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Howard Bancorp (NASDAQ:HBMD)
Q2 2020 Earnings Call
Jul 28, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the Howard Bancorp, Inc. Second Quarter 2020 Financial Results Conference Call. My name is Doug, and I'll be your operator for today. [Operator Instructions]. There will be a question-and-answer session after the presentation. [Operator Instructions]. I will now turn it over to Robert L. Carpenter, Executive Vice President and Chief Financial Officer of Howard Bancorp, Inc. Mr. Carpenter, you may begin.

Robert D. Kunisch -- President and Chief Operating Officer

Thank you. Good morning. I would like to begin by thanking everyone for joining the call this morning. Again, my name is Bob Carpenter, and I am the Chief Financial Officer here at Howard Bancorp.

Before we begin this presentation, I'd like to simply remind everyone that some of the comments made during this call might be considered forward-looking statements. Our Form 10-K for the fiscal year 2019, our quarterly reports on Form 10-Q, and our current reports on Form 8-K, all identify certain factors that could cause the Company's actual results to differ materially from those projected in any forward-looking statements made this morning.

The Company does not undertake the process to update any forward-looking statements as a result of new information or future events or recent development. Our periodic reports are available from the Company, either online or on the Company's website or via the SEC's website.

I would like to remind everyone that while we think our prospects for continued growth and performance are good, and we -- and we have to keep in mind the COVID-19 related challenges, it is our policy not to establish with the markets any earnings, margins or balance sheet guidance. With that said, I now would like to introduce Mary Ann Scully, the Chairman and CEO of Howard Bancorp.

Mary Ann Scully -- Chairman and Chief Executive Officer

So, good morning everybody. Thank you for joining us. We're looking forward to hearing your questions later in the presentation. Let me begin as I often do with just a short restatement of what we believe is our investment value thesis.

We are a commercially focused bank, almost exclusively focused on small and medium-sized businesses from a lending standpoint, operating in demographically attractive regions. We've touched on in both the press release and later in this earnings presentation the fact that this has been an economy relatively more resilient in downturns, and one that even in this public health crisis is proving to be more resilient.

Our goal is to leverage our scale, and our market position as not only the largest locally owned bank in Greater Baltimore, but as a result of the consolidation in the industry, now the third largest state headquartered bank. Our core PPNR increased 29% year-over-year, and our core net income also increased. We had an outsized participation in the Payroll Protection Plan program with a greater share of PPP loans versus deposit market share, and we will also touch on that several times throughout the presentation, both in terms of what it does for us in market share opportunities, but what it also has provided us with income and EPS in this quarter.

Our funding costs continue to drop faster than portfolio loan yields. Although earning asset yields has been impacted both by those lower interest rate on the PPP loans and by the level of liquidity maintained in this crisis, still positive EPS, but that outsized participation provides us with further opportunities to leverage that market position, and to take loan and deposit share going forward.

And the funding costs allow us to fund that more efficiently, as does our fixed versus floating loan mix. We've got significant economic uncertainty and headwinds however, both from a health perspective the impact that has on profitable revenues as well as the impact that that has on the net interest margin, and therefore it's prudent for us to continue to increase our allowance, and we did so 79% year-over-year, providing us with a 1.43% coverage of portfolio loans, which is 1.4 times our coverage of classified assets.

As Randy Jones, our Chief Credit Officer will talk about our general underwriting standards, as well as how we are monitoring our portfolio at this presently stressful time, we do not maintain significant concentrations in individual customer exposures and to our individual highly impacted industries.

Our capital levels remained strong at 11.66% well in excess of well capitalized. As noted earlier in the discussion of earning asset returns, we have exceptionally strong liquidity and again, significant participation in the PPP program, which we believe will have significant fee upside in late 2020 or early 2021 that has also driven customers out of those larger out of state banks to open relationships. I would note that our participation level in Maryland loans in the PPP program was almost twice our deposit market share in Maryland.

We have new relationships already tangibly being built in small business, business banking, and middle market portfolios. We maintain a very strong proactive approach to managing health, both on an employee and a customer basis, and we have upped modestly our community support in excess of $100,000.

And I note at this time of great sensitivity in historical inequities that the majority of our community philanthropic support has always been focused on underserved populations in majority and minority jurisdictions. I'll talk briefly about our ongoing commitment to the health and safety of our employees and our customers in the context of what's happened in the State of Maryland.

On July 15th, our Governor held his most recent press conference and shared the following tangible facts relating to this resilience of the economy. We were able in Maryland to keep 70% of the economy open during the pandemic. In our roadmap to recovery, 52 days ago the stay-at-home order was lifted and we entered stage two of the recovery plan. 98% of the economy is presently open and able to operate safely. And Bob will talk about this in the allowance discussion, but our unemployment rate while higher than historical levels is much lower than the national rate, better than most states in the USA and the best among states in our region.

Seeing a recent spike, we've certainly seen a cessation of any additional opening, but we had a 9.9% May unemployment in Maryland, 13.3% for the US and interestingly, 11.2% for the Fifth Federal Reserve District. And again, that ties to historical outperformance of this state resilience and balance.

Our Headquarters and regional commercial staffs are still working successfully from home, we've taken again a cautious and prudent position to returning to the office and our branches continue to be open. 12 of our 15 branches have operated throughout this pandemic, but operate continuously in drive through and call ahead mode.

