Great Western Bancorp (GWB) Q4 2020 Earnings Call Transcript

Great Western Bancorp (GWB)
Q4 2020 Earnings Call
Oct 28, 2020, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day. And welcome to the Great Western Bancorp fourth-quarter and the full-fiscal year 2020 earnings announcement call. [Operator instructions]. I would like now to turn the conference over to Seth Artz, head of investor relations.

Please, go ahead.

Seth Artz -- Head of Investor Relations

Thank you, and good morning. Joining us through our presentation this morning, we have Mark Borrecco, president and chief executive officer; Peter Chapman, chief financial officer; and Steve Yose, chief credit officer. Also here with us to support our Q&A session after our prepared remarks, we have Doug Bass, our Chief Operating Officer; and Karlyn Knieriem our chief risk officer. As usual, we have a prepared presentation for today's earnings review which is available for webcasts on our website at greatwesternbank.com.

Before getting started, we would like to remind you that today's presentation may contain forward-looking statements that are subject to certain risks and uncertainty that could cause the company's actual future results to materially differ from those discussed. This is especially true in the current environment with continued uncertainty stemming from the COVID-19 pandemic. Please refer to the forward-looking statement disclosures contained in the earnings materials on the website along with periodic SEC filings for a full outline of the company's risk factors. Additionally, any non-GAAP financial measures discussed in the conference call are only provided to assist you in understanding Great Western'ss results and performance trends, and should not be relied upon as a financial measure of actual results.

Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation. I would now like to turn the conference over to Great Western Bank Corp's President and Chief Executive Officer, Mark Borrecco. Mark, please go ahead.

Mark Borrecco -- President and Chief Executive Officer

Good morning, Seth. Thank you, and thank you everyone for joining us. I hope that you, your family, your co-workers are doing well and are staying healthy. Before we discuss results for the quarter, I would like to take a moment and acknowledge that this will be our last call with Doug Bass, our chief operating officer who recently announced he will be retiring at the end of December.

We are grateful for Doug's 11-years with the bank and his many contributions. I also appreciate his support as I transition into the company over the past seven months. Doug, thank you for all that you have done for Great Western, and we wish you all the best in your retirement. A quick update on our markets and operating environment.

All of our branches are essentially reopened and we are following CDC guidelines and internal protocol, including temporary closure and cleaning for branches when we become aware of close contact. We remain cautiously optimistic about our footprint while COVID cases are on the rise, our tracking continues to indicate market activity is still faring better than the majority of other US markets. Now for an update on our key initiatives and developments from the quarter on Slide 2. We've talked about best during our credit risk management, our external loan review completed by Protiviti resulted in minimal, non-material findings.

As a reminder, the scope for this review included 99% of loans over 5 million in our high-risk segments. Along with other smaller credits to ensure that they are accurately risk-rated and underwritten to appropriate standards. I'm very pleased with the outcome. Steve, will provide additional comments later in the presentation.

But for me, the key takeaways are less than 1% of the loans reviewed had a downgrade from past to criticized. We now have a level of assurance that our Credit team along with our first line bankers are appropriately leveraging our new risk rating system. In addition, we have been diligently managing our COVID-related deferrals. At the peak, loan deferrals for Great Western Bank we're just over 17.7% of total loans, excluding PPP.

As of October 22, 2020, our loans on deferral have declined to 1.98% of total loans excluding PPP. To improve ongoing credit monitoring, we have decided to outsource our loan review function to a third party. This new relationship will elevate the level of independent review, and improve our ability to have early detection of any material credit issues. Conservative and measured actions.

Our previous conservative decisions have contributed to our improving capital ratios which Peter will discuss later on. Loan loss reserves provide a healthy coverage of 2.02% of total loans, excluding PPP, and PPP shares our day one estimates for our CECL adoption later on. We did not fill positions and we reduced FTE resulting in an ongoing cost savings of $4 million a year. NIM contracted only 7-basis-points for the quarter.

