Logo of jester cap with thought bubble.

Image source: The Motley Fool.

MidWestOne Financial Group Inc (NASDAQ:MOFG)
Q2 2020 Earnings Call
Jul 31, 2020, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the MidWestOne Financial Group's Second Quarter 2020 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Charlie Funk, CEO. Please go ahead.

Charles N. Funk -- President & Chief Executive Officer

Thank you very much, Sean, and good day to everyone and thank you so much for joining us on the MidWestOne second quarter earnings call. We're calling from Iowa City as we always do today. And in the room with me is Barry Ray, our Chief Financial Officer; Gary Sims, our Chief Credit Officer; Jim Cantrell, our Treasurer and Chief Investment Officer. And we also welcome Len Devaisher, our new President and Chief Operating Officer, to the call today as well.

I'll begin by reading the forward-looking statements and just remind you that this release and this call will contain certain forward-looking statements within the meaning of such terms in the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any results levels of activity, performance or achievements expressed or implied by any forward-looking statement.

Forward-looking statements are generally identifiable by the use of words such as believe, expect, anticipate, should, could, would, plans, goals, intend, project, estimate, forecast, may or -- and may or similar expressions. Additionally, we undertake no obligation to update any statement in light of new information or future events except as required under federal securities law.

And with that, I would like to offer a few opening comments and just say we think this was a good quarter, the second quarter, for our Company. We recognize there's much uncertainty in the world today and we expect this to continue for the foreseeable future. We're planning for that in all that we do. So we take this quarter-to-quarter and again, I thought that there were many positives in the second quarter. I will offer some general comments and then turn it over to Barry Ray and Gary Sims for further comments.

Thanks to PPP and other programs, our assets rose to more than $5.2 billion during the quarter. As we indicated in the earnings release, we did $345 million roughly in PPP loans. We also recognize that there's significant earnings volatility in our industry and there's less focus than usual on earnings metrics. But with that said, we're very pleased to report a 13.5% return on tangible equity for the quarter and efficiency ratio, as we calculate it, under 55%.

Clearly, our margin, as most margins did, suffered from a mix change as loans paid off, plus we did have excess liquidity created from all of the government programs. For -- just for your information, we do calculate that the all-in yield on the PPP loans was 1.70% [Phonetic] in this quarter. We are -- as with many, we expect that forgiveness will occur in the fourth quarter of this year. And we think the fourth quarter will shape up to be a pretty good quarter for net interest margin as we look ahead.

We do believe that we have some more room to lower deposit costs in the third quarter. We started that at the end of July, and we're going to take a further look at that during the month of August. So we do think there's some room to bring deposit costs down further from what they were in the second quarter.

Our loans, ex-PPP were down, as stated in the earnings release. We did have lines of credit that paid down. There were number of borrowers who would normally carry lines of credit -- line of credit balances at this point in the year that completely paid out. We also had several borrowers that have lots of liquidity on their balance sheet, either pay off their loans entirely or pay down their loans substantially. And that contributed to the decline in our loans outstanding during the quarter. We can't predict payoffs in the third quarter. But I think there's a reasonable pipeline as we enter the second quarter. I would not call it a robust pipeline, but I would call it a reasonable pipeline of new loans as we look forward.

Non-interest income, very, very pleased with the mortgage results. And most of the mortgage results were driven from our Iowa footprint, just as a sort of marking the progress we have in mortgage. Our volumes for the first six months of 2020 is 114%, higher than it was for the same period in 2019. In the second quarter of 2020, we've doubled our production from the first quarter.

And the other thing, unlike some of our competitors around our footprint, we have not shut-off our business and we're taking all applications as they come, even though closed times tend to get a little bit longer due to the volumes.

We're very happy with the wealth management results for the first six months of this year. Trust and investment services are both ahead of their budgets -- respective budgets for the first six months. I think it's fair to say, they do face some headwinds. And I would categorize the headwinds that they face primarily as being market volatility as well as just in the COVID age, it's just hard to undertake new business development. But they've hung in there very, very well for the first six months, and we're very, very pleased with the results. If you're familiar with our Company, you know that two-thirds -- roughly two-thirds of our trust assets are located in the Dubuque footprint. And that merger seems to be working very, very well with good client retention and continued growth in fee income.