Customers have taken advantage of digital bank offerings and of course we've seen decreases in traditional branch transactions. The year-over-year reduction in card transaction volumes that many in our industry have seen started to reverse in June and continue to reverse in July. And we have continued to invest in the future in digital investments and online business account opening modules that we implemented earlier this year that we use in a different fashion in customer offices.

Our initial entree onto the Zelle platform which is a consumer P-to-P best practice ongoing investment in the Architect online business banking upgrade and a recent business line dashboard investment. So with that as a prelude, I'll turn it back to Bob and he'll begin to discuss the strong capital position that remained the key focus of the Company.

Robert L. Carpenter -- Chief Financial Officer

Thank you, Mary Ann. Yes. We've -- might as well just mentioned briefly that when you look at our total active cycle -- it did in fact decline in the second quarter as a result of the goodwill impairment charge by $34.5 million. Again, we have to emphasize that the non-cash items, that had absolutely no impact on our tangible equity or our regulatory capital. When you look at our regulatory capital ratios, we're in a very good place. All ratios improved over the March 31, 2020 levels. For example, our leverage ratio of even including the PPP loans, was still up slightly at 9.18% from March.

Our common equity Tier 1 and Tier 1 capital ratios, 11.66% which is up from 10.95% in March, and finally, our total capital ratio of 14.09%. So again, as you can see, all those ratios well -- are well in excess of regulatory well capitalized.

As we talk about liquidity, you know as we look at Q1, we certainly had expectations of major liquidity challenges, not only for our institutions, but for the entire banking industry. The good news, some of those pessimistic assumptions around liquidity didn't come to fruition. We're in an excellent position from a liquidity perspective, our available liquidity, both on and off balance sheet of over $750 million.

One of the challenges we've had in the current environment is reducing our excess on balance sheet liquidity. We continue to look at opportunities to increase our contingent funding capacity. And then we talk about PPPLF, the Paycheck Protection Program Lending Facility established by the Federal Reserve. When we talked to you back a quarter ago, our expectation was that we would fund all of our PPP loans through the facility. As it turns out, we've used the facility on a very limited basis. And given our -- the strength of our deposit base, which we'll talk about later, we are -- we're -- at this point in time, we will continue to evaluate using the PPPLF versus other less expensive sources of funding.

And so with that, I will now turn it over to our present Chief Operating Officer, Rob Kunisch.

Robert D. Kunisch -- President and Chief Operating Officer

Thanks, Bob. Good morning. First thing I want to highlight here is our PPP initiative which Mary Ann hit on earlier. If you have access to our investor deck, you'll see that our stratification across loan size, the majority of our loans in the PPP program came below $350,000. So we achieved the maximum fee on each of those loans of 5%. I would like to note that we received 100% of our customers that applied for PPP were qualified. We obtained funding for them and it was very well received both in the market. So we're going to continue to leverage that.

Also I want to note that as we underwrote each of these loans, we did underwrite forgiveness at 100% within the original eight week guidelines provided by the SBA. So now that that's been extended, we expect that we will successfully obtain forgiveness for the majority of these loans.

So I'll also note that we did the majority of the underwriting and due diligence on the front-end in terms of obtaining good standing certificates in all compliance requirements, so that will help efficiently obtain the forgiveness for these loans. Not surprisingly for us, the majority of the dollars, the total dollars went to the construction industry. As a large C&I lender, we do have a lot of customers in the construction trade and based on their employment, the total number of employees that a lot of those companies hire, they obtain the largest amount of dollars.

As we look at our loan portfolio at 6/30, it continues to be well diversified. We saw a slight growth in our CRE portfolio which was offset by a run down in our residential portfolio as a result of lower interest rates and refinance pressure on that portfolio. We also saw a decrease in our line utilization by our C&I borrowers. It was down $31 million quarter-over-quarter, but despite being down $31 million, our total loans in the C&I segment were only down about $5 million on average. The offset is due to expanded relationships -- expanding existing relationships and new customers coming into the bank.

If we look at our credit line utilization as I just mentioned, it was down about $31 million for the quarter. It is a result -- we can make the assumption that some of that is driven by the PPP success that we had, but we would also state that we are seeing -- still seeing strong operating results for a number of our C&I clients which are driving their line utilization down at this time.

So with that, I'll turn it over to Randy Jones and ask him to comment on our credit culture and underwriting standards.

Randy Jones -- Executive Vice President, Chief Credit Officer

Good morning. Last quarter, and again this quarter, we showed you several of the pillars of our credit culture that we've built here at Howard Bank. We believe these continue to serve us well, especially in this challenging environment. Some of the additional things we've taken on this past two quarters in the pandemic have been a fairly rigorous series of portfolio reviews, very targeted, specific to first, our highly impacted businesses and then moving out broadly throughout the portfolio. These have proven very valuable and kind of gaining intelligence from our customers and our loan officers and what they're hearing on the street.

We've also continued to track our migration of risk and are keeping a very close eye on changes in the trends. Our asset quality picture for the last -- or some of our key metrics for some of the last few quarters has remained fairly stable, and we're not seeing tremendous increases in our non-performers charge-offs. Delinquency is following our normal historical patterns and the classified loans have remained stable.