In addition, we paid off $205 million of our FHLB borrowings to improve our balance sheet and earnings profile moving forward. Organizationally, we continue to fill a number of important senior roles. We announced last quarter the importance of improving our treasury management client experience and performance. We are delighted to have hired Amy Johnson, to lead this enhanced function.

Amy comes to Great Western with over 20 years of experience, with a large financial institution in the Midwest where she led multi-region treasury management and sales teams. We implemented a centralized facility function and hired a new head of facilities. We are currently doing a thorough review of all of our branch and office locations. The small business center of excellence.

As we discussed previously historically, we have originated and decisioned all commercial credits regardless of size using the same process. To support our key initiative to reinvent our small business segment, we have selected the foundation as our third-party loan origination provider. We expect to launch our pilot by March 1 of 2021. I am appreciative of how the team has come together to support our modified agenda.

I am also pleased about our ability to attract high caliber, new employees, during this period of volatility. We are clearly making progress on the credit front, and I'm excited about what lies ahead for us in 2021. Now, for a review of our financial results, I will turn the call over to our chief financial officer, Pete Chapman. Pete.

Pete Chapman -- Chief Financial Officer

Thanks, Mark. And good morning, everybody. Looking at Slide 3, you'll see we had a number of significant items included within net income this quarter. Net income was $11 million, an increase from $5.5 million in the prior quarter, and earnings before taxes provision and fair value credit charges that do not flow through the provision with $52 million for the quarter.

During the quarter the pay, off with FHLB borrowings which had a cost of 2.75% resulted in a $7.6 million prepayment costs through expenses, which was offset with a $7.9 million realized gain from the sales securities or non-interest income. This is forecast to pick up $2.0 million in pre-tax earnings in fiscal 2021. Also, within non-interest income, you can see we realize certain credit-related charges related to the loan portfolio account of fair value which totaled $31 million, including an $8.0 million charge from the sale of a classified healthcare loan. A $4.2 million charge for credit mark and a break fee for credit moved to substandard, and also a $12.5 million loss history adjustment to increase the credit mark on the fair value loan portfolio.

Finally, other expense items realized in the quarter included a $2.0 million expense related to the completion of an FDIC loss-sharing agreement we entered into in 2010. Additionally, we recognized the write down to $4.0 million on OREO asset, and also occurred approximately $1.8 million in costs related to severance and consulting costs. Also on Slide 3. You can see we've provided comparative this year's results as there were some unique and significant items throughout the year.

Credit-related charges include $71 million in costs related to the impact from COVID-19 in the March quarter and certain other reserve items. Non-interest expenses included measured actions taken in the past three quarters which further improved the bank's position, and despite lower interest rates for much of the fiscal year, net revenue generation showed resilience through the fiscal year. Now looking closer at revenue on Slide 4. Net interest income was $108 million dollars which were flat with the prior quarter and adjusted NIM as Marcus mentioned that only contracted 7-basis-points to 3.4%.

Interest expense decreased $2.7 million, including a 9-basis-point decreasing deposit yields to 28-basis-points as successful in further reducing higher-cost deposits. Interest income also decreased by $3.0 million, due to a decrease in securities and loan yields given the environment. Moving to Slide 5. Our loan portfolio yield continues to be supported by $4.6 billion of fixed-rate loans yielding 4.4%, $2.0 billion of loans that have reached their flaws averaging 4.45%, and a billion dollars in variable loans reprice beyond 90-days that are currently yielding 4.51% Together, these items make up more than 80% of our loan balance, excluding the PPP loans.

Also with a net interest income was a combination of Triple Payment Protection Program interest and fee income for the quarter of $6.2 million. The remaining PPP fee income to be recognized just over $16 million over the life of the program. Looking at Slide 6. Total net interest income resulted in a net loss of $4.0 million for the quarter, excluding unique items related to the fair value loan accounting and securities gain underlying non-interest income with $17.2 million for the quarter, up from $14.1 million in the prior quarter. We saw a rebound in deposit transaction activity which contributed to a $1.7 million increase in service charges.