Our swap income was down in the second quarter. I think we previewed that in the first quarter earnings call. And that's really due to the significant drop in short-term rates that makes the math not work quite as well whenever we take the variable side of swaps. Also, we've seen some of our competitors who've been slightly more aggressive than we have with our swap terms and offer for longer period of times than we've been willing to -- than we typically offer. So we would think that swap revenues will continue to be lower as we go forward in time.

On expenses, we continue to focus on the expense line. We recognize that's one of the few levers that we have to pull. And we announced that we -- as we announced in the earnings release, we're closing our Newport, Minnesota office. Our South St. Paul, Minnesota office is 5.5 miles from our Newport location. And as we disclosed in the earnings release, we think we'll save once this is all flushed to the system about $360,000 in annual expenses.

If you look at our footprint around the MidWest, I think we have limited opportunities for outright closures because we operate in many communities where we only have one office in that community. So it makes it much, much harder for us to think about closing a great deal of offices, but we will continue to look at this as we go forward. We also recognized that we have to continue to focus on non-interest expense control, and we will continue that focus on reducing our non-interest expense into the third quarter of this year.

I want to make just a couple of comments on asset quality. Gary Sims, will talk about this more completely when he speaks. We did try to get ahead of the curve in the first quarter with our credit loss expense. And at $4.7 million for this quarter, that's still what we consider about twice our annual -- what would [Phonetic] be an annual run rate or a quarterly run rate -- I should say, quarterly run rate. The allowance for credit losses at 1.70% of total loans ex-PPP, we think is -- puts us in a strong position. And I also note that our non-accrual loans were down slightly to 1.15% of total loans and that decreased from 1.28% at the end of the first quarter.

Just a few comments on ag. We always get a lot of questions on ag. If you look at our watch plus substandard loans as a percentage of total ag loans, it's the best quarter we've had in several years. 18.1% of our ag loans were rated either watch or substandard at the end of the second quarter. And to give you an idea in March of 2018, just over two-years ago, that number was 23.6%. So we've done a nice job of moving the watch and substandard ag loans down as a percentage of ag loans. Ag loans as a percentage of our total portfolio stand at 8.4% at the end of the second quarter, that's down from 9.2% at the end of quarter one. We expect that to stay the same or go down as we move forward.

But I think the most important thing for the outlook for our ag borrowers is that crops in our footprint look very good. Our footprint being mainly eastern Iowa for -- eastern and southeastern Iowa for ag loans and our crop growers. The government support programs that came from the stimulus program provided a nice boost to our growers and prices have plateaued. Corn and soybean prices have plateaued and -- at slightly lower levels than they were before COVID-19. But they're off -- well off the lows that we saw during the first outbreaks of COVID-19. Land prices are basically unchanged from last quarter, which would be down 2% year-over-year and down 13% from the peak. So a little bit weaker, but certainly they have not fallen precipitously.

So overall, I would say that the ag outlook is about the same as it was three months ago and I would think that we're starting to see some stability in the ag sector, although at a lower level than certainly the peak years of 2011, '12, and '13. Still a tough environment, but it's not spiraling down as we sit here today. As I said, Gary will cover this in more detail when he speaks.

We do expect deferrals to be materially lower than what was reported at the end of the first quarter. And when that all flushes through, we think only about 25% of those borrowers will request another 90 days. So we feel very comfortable in our ability to monitor and manage our loan portfolios as we look forward.

A few comments on capital. We think we shored up our regulatory capital in a good way with our $65 million sub debt issue. It was well received in the marketplace and we appreciate all those who invested in our Company. We also feel comfortable and confident in the current levels of capital ex-PPP. Tangible common equity stood at 8.35% at quarter-end. And we do note that our tangible book value per share increased to $24.74 and was up 5.8% during the quarter.

We also were very pleased to welcome Len Devaisher as our new President and Chief Operating Officer. Devaisher has been FP [Phonetic] for a year and we appreciate -- I especially appreciate the way the entire management team stepped forward, came together to keep our Company moving forward. And I do think we've moved forward during this time.