As we -- we'll talk through a couple of points in the presentation today, we've continued to build our allowance. This is not related to identified losses at this point, but more out of prudence to what we're seeing in the outside environment with some of the economic factors that are going on. We've had a lot of success with our loan modifications. I believe we were very proactive in our loan modifications that we offered for clients. We've seen a decline, both through all kind of reporting periods. As of April 24th, our last reporting period, we had 314 loans -- $314.7 million in loans modified, mostly deferrals, three months to six months deferrals.

Those total portfolio -- those total modifications have declined by June 30th to $291 million and has continued to decline through this month, with the resumption of payments in July, down to $227.9 million. So we're seeing lots of success with our customers that we helped out through short term deferrals. We still have several months remaining step downs as we will be tracking this. And only a handful of a very highly impacted businesses are asked -- have asked for an extended period of deferral, most of those have been in the restaurant and hospitality, one of the business which we anticipated to be impacted heavily from the start.

Our impacted loan sectors have remained, through all of our intelligence gathering it remained consistent. Our take on these has remained consistent quarter-over-quarter. We outlined our exposure last quarter, and it has largely remained stable. We have seen 57% of our modifications were in these highly impacted segments and about 20% of our total PPP dollars went to businesses in these highly impacted sectors.

So some of them are getting relief. I will note, some of the sectors are not a large employee -- don't have a large employee base such as the hotels and some of the commercial real estate. So they weren't able to get under the PPP program as large -- as well as relief. I'll let Bob go into further detail on our allowance and our build and the provision.

Robert L. Carpenter -- Chief Financial Officer

Thank you, Randy. Yes, certainly one of the -- one of our stories for the first half of 2020 is our growth and our allowance for loan losses. We've been -- in my opinion we've reacted appropriately to the current -- to the evolving economic environment, and if you look -- step back and look at what we're seeing, our historical losses in fact using our rolling average loss rate over an eight quarter period of time has continued to decline.

We were 29 basis points average historical losses in Q4 or at 12/31 that dropped to 25 basis points in Q1 and down to 20 basis points in 2Q. As Randy said, we haven't currently seen significant downward stress in terms of downgrades, etc. But what we've done as we've looked at our qualitative factors and we focused -- our methodology has focused a, on the state of the economy as Mary Ann mentioned. The good news is the Maryland economy, the fifth Federal Reserve District economies in terms of unemployment have held up better than nationally, but still, it's been a dramatic -- it's been a dramatic change -- adverse change in terms of the economic conditions here locally.

We've used a combination of not only an economic qualitative factor, but we've also looked at those for potentially highly impacted loan sectors that Randy described earlier, and we've done some analytics around those and adjusted some of our qualitative factors to reflect the potential stresses from those particular portfolios.

So again, that's on average you can see here our allowance has increased from 60 basis points of loans at year-end to 76 basis points of loans at March 31 and now 96 basis points of loans as of June 30, 2020. And I should emphasize that number excludes the PPP loans, that 96 basis points.

The -- a lot of the build has been in our commercial portfolios over our personal portfolios, and a couple of takeaways here, we certainly feel that the loan modifications, the PPP loan assistance will reduce some of the short-term risks in the portfolio. But again, our sense is that we will, as we move through time, see the risk of downgrades and potential charge-offs will exist in those future periods.

Let's talk about our net interest income and our net interest margin. A couple of things that stand out is, our net interest income increased this quarter. Now one of the big factors of that was our PPP loan program which was accretive to net interest income, although it was dilutive to our net interest margin. Our interest margin for the quarter was down 12 basis points and basically what we saw is a drop in our earning asset yield largely driven by the loan portfolio, but we also saw a pretty significant reduction in our cost of our interest bearing liabilities.

And one of the things that helps us is the fact that approximately $1 billion of our loan portfolio is a fixed rates. And then throw in another $0.25 billion, $250 million or so of adjustable-rate mortgages with only a small portion of those resetting the remainder of this year. And then within the variable -- the true variable elements of the portfolio, we have about $400 million that have already repriced in reaction to the change in prime LIBOR and other variable rate indices.

The PPP impact on our -- some of our key numbers were [Phonetic] 13 basis point adverse impact on our loan yield, that 9 basis points on our earning asset yield, 7 basis points on [Indecipherable]. One of the things we saw in Q1 is we built substantial own balance sheet liquidity, some of that was in the form of wholesale CDs and institutional CDs, at fairly high rates. We're estimating that the -- drag on our net interest margin for Q2 from that build of liquidity is roughly 5 basis points.

If we look at our loan yields and deposit rate trends again, I think this -- if you have our deck on Page 20, we see that our -- over the five quarter period, our loan portfolio yield has dropped about 69 basis points, but during that same period of time, prime is down to 225 basis points, one month LIBOR down 208 basis points. So that demonstrates this -- the good news is in a declining rate environment, a fairly high percentage of fixed rate loans has certainly helped -- helped mitigate some of the damage to loan yields and net interest -- net interest margin.

On the deposit side, we've been very aggressive over the last three, four months in terms of lowering those rates we pay on our customer deposits. The CD portfolio, of course, it's going to take some time as some of the higher rate CDs mature, are reinvested at lower rates or moved to other deposit products.

And with that, I'll turn it over to Rob.

