -- unemployment, I'm sorry, is around probably 15%, kind of, if we see something in the low-double digits, above your 9% forecast in the next six months; what does that do with regard to your reserve?

Jack L. Kopnisky -- President & Chief Executive Officer

Yes, that's a good question. So, it's a good question and at the same time, a very difficult question to answer, because the model literally have thousands of assumptions in them, right? And so, just a -- kind of isolating the impact of just moving one assumption isn't really the right way to think about it, because there's -- that would have a vast majority of implications for a bunch of others, right?

So, it's a difficult question to answer and I couldn't give you a specific number that says for each 1% of this, it makes it go to that. I couldn't really provide you, because it wouldn't be -- it wouldn't be a fair way to think about how we are thinking about the estimated losses.

What I will tell you is that a substantial chunk of the seats are reserved, continued to be driven by qualitative factors and not just quantitative. And so, some of the things that we do from a qualitative perspective when we think about the various portfolios is that we do exactly what you're suggesting, Steve, which is what -- OK, so the models, they're saying that -- we realize the models are not perfect. Where are the portfolios that we're seeing? Where we are seeing the more kind of the bigger stress and where we're seeing more of kind of deferral requests and so forth. And then let's use qualitative factors to cover things like what happens if the unemployment rate gets worse for residential mortgage, for example.

So, if you'll see, our reserve requirements on -- CECL reserve on residential mortgages, if you look at the slide deck, the detail that we have in the back is about 175 basis points. Why is that? Our models are not assuming that there's 175 basis points of losses. The quantitative model is not assuming that. We're making qualitative overlay based on exactly that which is what happens if the models are wrong? And how do we -- for exactly that, key assumptions and then let's essentially allocate more from a qualitative perspective to the portfolios where we see that there's greater risk on kind of major assumptions getting worse.

And so, that way -- I hate to use the words, the smoothing, because I know my -- the external auditors are listening to this call as well. But that's exactly what the qualitative factors are there to do, which is you're essentially reserving today. And so, the mix in shift between a qualitative versus the quantitative component of an individual asset class would likely change because you are essentially already reserving for some model uncertainty on the qualitative factor.

Steve Moss -- B. Riley FBR -- Analyst

All right. That was my one question. Thank you very much. Appreciate it.

Jack L. Kopnisky -- President & Chief Executive Officer

Hope that answered it.

Steve Moss -- B. Riley FBR -- Analyst

Yes.

Operator

Thank you. This concludes today's question-and-answer session. Mr. Kopnisky, at this time, I will turn the conference back to you for any closing remarks.

Jack L. Kopnisky -- President & Chief Executive Officer

Hey. So, thanks for following us. If you step back a little bit, this is probably the most unique period of time I think we've all lived through. So, we're working through coming out of this.

Again, the two things we're focused on is resolving the credit challenges as we go through and we're working through that. And secondly, produce strong earnings driven by revenue. The pre-provision net revenue where we're pretty comfortable that each component will continue to improve, so net interest income, the fees -- fee portion of it and the expense side of this thing, given a number of the onetime items we took to take care of our folks and the communities in this quarter.

So, appreciate you following. Thanks a lot. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 59 minutes

Call participants:

Jack L. Kopnisky -- President & Chief Executive Officer

Luis Massiani -- Senior Executive Vice President & Chief Financial Officer

Rob Rowe -- Chief Credit Officer

Casey Haire -- Jefferies -- Analyst

Alex Twerdahl -- Piper Sandler -- Analyst

David Bishop -- D.A. Davidson -- Analyst

Collyn Gilbert -- KBW -- Analyst

Matthew Breese -- Stephens, Inc. -- Analyst

Steve Moss -- B. Riley FBR -- Analyst

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