So overall, I think it was a good quarter for our Company, certainly operating in difficult circumstances. And based on what we see today, we're confident in our ability as well to maintain our dividend on a go-forward basis.

With that, I will turn it over to Barry Ray.

Barry S. Ray -- Senior Executive Vice President & Chief Financial Officer

Thank you, Charlie. Unless otherwise noted, my commentary today will be a comparison of the second quarter of 2020 results to the first quarter of 2020.

As an overview, the Company reported net income of $11.7 million or $0.73 per diluted common share, compared to a net loss of $2 million or $0.12 per diluted common share in the linked quarter. On a pre-tax pre-provision basis, net revenues were $18.9 million for the second quarter of 2020, up 8% from $17.6 million in the first quarter of 2020. The increase in pre-tax pre-provision net revenue resulted from a higher net interest income and lower expenses, partially offset by lower fee income.

Credit loss expense of $4.7 million reflected loan credit loss expense of $6.3 million, partially offset by a $1.6 million reversal of credit loss expense related to off balance sheet credit exposures. On the balance sheet aided by the SBA Paycheck Protection Program activity, average loans grew 6% and average deposits were up 11%. The Company's tangible book value grew 6%.

Returning to earnings components, net interest income of $38.7 million was up $1.3 million from $37.4 million in the linked quarter, as greater average earning asset balances offset a 22 basis point decline on the Company's tax equivalent net interest margin. The increase in average earning assets were driven by the origination of SBA PPP loans, as well as investment of excess liquidity into debt securities.

The decline in the Company's margin reflected a full-quarter impact from the 150 basis point drop in the federal funds target rate in March 2020, a shift in earning asset mix to lower yielding assets, and the lack of meaningful term premium on the yield curve, particularly in the overnight to five-year term, which is most relevant to the Company. Earning asset yields declined 47 basis points, 8 basis points of which was attributable to the SBA PPP loans which yielded only 2.68%, 7 basis points was attributable to loan purchase discount accretion, and 7 basis points of mix. Total deposit cost declined 23 basis points as we continue to manage our funding costs directionally consistent with asset yields.

Finally, while there remains some uncertainty as to the timing of SBA PPP loan forgiveness, we expect 70% or more of SBA PPP loan fees to be recognized by the fourth quarter of this year, which should otherwise bolster the margin in the near term. Net PPP loan origination fees totaled about $10.4 million. And during the quarter we recognized approximately $1.1 million of those fees in spread income.

We recognized credit loss expense of approximately $4.7 million in the second quarter of 2020, down markedly from the $21.7 million in the first quarter. However, that smaller credit loss expense resulted in continued reserve build at June 30, increasing our allowance for credit losses as a percentage of loans held-for-investment to 1.55%, or 1.70% excluding the SBA PPP loans.

Turning to fee income, fees were down $1.9 million from the linked quarter, as solid mortgage production, included in the loan revenue line item, was more than offset by reductions in most other line items. Mortgage revenues of $1.7 million were up $855,000 from the linked quarter, as mortgage production volumes increased 141% from the linked quarter.

The revenue increase included a $745,000 negative valuation adjustment to their mortgage servicing right in the second quarter of 2020 compared to a $447,000 negative adjustment in the linked quarter. The decline in other non-interest income was driven by reduced income from our commercial back-to-back swap program. And as noted in our public release, the decline in service charges and fees line item reflected lower customer overdraft experience as well as increased waivers of such fees.

Moving briefly to expenses. The $2 million decline in total non-interest expense resulted primarily from a $1.4 million benefit to compensation and employee benefits from origination costs related to SBA PPP loans. Generally, other expenses were well controlled and down from linked quarter, say for equipment, which was up slightly due to additional purchase of IT equipment to support the Company's work-from-home efforts. Our target efficiency ratio remains at less than 60%. And to that end, we continue to evaluate opportunities to improve efficiency, including branch consolidation activities, as discussed in our public release this quarter.

Moving to taxes. The Company's effective tax rate for the quarter was 18% and we expect the tax rate for the year to be 17% to 18%, below the statutory tax rate, due primarily to benefits from taxes and instruments, and tax credits.