Robert D. Kunisch -- President and Chief Operating Officer

Sure. Thanks, Bob. If you look at Page 21 in our investor deck, you will see a very strong deposit growth strategy or story, particularly as it relates to our transaction accounts which now accounts for 47% of our total deposits. Really the growth in the transaction accounts is a result of multiple factors, one obviously being the PPP program, the second being that we really began focusing on transaction accounts in early 2019.

We hired a number of business development officers focused exclusively on new deposit relationships, and we're starting to see the fruits of their labor. We've received -- opened up a number of accounts for new clients who are upset at their current bank and the way their PPP application was handled.

We're seeing increases in existing customers accounts across the board as they're maintaining higher liquidity levels. And all of the growth in these transaction accounts will lead to higher treasury management fees going forward, and interchange income from additional card usage. As we look at 2021 and we focus on what the opportunities are for us, we as a bank will continue to leverage the heightened brand awareness achieved through a successful PPP initiative.

And although we are not seeing a lot of growth out of our existing customers in the market in terms of loan demand, we're very focused on moving existing relationships to the bank. We're continuing to hire seasoned commercial bankers who have deep relationships with their business banking, commercial clients and real estate clients.

We're very focused on the business banking segment here as we look to get more granular within our loan portfolio. For those of you who followed us for a couple of years now, you'll recall that quarter-over-quarter we do have large variances due to pay-offs or drawdowns on lines of credit or withdrawals from large depositors. So we're going to try to smooth that out going forward.

We're going to continue to expand down into the greater Washington DC area. We hired one individual in the first quarter to cover this market for us -- for our commercial real estate. We're already starting to see the benefits of adding that individual. We're focused on increasing our non-interest income and as the previous slide showed you on the deposit side that we are confident that we will see increases in each of these non-interest income categories.

We continue to focus on the consumer loan growth, we'll continue to look at HELOC utilization programs and marine lending and we're going to continue to capitalize on the successful deposit gathering initiatives to further reduce our cost of funds. With that said, we're always focused on reducing costs and expenses at the bank. We've implemented a very prudent hiring practices right now. Back when the two banks merged in March of 2018, we had 532 employees, today we have 238.

At the same time the banks merged, we had 28 branches and we're down to 15 branches today. We continue to monitor the staffing levels at each of these branch and just for change in consumer behavior. We completed the renegotiation of our core processing system in the fourth quarter of 2019. We expect to see the full benefits from this negotiation in 2020. And we're continuing to review all of our variable expenses including incentive plans, traditional business development, vendor management and looking to achieve efficiencies through leveraging digitalization.

Robert L. Carpenter -- Chief Financial Officer

I'll talk now about some of our quarterly results. Again the reported number has a large goodwill charge, if we take that out of the numbers, our reported loss excluding goodwill charge was approximately $9.8 million, so a nice growth, up from $6.3 million in the first quarter and we had some security gains I'll talk about in a minute in those numbers. Focusing on our core earnings where we take out the certain items that picked up the goodwill charge of course among those items, the former performance of our mortgage banking operations in previous periods. Our core PPNR $7.9 million, nice growth, almost $1 million from the prior quarter, up almost $1.8 million from the same quarter a year ago.

Net income, core net income, $3.7 million, built $1 million up from last quarter, pretty much in line with the same quarter a year ago. And the $0.20 core diluted EPS, up $0.06 from the first quarter of this year flat versus the same quarter last year. A couple of comments I'd make as we look at those -- at those earning numbers.

The -- we certainly have seen in that core -- or in the [Indecipherable] key PPNR [Indecipherable], we do have an increase on net interest income, pretty much largely because of the PPP program and the net interest spread on that program. We've got some weakness that we talked about earlier in terms of non-interest income. On the operating expense side, we're running lower than Q1 and -- so that's the story on that.

Finally, just talking about some key ratios, and I do -- for those who have a deck, I do apologize, we have a little error on [Technical Issues] our efficiency ratio found on Page 26. The development numbers, really relevant [Phonetic] for the reported because of the goodwill charge. But on our core numbers, we're 60% for Q2, that's down from 63.8% in Q1 and down from 68% same quarter a year ago. So that demonstrates that we're making some good progress in terms of improving our efficiency.

If we look at our tangible return on average, tangible assets, again as a non-GAAP measure, as is all of our references to core or non-GAAP measure. But our tangible return on average tangible assets, on a reported basis 91 basis points, up from 67 basis points in Q1. I should add of course I had security gains in that reported number for Q2. So if we focus now on the core number, core tangible return on average tangible asset 69 basis points, in Q2. And so again, keep in mind that reflects in that core number the entire provision for loan losses is deemed core results, so 69 basis points in Q2, up from 35 [Phonetic] basis points in Q1, 81 basis points in a lower provision environment back in second quarter of 2019.

Just a few final comments, we did embark in fact on a strategy to monetize certain of our unrealized gains in securities portfolio late in the second quarter. The bottom line effect was we generated roughly $3 million of security gains. And if we look at the security gains and the pre-tax income benefit of the PPP program, it provides a nice source of earnings to offset the impact of our efforts to build the allowance.

I talked about liquidity earlier in our challenge of trying to -- in an environment with strong deposit -- strong core deposit growth reducing any excess liquidity on the balance sheet, that's a continual process, and we also did have a small prepayment on our FHLB advances, we look to optimize our cost of funds.