Mortgage revenue is very strong at $3.8 million, up 56% from the prior quarter. As our origin Asian activity and processing teams were really effective in supporting the strong demand, innovation in originations built by the low-interest rate environment, and also seasonal demand in the Midwest. Wealth management revenue was $2.9 million, up slightly from the prior quarter, and full-year income for that business increased 32% or $2.9 million in the prior which was a great result. Non-interest expenses were elevated this quarter at $75 million, and adjusting for the non-recurring items I outlined earlier on Slide 3.

Underlying expenses were approximately $62 million for the quarter. This compares to $67 million in total expenses in the prior quarter which also included about $6.0 million in non-recurring items. Loan loss provision expense was $16.9 million, a decrease of $4.8 million in the prior quarter. The provision this quarter was largely a net result of new specific provisions on newly classified loans identified during the quarter which Steve will touch on later, along with the portion of related to current period charge offs which increased our loss history. Moving to Slide 8.

We can see that our loan loss reserves excluding PPP loans increased to 1.6% from 1.54% in the prior quarter. In addition, we have a $30.5 million credit market that is 4.66% of our $655 million dollar portfolio of long-term loans account of fair value. And we also have an $11.6 million mark provided on our $315 million of acquired loans. Collectively, these represent total credit coverage of 2.02%, excluding our PPP loans. Importantly, we move from the incurred loss method to the adoption of CECL as of October 1, the beginning of our new fiscal year in 2021. We're finalizing our Day 1 impact as it stands and we estimate a 70% to 90% increase in our reserve with the total coverage ratio estimate that somewhere between 3.1% and 3.5% on the adoption of CECL.

This is an increase from our prior estimate, and generally reflects an overlay of expected loss assumptions on the exposures we have to industries such as accommodation that may be more impacted by COVID as this pandemic continues. On Slide 9, we see current capital ratios as well in excess of internal thresholds which are above regulatory levels also. Total capital increase full basis points to 13.3%. Tier 1 capital increase 5-basis-points to 11.8% and common equity Tier 1 increased to 11%. A tangible common equity ratio also improved to 9.2%, and is at 9.70%, excluding the impact of those PPP loans. Tangible book value per share also improved to $21.03, up from $20.52 in the prior year.

We continue to believe it's prudent to preserve capital in the current environment and consequently would equate a dividend of $0.01 per share for the quarter ended September 30, 2020. Now looking at deposits. Deposits decreased slightly to $11 billion, while average balances are actually up $206 million in the prior quarter. Balances from PPP proceeds and consumer stimulus receipts in the prior quarter largely remain intact as customers are showing a tendency to preserve liquidity. We've been successful in improving our mix with a reduction in the average time deposits of $60 million, and also an increase in non-interest bearing deposits at $158 million during the quarter.

Looking at loans. Loans at the end of the period with $10.1 billion which includes $727 million of PPP loans. Ended the period balances were down $240 million, while the average balances were relatively flat with the prior quarter. The decline in the loan balance was driven by an exit of a large commercial non-real estate facility, and also some progress in deleveraging some non-preferred sectors within agriculture. An acceleration of pay downs in commercial and also consumer hayloft balances during the quarter.

With that, I'll now hand over to our chief credit officer, Steve Yose to provide an update on credit initiatives, asset quality metrics, and key segments of that portfolio. So, over to you Steve.

Steve Yose -- Chief Credit Officer

Thank you. As Mark has repeatedly said improving our asset quality is the primary focus, and I would like to give you an update on the progress made in the quarter along with reviewing key asset quality results. Looking at Slide 12. You've outlined key initiatives sticking within the framework of timely and accurate risk ratings, focused risk-based credit positioning, and more specialized credit administration.

As Mark noted earlier, last quarter we said, we were proceeding with an independent review conducted by a third party of critical areas within our loan portfolio, and I'm pleased to share that it was completed by the September target. As previously noted, less than 1% of the loans reviewed required a downgrade from the past to criticize. Those have been corrected, and at this stage, the exercise helps provide a level of assurance on the state of our portfolio as we take steps to improve asset quality. We have been discussing our new risk rating system for a few quarters now, but it is now fully integrated as of October 1st following what was a thorough development and training exercise.