I'll end my remarks with some commentary on capital. The Company's tangible common equity ratio was 7.8% at June 30 down from 8.11% at March 31, 2020. Excluding PPP loans of $327.6 million, the tangible common equity ratio was 8.33%. Our target for this ratio remains 8.5% to 9%, and we expect to return to that range in the coming quarters.

Finally, earlier this week we announced the completion of the private placement of $65 million of the Company's fixed fixed-to-floating subordinated notes. The notes carry an initial fixed rate of 5.75% and are structured to [Indecipherable] Tier 2 capital at the holding company. That capital bolsters the Company's capital levels as we've positioned our balance sheet to weather these uncertain economic times.

And with that, I will hand it off to Gary Sims for credit.

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Thanks, Barry, and good afternoon or good morning depending upon where you are at today. I wanted to just take a minute and focus my comments on three areas of detail, all of which are outlined in the supplemental financial disclosures, provide a bit more color to what we've provided to you in those documents.

First thing, I wanted to kind of walk-through was our enhanced credit monitoring. And what we, as we finished the first quarter and identified what we believed could be our possible vulnerable industries within our portfolio, the six vulnerable industries that we identified at the end of the first quarter, we undertook an effort to build upon our existing monitoring processes and create some enhanced monitoring appropriate for the current economic position that we find ourselves in.

So what we did was, we identified all of those loans in the vulnerable industries greater than $1 million and we also identified our top 30 relationships. So we focused on higher risk and then we focused on higher exposure for those two categories. And we put together a monitoring process for those two categories that we completed at the end of the second quarter, which really took a deep dive into all of those relationships and gave us the ability to clearly understand where those relationships were and where we believe they were going over the course of the current economic cycle. And to give you an idea of just the penetration, when we combine that with our existing monitoring processes associated with our watch and worst credits, when we combine all those efforts, we took a -- I would consider it to be a deep dive into $1.04 billion of our portfolio, which represented 29% of our portfolio.

So I wanted to share with you kind of what the key takeaways from our efforts in the second quarter were. First of all, we experienced migration in the portfolio. We expected that. Based on our identification of vulnerable industries, we expected to start seeing some of those credits migrating to pass to watch, watch to substandard. And that was identified in the supplemental information as well. Primarily within that migration, you saw three of the vulnerable industry categories migrating, hotels, restaurants and retail. And it's not to say that, within the vulnerable industries, we won't see additional migration from other industries. It's that those categories had the most immediate negative impact from the pandemic.

The second thing that that we experienced from our due diligence was the non-performing assets were relatively stable for the quarter. That was also expected as we looked at our migration trends. We didn't expect a lot of migration to non-performing this quarter. And it turned out that was the case.

Another deliverable that was possibly as -- not as expected was that we identified two categories within vulnerable that based on our analysis of our customers, we feel like that they're not going to be materially more vulnerable than our average portfolio over the course of the cycle. And those categories were senior living and our QSR, or quick service restaurant, portion of our restaurant portfolio. As a result of what we actually saw from our customers' performance, we did remove those two categories from our vulnerable industries calculations. And so what you saw as a result was our vulnerable industries that we are identifying represent 14% of our portfolio on a go-forward basis.

And then the last thing I wanted to point out in terms of what we found was our deep dive into our portfolios gave us the ability to provide significantly more detail around each one of those vulnerable categories as is outlined from pages -- I believe, pages 9 through 13, a lot more detail for you to dive into and understand what those portfolios look like, and how we believe they'll perform over the course of the cycle.

Last thing, I did [Phonetic] want to point out about this enhanced level of credit monitoring is we do expect this to continue for the foreseeable future as we manage through this cycle, we expect to be doing this enhanced monitoring through the cycle.

So the second thing I wanted to share with everyone was kind of our experience with deferrals, and Charlie had alluded to it earlier. As we finished up the second quarter, for the most part, the first round of deferrals that we have grounded were put in place and that represented 13% of our total portfolio, 14.5% ex-PPP.

Based on what we're seeing and what we're talking about with customers right now because for the most part, that first round is starting to roll-off, and we're seeing customers go back into repayment mode, but we're also seeing customers ask for a second round. Based on what we're hearing from our customers, we -- as Charlie alluded to, we expect -- compared to the 13% of total portfolio, 14.5% ex-PPP, we expect 3% to 5% to be the range of second round of deferrals of total portfolio.