I think I noted -- as we noted in our first quarter investor presentation, we did successfully [Phonetic] complete the exit of our mortgage banking activities in Q1. That business is totally behind us here in Q2 and from this point forward, our focus is on the -- our traditional commercial -- community banking business.

I'm going to turn it back over to Mary Ann at this point.

Mary Ann Scully -- Chairman and Chief Executive Officer

So I'll briefly conclude just by reiterating that we do believe that we have unique market positioning, which is uncommon in our particular industry. And it has been strengthened by the marketplace reaction to the PPP program.

We are tangibly building on growth from earlier into the year and the funding strength exhibited early in the quarter. Our core operating and PPNR growth numbers are tracking up. We do have the short-term headwinds of liquidity and PPP impact on asset yield, but that's mitigated by the fixed and floating portfolio and offset by the longer-term tailwinds of the transaction deposit growth and the cost of funds trends, especially as those CDs mature.

We're well prepared and positioned we believe for this once in a century exogenous shock. We've focused on customer safety, employee safety, diversification of portfolios, expanding the allowance, how we have funded that expansion of the allowance, liquidity and at all times, both protecting and preserving as well as positioning our capital growth. The securities gains and PPP income as Bob noted have helped us to build the ALLL, and not allowed us to devote the PPNR to unallocated capital.

We are at the same time continuing to invest in the future, especially with the number of digital technology investments. We have noted repeatedly the breadth of our team, the experience of our team, the depth of our team, as providing us with unparalleled resilience in this market, and we're not only retaining and rewarding a deep bench of experienced bankers, but we are attracting new talent, including talent in the contiguous greater Washington market.

So with that, I'm going to turn it over to you for your questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Stuart Lotz with KBW. Please proceed with your question.

Stuart Lotz -- KBW -- Analyst

Hey guys, good morning.

Robert D. Kunisch -- President and Chief Operating Officer

Good morning.

Stuart Lotz -- KBW -- Analyst

Yeah. I hope everyone is doing well. Mary Ann, I guess -- can we start on kind of revenue opportunities? I know you guys are focusing more on improving fee income businesses now that the mortgage sale is behind you. Can you just talk about how you -- what your revenue outlook is? And, you know, with your excess capital position, are there any opportunities you're looking at on the fee side to kind of supplement the run rate right now?

Mary Ann Scully -- Chairman and Chief Executive Officer

Well, I think to clarify what we're working out on the revenue side, continues to be whole relationships, and the thrust is that's not only our existing team but some of these hires. We obviously are focused on ensuring that as we build loan volume at a more modest level for the remainder of the year given the economic conditions, that we will be able to supplement the normal interest income with a focus on getting fees in those loans as we book them in an existing loans.

We're also very focused from a deposit standpoint on building rich operating relationships. So not just deposits that sits here and aren't active, the true operating relationships, which leads us to be able to project higher treasury management fee income for the remainder of the year. The consumer side, we expect to continue to be relatively soft as behavior will bounce up and down depending on the opening of the economy.

But we think our short-term greatest opportunities are on the treasury management side and the loan fee side.

Stuart Lotz -- KBW -- Analyst

Thanks for the color. And Bob, maybe if we can turn to the provision and kind of the reserve build this quarter. As we look at the back half of the year, if growth is slowing and you've got relief from PPP, how can we think about further reserve build from here if we don't really see any material credit deterioration? Like how much more room do you have from a qualitative standpoint to adjust your reserve higher?

Robert L. Carpenter -- Chief Financial Officer

Well, from -- my perspective from a qualitative perspective is we're starting to run out of opportunity. I think we still have one more quarter where we can -- assuming that some of the key metrics like unemployment don't turn positively significantly in a good direction, we'll look at -- you know in terms of some of the other economic metrics, I think there still is the potential we can increase based on those factors. We'll continue to look at our potential highly impacted portfolios.

Again, the story there is, we haven't seen -- again, we're monitoring carefully, but we haven't seen major degradation. What I would say though is we have to keep in mind that there is a little bit of artificiality in the economy we're dealing with right now, when you start thinking about all the stimulus money, PPP and the likes, which we think is masking -- it's potentially masking some downside. But so what I would say again is -- if -- ask if we don't see significant deterioration in terms of downgrades, losses, etc, we will run out of growth in terms of key factors probably after Q3 in my opinion.

Stuart Lotz -- KBW -- Analyst

Got it. You know, inclusive of the marks, I think you're now around like 1.25%. Now, you kind of expect to -- maybe one more quarter of reserve build and then kind of 3Q being the high watermark unless there's significant deterioration in the back half of the year?

Robert L. Carpenter -- Chief Financial Officer

That would be my initial -- that would be my initial reaction. Again with the marks, we're right now like June 30, 1.43%. But yes, I think -- again, I think that would be -- my thought right now is one more quarter absent any noticeable deterioration that manifests itself and significant downgrades or actual credit losses, for specific allocations.

Stuart Lotz -- KBW -- Analyst

Okay, thanks. And sorry, maybe one more from me. Looking at your hotel book and -- kind of an update on kind of what you're seeing from occupancy standpoints in Baltimore and your surrounding markets related to the hotel book.

Randy Jones -- Executive Vice President, Chief Credit Officer

Well, hotel book is kind of dispersed, it's not a lot of loans. It's about -- about a dozen of properties. They're located in both Baltimore City, a couple in Delaware, couple on the Eastern Shore.