The added granularity of the scale and the addition of a special mention in between Watch, and substandard combined with Moody's Analytics modeling is helping us identify more effective early warning indicators so we can better prioritize our actions and manage the portfolio. As an example, we use the model to restore the hotel portfolio with COVID conditions which allowed us to risk rate with greater objectivity. We continue taking steps to help us become more risk-focused, and create a more unified credit risk culture as an organization. Our new and enhanced credit policy went into effect August 1st and is providing a risk-focused approval process that requires further approval elevation for higher risk specialized industries.

A risk-based hold limit that leverages the new risk rating system and a focused on a more accountable credit positioning process. The key to driving the culture is having the right leadership, and I'm very happy to now have my senior team fully in place. We have hired an experienced real-estate appraisal manager, Tom Mueller in September, and Travis Roebuck joined us in a critical role as senior and credit officer to support our modified ag business line. While these key strategies have given us lift and focus, I am even more pleased as a new chief credit officer, we have made significant steps in improving the credit risk culture of the organization.

As most management experts will say, including the late Peter Drucker, culture almost always trumps strategy. I've been very pleased with how our frontline and other employees have embraced our changes and our strategies to provide a significant cultural shift. Our commercial workout team continued to build momentum in the quarter. We have added resources and skill set to bolster that team which is starting to drive deleveraging and other tangible workout resolutions with customers.

We completed the sale of a large non-accrual loan in a clean and efficient manager -- manner which helped us get perspective on the market and the viability going forward. We're being deliberate, and strategic, and our actions with credit risk management. Some improvements you will see immediately, and some will evolve over time. What we're doing fits with the overall strategy Mark touched on earlier, and I'm looking forward to the impact they will have on this organization and on asset quality.

As we turn to Slide 13, I have some further details on the third-party loan review. The total revolving loans reviewed this quarter were $5.4 billion which included $4.0 billion that went through the external review. The reviews covered 10 different segments including the hotel portfolio. As I noted earlier just five relationships for $42 million in commitments were downgraded from past to criticize representing less than 1% of the launch reviewed.

No not accrual or charge-off recommendations came from the reviews. March -- Mark touched on deferrals earlier, and you will see our levels have subsided to just under 2% of total loans excluding PPP. Looking at the top segments. Deferrals linked to hotels were $167 million which is 14% of the hotel portfolio loans.

Arts, entertainment, and recreation reduced to $12.0 million, and makeup 10% of that portfolio. Our balances are in a good spot and we are going to remain diligent in this effort as progress through the coming months with COVID uncertainty. On Slide 14, we have our asset quality metrics. Net charge-offs for the year were 0.40% of average total loans or $39 million, which includes %15 million for this recent quarter.

Loans graded "Substandard" or worse increased to $770 million, and not accruing loans increased to $325 million. The substandard increase was largely related to two larger Ag relationships that have not been able to rebound and a number of hotel relationships for approximately $60 million that were downgraded through our risk rating assessment offset with the sale of a healthcare facility and a charged-off dairy relationship. The increase of nonaccrual related to large Ag relationships associated with the Dairy industry who have not been able to improve their financial position. Watch loans were $983 million for the quarter, an increase of $506 million as a result of $230 million in the hotel and resort space, $109 million in healthcare, and $75 million in another CRE relationships moving to Watch, and the ongoing rating system in the outgoing rating system reflecting the current operating environment.

The Watch category will be changed for the December 2020 quarter as the lowest level of the pass category. With the remainder replaced with a special mentioned category to better align with peers. You'll see on Slide 14, we have a summary showing the rating of our loan portfolio under the new risk rating system which formally began October 1st. Out of our current legacy Watch portfolio, we have $503 million rated a special mention in the new system along with $770 million Substandard and worse.