And then the last thing that I'll highlight there was our vulnerable industries are -- were heavy users of our deferral program, as you would expect. And even more specifically, hotel and retail CRE were heavy users of the program. So it served the purpose that was -- that it was intended to serve, no question.

And then the last thing I wanted to touch on briefly was the PPP program. As we said earlier, PPP -- roughly $345 million in PPP loans over the course of the program. As Barry mentioned, I'll emphasize it as well. Based on the conversations that we're having with our customers, and we're having conversations with all of the major users of the PPP program, we expect a very high percentage of forgiveness as a result of their utilization of the PPP program and then enhancements in the PPP program over the course of the past few months.

And then the last thing I'll emphasize there, I mean what we're and Charlie alluded to it in his comments relative to the usage of the PPP and the deposits that we've had on hand as a result. And what we're experiencing from our customers is that many of our customers, the PPP program will make a very material difference in how they are able to survive and thrive through this pandemic cycle. So we were active participants, and we're big proponents of the program as it played out.

So with that, that's the some of my comments, and I believe I need to...

Charles N. Funk -- President & Chief Executive Officer

Yes, I'll take...

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Pass it back.

Charles N. Funk -- President & Chief Executive Officer

Just one clarification in my comments. I've mentioned the overall yield on the PPP, the all-in yield on the PPP loans was 1.70%, it was actually 2.68%. I picked up a wrong number in my comments and I apologize for that. 2.68% all-in yield on PPP.

And with that, Sean, we will send it back to you.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session.

[Operator Instructions]

Our first question today will come from Brendan Nosal with Piper Sandler. Please go ahead.

Brendan Nosal -- Piper Sandler -- Analyst

Good morning.

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Good morning.

Brendan Nosal -- Piper Sandler -- Analyst

Just want to start-off on the reserve. So yes, you did this pretty in-depth review of your entire or most of your portfolio this quarter. And as you said there's some negative migration as expected, but the provision was still relatively low in comparison to the first quarter, still built the reserve but at a much lower -- so just based on what you can see at this point, do you expect to keep building the reserve throughout the second half of the year or are you pretty happy with the 1.70% level you're at today?

Gary L. Sims -- Senior Vice President & Chief Credit Officer

I'll start, Brendan, this is Gary. And I'll start to answer the question. If I miss any highlights, I'll ask Charlie or Barry to add-in as well. What you've seen from our reserve and the provisions that have gotten us to where we're at is in the first quarter, based on the expected migration we saw in our portfolio over the course of time and even more specifically, in the second quarter, we did put together a pretty significant provision, which materially bolstered our reserve as we finished up the first quarter. As the quarter really played out the way we believed it would, that allowed us to moderate the level of provision that we were putting in place for the second quarter. And as we provided more than our net charge-offs that created the reserve build that you alluded to. What we -- I mean what we anticipate happening in this quarter and on a go-forward basis is we'll continue to monitor that migration and match it up against our belief about where the portfolio is going. CECL has given us very good tools with which to manage that reserve. But at the end of the day, it is management's responsibility to estimate the reserve based on what they're seeing in the portfolio. So, if I had to venture an estimation right now, I believe that for the third quarter, we'll continue to moderately build reserve until such time as we actually start seeing the losses that we've been building toward.

Brendan Nosal -- Piper Sandler -- Analyst

Got it. That's super helpful to hear your thoughts on that. So thank you. Just one more from me, just on the goodwill or the potential for goodwill impairment that you alluded to in the pre-release, is that review complete or is it still ongoing?

Charles N. Funk -- President & Chief Executive Officer

The review is complete.

Brendan Nosal -- Piper Sandler -- Analyst

Got it. Perfect. And then if I can just sneak one more in there. Just curious for your thoughts on how the core NIM behaves from here, once you factor in kind of the subject issuance perhaps offset by the flex you still have on the funding side, just the core margin kind of the rest of the year?