And it's hard to summarize these generically, because we're actually hearing different things from each of these segments. None of them are particularly business travel focused, a lot of them are leisure, the ones on the Eastern Shore are holding up fairly well and we're getting good reports out of those. A lot of this hit very early before their season started, so not terribly impactful, and has been a decent summer at the beach, so far for our customers.

Delaware has some different rules and business resumptions. So a couple of those are little laggard in terms of their -- getting back to capacity. And Baltimore City, we only have a couple of properties here and both of them are kind of different dynamics and experiencing different factors. So I can't throw a blanket over all of them, we're hearing different things from different operators. But, we do have a good set of operators, very, very skilled, and I think are making this landing as soft as they can.

Mary Ann Scully -- Chairman and Chief Executive Officer

Stuart, the other thing that I'd mention is that clearly, rather than just focusing on occupancy, we're focusing on revenues because what a lot of these operators are naturally doing is lowering their rates in order to increase their occupancy. But the good thing about the portfolio that we have as Randy noted is it does not have exposure to business travel, it also doesn't have exposure to conference revenues nor to restaurant revenues. So these are generally drive up, not fly through, drive up, plain vanilla hotels, and that provides them with some flexibility.

Stuart Lotz -- KBW -- Analyst

Great. Appreciate all the color guys, and thanks for taking my questions.

Mary Ann Scully -- Chairman and Chief Executive Officer

Thanks, Stuart.

Operator

Our next question comes from the line of Brody Preston from Stephens. Please proceed with your question.

Brody Preston -- Stephens Inc. -- Analyst

Good morning, everyone.

Robert D. Kunisch -- President and Chief Operating Officer

Good morning.

Brody Preston -- Stephens Inc. -- Analyst

As I just -- I'm sorry if I missed that, I hopped on about five minutes late. I just wanted to get a sense for what the interest income, interest expense and non-interest expense was related to PPP this quarter?

Robert D. Kunisch -- President and Chief Operating Officer

Hi. Yes. The breakdown of the numbers in Q2 were -- first, the interest income at the 1% interest rate was about $365,000 for the quarter. The deferred processing fees net of our origination costs, the net accretion of those numbers added $530,000. So we had -- our total interest income was $896,000. For the purpose of our internal analysis, we're applying a 35 basis point cost of funds as if we were funding these through the PPPLR.

So that results in $24,000 of interest expense, so sum at $72,000 of net interest income and then we ended up our net cost deferral during the first quarter with $242,000. Now, I should add, this is an important point, we actually deferred roughly $70,000 of cost in those loans. But we -- but for the -- for analytical purposes, we're looking at the incremental costs other than salary costs. So for instance, we had some outside cost related to some initial processing by a third-party, some paralegal help to work through the backlog of documentation.

We had a small bonus, a program for the extraordinary effort by our team that were -- that lived and breathed this program for a large part of the month of April. So when we look at that, that's why we get to a net number of $242,000, that's how we get to a pre-tax, our pre-tax income effect of $1 [Phonetic] million.

Brody Preston -- Stephens Inc. -- Analyst

Okay. And so expenses, I thought were well managed this quarter. Just thinking about that, I guess some of the deferred PPP cost, how would you characterize the core run rate on expenses moving forward, would 12.1 to 12.2 be a good run rate?

Robert L. Carpenter -- Chief Financial Officer

Yeah, I certainly think that's -- I think that's -- I think that's -- my sense is that we're going to be a little below that, but I think that's using that as a high end, that's a fair high end of a range.

Brody Preston -- Stephens Inc. -- Analyst

Okay. And then you guys gave great detail on Slide 16, with regard to deferrals and sort of the roll-on, roll-off. And so between the three months from April to July, you added $16.5 million, $103.2 million rolled off. So all in we end at $228 million, still modified, should I interpret that as sort of $212 million of the $228 million is on a second modification period or how should I be thinking about that?

Robert L. Carpenter -- Chief Financial Officer

No, we've only had a handful kind of go into a second modification phase. Although some of our really impacted businesses, we did longer deferrals from the start. So this -- if you envision kind of a step down over the next several quarters, our deferral terms will be ending in kind of a step down fashion. We already saw that in July with a pretty significant reduction, just from the end of June.

Brody Preston -- Stephens Inc. -- Analyst

Okay, OK, thank you for that. The line utilization rate, I noticed -- you know, you mentioned in your prepared remarks and then in the slide deck, it was way down in June. Just wanted to get a sense if that leveled off or if it's still decreasing incrementally from here?

Robert L. Carpenter -- Chief Financial Officer

So my guess is, it's going to be leveled off. The biggest driver of that is probably the PPP program, but we are still seeing strong performance from a number of our C&I clients, and their spend is down, and they're collecting the receivables that are pretty quick rate because of the liquidity that's in the market. So my guess is it's flattened out for now, and we should probably start to see it pick back up the other way as PPP funds are utilized.

Brody Preston -- Stephens Inc. -- Analyst

All right. And then just two more from me. You mentioned that you're expecting to start executing on some residential purchases in the third quarter. Just wanted to get a sense for what we could expect there and what the yields are on these loans right now in the marketplace.

Robert L. Carpenter -- Chief Financial Officer

So really our strategy there is just to keep the portfolio flat, to where it is right in that $500 million range, on yields that we're currently seeing there about 3.75 of pre-premium, all-in down closer to 3.55.