While the metrics moved unfavorably again this quarter, I am actually encouraged at how diligent we have been in using our new credit policy to identify early indicators, and conclude accurate and timely risk ratings. Looking at the culture at the loan portfolio. I am generally comfortable with the diversification we have, however, there are a few key segments that I want to make sure we are managing effectively. On Slide 15, we have key information about our hotel portfolio which is obviously being impacted by the COVID pandemic.

The concentration while within our footprint a most of the nonprofit projects are linked to in footprint customers who are seasoned at developing projects. The concentration is well diversified across 130 different cities with the most and small to midsize locations at 86% carry a franchise flag. The biggest change this quarter is reflected in our risk rating migration following substantial reviews, and risk scoring in the quarter. Substandard loans in this sector rose from $26 million to $88 million.

Special mention rose to $175 million as we adopted the new risk rating system, and $910 million remained as pass rate. The diversity in our Ag portfolio remains a key characteristic of the book. From a grain perspective, the USDA reported harvest is progressing very well, and the national average of 60%. In our main footprint, South Dakota, and Iowa are tracking better at 64%, and 65% respectively, and Nebraska is very close to 58%.

Soybean harvest is also progressing well with the national average of 75%. South Dakota, Iowa, and Nebraska are all far ahead of this base ranging from 90% to 92%. Milk prices have subsided somewhat from very high levels in the summer as the September clustering milk price averaged $16.43 with four levels at or above this level. We continue to monitor the Healthcare portfolio as there are mixed signals as to what is happening from an industry perspective.

The few problem loans we have had with Healthcare related loans have been situational and not linked to any broad COVID issues. There is balance in the portfolio across senior care, assisted living and retirement communities, skilled nursing, hospitals, and other healthcare services and social assistance. We have about 45 relationships in senior housing, 45 in skilled nursing, and 32 in hospitals which make it more manageable to engage with customers and ideal by early indicators. That wraps up my comment -- That wraps up my credit commentary, and I'll now turn it back to Mark.

Mark Borrecco -- President and Chief Executive Officer

Thanks, Steve. Improving our asset quality remains a major focus for us. And with Steve's support and guidance, and with a stable third-party review of our loan portfolio complete, we continue to make progress on addressing our credit quality issues and de-risking the balance sheet. Our NIM continues to hold up well in this low rate environment, and as we begin our new fiscal year, I am excited about how our small business and other initiatives will accelerate our performance going forward.

Operator with that, let's now move to the Q&A section.

Questions & Answers:

Operator

We will now begin the Q&A session.[Operator instructions]. Our first question comes from Jeff Rulis with D.A. Davidson. Please, go ahead.

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

Thanks. Good morning. The first question on the expenses. Peter, it's -- in terms of the -- I guess it starts with the -- what would you deem as the core balance in the quarter given all the puts and takes as well as projecting what you think that path is with if we bake in some of this severance.

And think that the cost savings. The LPO and the reduction in employees. What is that drive that going forward.

Pete Chapman -- Chief Financial Officer

Yes. In my comments Jeff, I said about$62 million which is what I'd peg underlying run-rate expenses as for the quarter. I think there was a slight uptick from there is pretty good for the next quarter. We've got some cost saves that were baked in.

Obviously, but we'll use that to fund some growth. Mark mentioned the initiatives we've got around the small business piece which will be a good one for us and some other infrastructure we want to invest in. But we should be able to maintain around there. It's not just up a little bit from that major.

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

So the just to clarify the expected annual cost savings on the FTE reduction that's already baked into that 62%, or that takes place over the course of the next quarter. Sorry about that.

Pete Chapman -- Chief Financial Officer

Yes, it is. Yep. So we're talking about $62 million to $63 million, $64 million for next quarter with the forecast is Jeff for next quarter. got it.

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

Got it. Ok. Thank you.

Pete Chapman -- Chief Financial Officer

No problem.

Operator

Our next question comes from Terry McEvoy with Stephens. Please, go ahead.

Terry McEvoy -- Stephens Inc. -- Analyst

Hi. Thanks. Good morning. I guess just my first question.