James M. Cantrell -- Senior Executive Vice President & Chief Investment Officer, Treasurer

Brendan, this is Jim Cantrell. It is a difficult thing to forecast. We've shared some discussions internally about the margin. I do think you're right, the subject will provide a little bit of drag on the margin going forward, that came on the books right at the beginning of the third quarter. Aside from that and aside -- absent any -- let me back up and recognize, there will be noise in the NIM from the PPP program and from any shift in mix. I think in the second quarter, our core NIM, absent the mix change and the PPP loans and the purchase accounting adjustment, was pretty flat. The rates on our deposits came down pretty comparably with our rates on earning assets. But the mix shift and those low yielding PPPs really caused some narrowing. We do think that the fourth quarter for the NIM because of the PPP is going to be significantly improved if we get the forgiveness that we expect in the fourth quarter. So, all that is to say there's going to be a lot of noise. The core of it, I think is going to be for pretty flat to maybe some pressure on the NIM as we move forward.

Brendan Nosal -- Piper Sandler -- Analyst

All right. Perfect. Well, thank you all for taking my questions.

Barry S. Ray -- Senior Executive Vice President & Chief Financial Officer

Brendan, this is Barry. I'll clarify on the goodwill when I complete -- management's completed their review, I would say it's 99.9% complete, our auditors would have us tell you that their review is not complete until we file our 10-Q. But right now all indications are that the review is 99.9% complete.

Brendan Nosal -- Piper Sandler -- Analyst

Got it. Thank you.

Operator

Our next question today will come from Jeff Rulis with D.A. Davidson. Please go ahead.

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

Thanks, good morning.Gary, I appreciate the color on the credit detail, that was informational. I guess beyond the deferrals, I did want to clarify the -- so if you are at 14.5% of loans, ex-PPP at quarter-end, I wanted to -- your statement about when you get to the second round of deferrals you expect there was a 3% to 5% number, does that equate to the -- you expect 14.5% on deferral to fall to 3.5% [Phonetic] when all said and done? Maybe I read that wrong.

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Right.

Charles N. Funk -- President & Chief Executive Officer

Yes.

Gary L. Sims -- Senior Vice President & Chief Credit Officer

That's correct. The 14.5% to fall to 3% to 5% of the portfolio for that second round of deferrals.

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

Okay, great. And the majority are on 90-day or I mean -- I guess how far are you through that? [Speech Overlap]

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Sorry didn't mean to interrupt. Yes, the program as we formulated it and put it forward was we offered an initial 90-day for the most part, an initial 90-day deferral opportunity. And then we have followed-up with a second 90-day deferral opportunity for those who have asked for it as a second round has been requested from customers. And as we've noted, our expectations is materially less usage in the second round. We're asking more -- we're contemplating more about what that second round means for the credit risk profile of the customer asking for that deferral. So it's being incorporated into our thought processes around risk profile.

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

Makes sense. Maybe just a question on the fee income side obviously kind of service charges and maybe swaps less so, but a little bit of customer behavior and the mortgage. I think Charlie referenced it's still going strong into the quarter; I guess maybe we don't get back to the ceiling on service charges immediately, but just thoughts on how the fee income line transitions through the back half of the year would be helpful, either specific or broadly speaking?

Barry S. Ray -- Senior Executive Vice President & Chief Financial Officer

I'll start off, Jeff. I think that yes, I think as we articulated last quarter, we thought that the $10-plus-million that we had was a high watermark, I think that I would say that probably $8.3 million to $8.5 million per quarter of a fee income rate is what we would expect.

Charles N. Funk -- President & Chief Executive Officer

I would also just add to that, Jeff, that yes, customers it appears are keeping larger balances and therefore we don't have as much NSF income, which is understandable in light of the current circumstances. If government stimulus programs don't come through, you might see that some of deposits start to run down and you might see a little bit more of that activity. I personally think that you might see a little bit of uptick in the service charges but I don't know they will return to prior levels anytime soon, but that's just a guess.

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

Okay. And maybe a last one, Charlie. Just -- you discussed the goodwill. But any further thoughts on the dividend? I think you've got certainly more clarity or a deep dive on the credit side, you've shored up with kind of the sub-debt issuance a bit, but you did have a little higher payout ratio, I'm just interested in the conversation about is that -- I imagine it continues to be monitored, but thoughts on the dividend? Thanks.