Robert D. Kunisch -- President and Chief Operating Officer

3.5 roughly.

Brody Preston -- Stephens Inc. -- Analyst

Okay. And last one, you mentioned sort of continuing to try to make inroads in DC, and so I wanted to ask if there are any specific industries that you're having success within the DC area currently and why the focus specifically on healthcare lending mentioned in the deck?

Robert L. Carpenter -- Chief Financial Officer

So I wouldn't confuse the two. I mean, so in the DC market, we're currently expanding our CRE efforts there. We hired somebody in the first quarter who has already hit the ground running, been pretty successful and we'll continue to look at that. In terms of the healthcare lending, in '19, we started to have a bigger push in that area, obviously with COVID we slowed it down, but we don't want to exit our efforts there. We want to make sure we're continuing to pursue it, we're in a pretty good market here for it. We have some pretty experienced credit underwriters that understand the industry pretty well. So we don't want to abandon that industry, but we want to be cautious with it right now to see what the outcome is going to be from COVID.

Mary Ann Scully -- Chairman and Chief Executive Officer

So, Brody what we've done there is, we've done a modest restructure in a small healthcare team because we do believe that's going to continue to be an important industry in greater Baltimore and greater Washington. As Rob said, we took a step back to see exactly how it will shape that in the new world, that has taken the opportunity internally to restructure that team a little bit in order to leverage a lot of those experiences and a strong network that one of our Senior Credit Officers has to position us to go back into that market, either late in 2020 or early in 2021. So it's really repositioning the platform as much as anything else.

Brody Preston -- Stephens Inc. -- Analyst

Okay, got it. Thank you very much for taking my call everyone.

Mary Ann Scully -- Chairman and Chief Executive Officer

Okay, thanks Brody.

Operator

[Operator Instructions]. Our next question comes from the line of Will Wallace with Raymond James. Please proceed with your question.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Hi good morning, thanks for taking the call. On net interest margin, you guys, I believe mentioned there was a 5 basis point drag from excess liquidity. Assuming that the liquidity levels don't change, do you think that net interest margin has bottomed or do you think we saw some pressure from the asset side to work through?

Robert L. Carpenter -- Chief Financial Officer

Well from my perspective, Will, we should be able to whittle down that excess liquidity challenge in here -- to some extent in Q3. We have a fairly sizable chunk of institutional CDs maturing during the quarter at 1%, 1.25% rate range. So that's going to be a big positive which will drive our cost of funds down. Yeah, I think there's still going to be -- I think one of the biggest challenges is as we book new business, what are the market rates going to be, and the impact that will have on our low -- lower loan yields, lower earning asset yields and thus the net interest margin.

I'm reasonably confident from some of the modeling we've done there. I don't see -- I don't necessarily see a lot of downward pressure on net interest margin by the end of the year. Some, but not a lot.

Mary Ann Scully -- Chairman and Chief Executive Officer

So, Wally I think as Bob said, some of this is going to depend [Phonetic] on the mix of new business. For example, how much of CRE versus how much is floating rate C&I and how much of that C&I is actually utilized. The downward opportunities are clearly in that CD portfolio, the institutional CD portfolio and the CD portfolio that Bob highlighted, where just because of the maturities in the CD, we're still looking at an average cost in CDs of 1.59% and that's all based on longer maturities that were put in place when rates were rising.

So I would say that -- as Bob said, we've modeled it to show some potential for modest drops, but we don't see the kind of drops going forward that we've seen in this last quarter. Does that help?

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Understood. That does help. And speaking to the loan growth side of the equation, if you back out the PPP, it looks like loans were down a little over 3%. And if you look at the line utilization declines, it looks like maybe half of that can be explained by the decline in line utilization. Looking at your pipeline and maybe give a little bounce back in line utilization, what are your thoughts in the back half of the year on your ability to book new good quality loans and offset any potential continued paydowns?

Robert L. Carpenter -- Chief Financial Officer

Yes. So we think there is a number of opportunities out there to continue to book new business with good relationships, Wally, the difficult part right now is to understand the timing, right. So appraisals are taking much longer than ever before because in some instances, they can't get inside of a building.

Equipment appraisals are taking longer than normal. So it's just really understanding the timing of when a lot of these transactions will close. We were also -- in our pipeline going into COVID, we had a number of acquisitions that we're getting ready to finance and those have all been put on hold. So how quickly they come back, that will really drive what the loan growth is. We are continuing to hire experienced lenders and when you do that, they're able to move business pretty quickly because they've had long-term relationships with a lot of their clients.

So, that's some cherry picking for us. So tough to say exactly where the loan growth is -- where it's going to come in at year-end. I would say our pipeline is pretty good, I certainly like to always see it higher, but the timing is the hard thing to project right now.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Understood. Couple of housekeeping questions. The legal accrual, can you tell us a little bit about the -- what is the issue being fought on the mortgages? Is it 1% or --

Mary Ann Scully -- Chairman and Chief Executive Officer

It's one of the -- one of these mortgaged litigations -- mortgage-related litigations that goes back over a decade. This is pre-First Mariner recapitalization, not legacy Howard and not the legacy First Mariner that we merged with in 2017. So it's just one of those lingering pieces of legislation, and we decided that it was appropriate to make an accrual for us.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Okay. And is this regarding then like mortgages that were put into trusts, and the GSEs wanted clawbacks on the guaranteed portions. And so there is fighting over who has to pay that.