Charles N. Funk -- President & Chief Executive Officer

Yes, we started running stress tests in the February/March timeframe. And we clearly think that based on what we see now, the dividend is secure and we're committed to the payout. If circumstances change, we're certainly -- we will certainly review that. And that's probably the best guidance I can offer you right now. As we look at things right now, it's a secured dividend.

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

Okay, thanks.

Operator

And the next question will come from Terry McEvoy with Stephens. Please go ahead.

Terry McEvoy -- Stephens -- Analyst

Hi, thank you. Good morning.

Charles N. Funk -- President & Chief Executive Officer

Good morning.

Terry McEvoy -- Stephens -- Analyst

Thank you for the presentation. I had a question I guess it's Slide 16, enhanced credit monitoring. It sounds like in the second quarter, you looked at your 30 largest loan relationships $16 million to $35 million in size. Any of the vulnerable industries fall into the -- your 30 largest loans? And then just broadly speaking, were there any downgrades, upgrades or any actions as it relates to those larger credits?

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Yes, this is Gary; I'll start to answer that question as well. There is overlap between our vulnerable industries and our Top 30. Within our Top 30, we do have two hotel relationships. And we also had from our original vulnerable list, we had several senior living relationships and then we had one quick service restaurant relationship. So there is overlap between the two. And as a point of clarification, because we'll continue our quarterly review of those large relationships, each one of those will stay in the mix. As we look at that Top 30 list, the two hotel relationships in that Top 30 list were downgraded to watch. None of the rest of the Top 30 either in the vulnerable or outside vulnerable were downgraded as a result of that review.

Terry McEvoy -- Stephens -- Analyst

Thanks for that. And then just as a follow-up question, I thought it was interesting earlier and I can't remember who said it, but the quarterly provision of 4.7% [Phonetic], I think was mentioned as being kind of two-times the normal quarterly run rate. And I guess my question is, was that a pre-CECL comment or what was behind that statement because so much has changed this year as it relates to reserving and provision and I just want to make sure I understand where that statement was coming from? Thank you.

Charles N. Funk -- President & Chief Executive Officer

That's a good question. And to clarify that, I was the one that made the statement. And I was referring to what we budgeted going into the year, which we would consider normal at times. And so we used roughly $2 million as a normal provision, but clearly we're in different times now and we're reserving appropriately.

Terry McEvoy -- Stephens -- Analyst

Great, thanks for clearing that up.

Charles N. Funk -- President & Chief Executive Officer

Thank you.

Operator

[Operator Instructions].

The next question will come from Damon Delmonte with KBW. Please go ahead.

Damon Delmonte -- KBW -- Analyst

Hi, good morning guys. Thanks for taking my question. I just wanted to -- as it relates to the outlook for expenses, Barry, could you just kind of go over your thoughts again on what a normalized expense base will be kind of when you factor in the deferred expenses from the PPP loan origination?

Barry S. Ray -- Senior Executive Vice President & Chief Financial Officer

Will do Damon. In the deferred PPP loan origination benefit, that's really a one-time benefit this quarter. And so I would say our quarterly expense run rate, Damon, probably somewhere $29 million to $30 million.

Damon Delmonte -- KBW -- Analyst

Got it, OK. And then, Charlie, I think you had mentioned that there was some decent pipeline activity for loan growth. You didn't characterize it as robust, but you said there was definitely some activity. Could you just talk a little bit about that? Is that from existing customers? Have you guys been able to win new relationships from the PPP lending program? Where you are able to bring over new customers through that? Just a little background on what you're seeing with the pipeline?

Charles N. Funk -- President & Chief Executive Officer

Little bit of both. There's a little bit of transition on PPP. I would say that most of the pipelines that we've seen have been existing customers. And we have a number of existing customers, who are still doing pretty well, and they're running their businesses and they seem to be doing quite well financially. In Denver, we've got -- we hired a new banker earlier this year, and he's sourced some relationships and I still think there's a lot of potential in Denver. We obviously have to be careful during these economic times. But in Denver, there's still some transition from some of the larger competitors, and -- but may not have handled the PPP process very well. So our Denver Group actually is -- had a conversation with them a couple of weeks ago and they're still very confident that they can make their budget numbers and it's just because they're finding opportunities that appear to be good opportunities. So a little bit of both, but especially in Denver, I think we've been able to find some new opportunities.

Damon Delmonte -- KBW -- Analyst

Got it. Okay that's helpful. Thanks. All my other questions have been asked and answered. So thank you.

Charles N. Funk -- President & Chief Executive Officer

Thank you, Damon.

Operator

And the next question will come from Brian Martin with Janney Montgomery. Please go ahead.

Brian Martin -- Janney Montgomery -- Analyst

Hey good morning. Just maybe two for me, maybe one for Jim and just going back to the margin. I guess a minute, Jim, I guess your thoughts on the mix changes, Charlie's comments about the mix changing kind of the volatility. I mean, I guess if the loan pipelines aren't super robust at this point, I guess is your expectation that mix that we're seeing this quarter based on trends really doesn't change in the near-term? Or I guess, are you expecting that any significant change or should we just kind of continue to think about the way it is today?

James M. Cantrell -- Senior Executive Vice President & Chief Investment Officer, Treasurer

Yes, well, thanks, Brian. I'll give you my best to answer and because you're asking about the future, I think we've seen a big -- the biggest part of the shift mix, I suspect has already happened. That's my gut tells me. Having said -- so we've increased the investment portfolio several hundred million dollars relative to the loan book. What is I think can offset that a little bit is we're going to get some -- we think we're going to get some PPP loan forgiveness in the fourth quarter. And my suspicion is that the PPP loans will be forgiven at a faster rate than the corresponding deposits that were attached to those loans will run out of the bank. That's my gut. That's my guess. And so we'll get some additional income because we'll release some fees upon forgiveness. But the result may be that the balance sheet could possibly become even a little more skewed toward investments. But how much of that will happen? I don't know. That's very much an unknown at this point.

Brian Martin -- Janney Montgomery -- Analyst

Okay, perfect. I appreciate Jim and maybe just one for Gary, I guess on the -- when you look at these vulnerable industries, can you just talk a little bit about the consistency of what's in the CRE retail bucket, I mean that seems to be the biggest -- biggest one out there. And just kind of, I don't know if you can offer kind of where the reserves are on that portfolio today, or just any more, little bit more detail on just that portfolio and how you're thinking about it today?

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Sure. And I don't have a specific breakout of the reserves specifically tied to the CRE retail, it's part of the improved commercial real estate category in the CECL detail there. So it's a subset of that particular category.

What we're seeing in the CRE retail is, it's actually held up to-date pretty well. And as we talk to our customers, we think the dynamic that's happening there is many of their customers small business -- dominated by small business customers, have been -- have benefited from the PPP program such that they've been able to on balance stay relatively current on their rents. So we haven't seen just wholesale rent abatements necessary, but what we see in the future is, probably two quarters into the future, three quarters into the future, we're going to see those small businesses struggling more than they have over the past quarter. And then rents will be challenged to be collected and we'll start to see deterioration in that particular space into the future. Does that help in terms of additional color there?

Brian Martin -- Janney Montgomery -- Analyst

Yes, no I think it does and it just sounds like it's more continued monitoring and more issues potentially down the road as opposed to near-term here. So thank you for the additional color. Okay, that's all I had guys. Other stuff was answered.

Gary L. Sims -- Senior Vice President & Chief Credit Officer

Thank you, Brian.

Charles N. Funk -- President & Chief Executive Officer

Thanks, Brian.

Operator

[Operator Closing Remarks]

Duration: 48 minutes

Call participants:

Charles N. Funk -- President & Chief Executive Officer

Barry S. Ray -- Senior Executive Vice President & Chief Financial Officer

Gary L. Sims -- Senior Vice President & Chief Credit Officer

James M. Cantrell -- Senior Executive Vice President & Chief Investment Officer, Treasurer

Brendan Nosal -- Piper Sandler -- Analyst

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

Terry McEvoy -- Stephens -- Analyst

Damon Delmonte -- KBW -- Analyst

Brian Martin -- Janney Montgomery -- Analyst

More MOFG analysis

All earnings call transcripts

AlphaStreet Logo