Mary Ann Scully -- Chairman and Chief Executive Officer

It's related to mortgages sold into the secondary market. Yes.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Yeah, that it. Okay, OK. And then on the goodwill writedown, is there any reason that that would trigger with your auditors, a need to test the valuation on the DTA?

Robert D. Kunisch -- President and Chief Operating Officer

No, not at all.

Mary Ann Scully -- Chairman and Chief Executive Officer

If you can imagine Wally, we've probably been working lockstep with the auditors on this whole process of whether an impairment was necessary, what we should do on the valuation side, but at this point in time, we don't see any linkage there.

Robert L. Carpenter -- Chief Financial Officer

Okay. And Wally, I assume you're raising the question from the perspective of our inability to carry a deferred tax asset.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Well, yeah, I mean there used to be the look back and so I just -- I wasn't sure if this would require a test. And then, and then does the goodwill writedown count I guess, it's not taxable so does it count against the forward -- is it a -- does the GAAP earnings count or does it not matter, they take out stuff that's not taxable. I guess that's what I'm getting at is.

Robert L. Carpenter -- Chief Financial Officer

Yeah. From my perspective and from all the conversation we've had, this issue has never come up and from my perspective, again -- it's a -- the goodwill is a non-issue if you think about it from a cash perspective tangible equity regulatory capital. And again, it's going to have no bearing on our ability to recognize deferred tax assets.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Okay. Yeah, good great. It's been a while since I've had to even think about the DTAs from a valuation perspective. So thank you for that. Okay, and then, Mary Ann or Rob, just big picture, we've been hearing really on all of the earnings calls commentary about how the pandemic has changed customer behavior, both consumer and commercial around utilization of technology to bank.

How has that changed at Howard? Changed your thinking around the branch network? And is there opportunity there to rethink the branches and perhaps find additional cost opportunity, maybe over the next three to six quarters?

Robert L. Carpenter -- Chief Financial Officer

Yeah. So the first part of your question, Wally, is look, it changed customer utilization of our technology overnight. I mean, there was always a lot of people out there that resisted depositing checks through online and things of that nature. And so, it has forced a higher utilization of our technology without question. You know, we did our branch utilization last year, we looked at every single one of our branches and you got to remember, we have branches now that go from the northern part of the state, all the way down to Annapolis Howard County. So when you look at how they're dispersed, we don't have a number of branches in any one area.

I mean it's kind of two per county tops. And so, even with the pandemic, we have actually, we've looked at it, we don't see the benefits of closing any branches at this time, we don't see the cost saves that could be achieved, because a, we're running them very efficiently today. And b, because based on where they're located we just believe that we need to have a physical presence in each of those markets.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Okay. So you're already -- you've already adjusted the staffing model to account for a meaningfully lower transaction count at the branch, is that what you're saying by operating them efficiently?

Robert L. Carpenter -- Chief Financial Officer

Yes, that's correct.

Mary Ann Scully -- Chairman and Chief Executive Officer

And Wally, if you remember part of the story in the branch optimization analysis and expense reduction that we announced last year, we were very intent on positioning it is, this was not just merger related cost reduction. This was based on what we saw at the time as a very different picture of how customers utilized branches. And that the utilization was primarily with the exception of a few of the branches that might still have an older consumer base. But the utilization is really the desk staff and the service and capabilities, and then the ability of people in the branches to get out.

So the good news is, I think we were a step ahead of anticipating what customer behavior would be and it's certainly panned out in this pandemic. The bad news is that a number of those things have already been implemented both from a physical facility standpoint where we think we've got branches where they need to be from just a sheer footprint servicing standpoint, and we've adjusted the staffing models accordingly.

Now that doesn't mean that there aren't other opportunities that we're looking at and Rob referenced those in terms of cost savings, whether it's very careful hiring, whether it's looking at some of our variable expenses and how they're structured, whether it's looking at how this is modified, how we spend our own travel dollars, how we spend our own business development dollars and how we utilize certain vendors.

So there are opportunities that's probably not opportunities in terms of additional branch closures.

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

Okay, thank you for that. I'll step out.

Operator

There are no further questions in the queue, I'd like to hand the call back to management for closing remarks.

Mary Ann Scully -- Chairman and Chief Executive Officer

Well, we just like to thank you again. We value enormously the engagement of our -- of our investors and others who are on the call, and encourage that ongoing engagement. I think that the two way communication is the best way for us to understand your concerns and your questions and for you in turn to understand what we believe is the best way to optimize long-term shareholder value.

So, these calls are important and they can certainly be complemented by and supplemented by additional calls, just reach out to us. But thank you for your time this morning and for all of the efforts that you put into reading a very dense press release, and a very complicated earnings presentation.

Operator

[Operator Closing Remarks].

Duration: 61 minutes

Call participants:

Robert D. Kunisch -- President and Chief Operating Officer

Mary Ann Scully -- Chairman and Chief Executive Officer

Robert L. Carpenter -- Chief Financial Officer

Randy Jones -- Executive Vice President, Chief Credit Officer

Stuart Lotz -- KBW -- Analyst

Brody Preston -- Stephens Inc. -- Analyst

William J. Wallace -- Raymond James & Associates, Inc. -- Analyst

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