The commentary on the external loan review, minimal non-material findings is the bullet point right on the first slide there. And I guess just as an outsider I just look at Substandard loans up to and some of the noise within the hedging or the fair value marks, and in some of the other credit, metrics moving in the wrong direction to be blunt. I'm just trying to get a sense of what's behind the non-material pleased with the findings versus maybe some of the trends. Again, as an outsider that we're looking at this morning.

Mark Borrecco -- President and Chief Executive Officer

Well, I guess from my perspective, we as I mentioned are talking about our focus on Ag risk grading. So as credit and frontline, we focused very closely on looking at the portfolio so that outsiders review was really to confirm as if we were looking at those correctly. And if we are really to look under the hood to make sure we're comfortable with our risk ratings which it indicated that we are. But the increase in risk ratings is driven primarily by us as I mentioned restoring our portfolio.

If you look at the bulk of the impacted risk rating changes, especially on the Watch. Special mentioned and to a degree and substandard it is really driven by our Hospitality section which is very natural when you consider the size of our Hospitality portfolio. So what really drove our asset quality changes was really what I mentioned the cultural change as well as the way we're looking at trying to be very conservative, and how we're reviewing the Hospitality sector and not driven. And that's why we emphasize that by any third-party review.

The third-party review confirmed I believe that we are doing the right things. But it did not drive our asset quality changes.

Terry McEvoy -- Stephens Inc. -- Analyst

Thanks, I appreciate that. And then Mark maybe as a follow up from just a strategic perspective, you closed the loan production office. Hired some individuals, rolled out SPA. Were you in the structure of the bank and making changes.

Do you think that's largely behind the company, or are there more to come.

Mark Borrecco -- President and Chief Executive Officer

I would say that most of it are behind the company. I would say that the one area, as I mentioned at the beginning of the call with Doug's announcement of his retirement, the one area that I'm going to get much closer to is really our first line. Our commercial retail Treasury wealth mortgage Ag business lines, and so for the next six months those business lines will report directly to me, and they'll give me a chance to better acquaint myself with those individuals, understand our market, our opportunities. And then decide what is the appropriate organizational structure for the bank moving forward.

So I think in other areas we're in a really good spot. The one area that we'll continue to focus on will be that first line or our business lines. As Doug retires and then not businesses or those businesses report to me for roughly six months for me to better understand.

Terry McEvoy -- Stephens Inc. -- Analyst

That's great. Thank you both. I appreciate it.

Operator

Our next question comes from Andrew Liesch with Piper Sandler. Please, go ahead.

Andrew Liesch -- Piper Sandler -- Analyst

Good morning, everyone. I just want to focus on the margin here. This should be a benefit from the FHLB prepay and still some opportunities on the funding side as well. Then I guess I'm also tied in with.

Is there a level that you expect the size of the balance sheet to be going forward in a certain type of securities. Look, overall I guess the size of that. And then what are you seeing with prospective lower rate vs. the ability to lower funding costs further.

I mean how should the margin and I shake out from this 3.51% margin and $106 million [Inaudible].

Pete Chapman -- Chief Financial Officer

And I look at business in a couple of quarters around the balance sheet. I'll say comments, so I'll make it just excluding PPP. Obviously, depending on the timing of when relief comes through there that could change the shape of the balance sheet pretty significantly. But certainly here, we're seeing good funding in this environment.

Certainly, we're not seeing as many loan opportunities, so if anything from a mixed perspective we may move more into securities and loans over the course of the period. But certainly, the focus for us is number one, Just any more high-cost deposits that we have, we'll continue to run those down to help with the funding cost. So, we've still got a little bit of room to move there may be moving into a little bit more on security. So from a mix perspective, we may see margin drift down a little bit more from where we are now, but we think it's manageable.

Just given where the loan portfolio is.

Andrew Liesch -- Piper Sandler -- Analyst

Are there any -- just are there any other higher-cost borrowings that you could prepay or was this blessed of it.

Pete Chapman -- Chief Financial Officer

Now that was the main one from a borrowing perspective. So now it's just really just working through that. Obviously, as time deposits roll through, we'll continue to reprice those down. We've got some money market that we can move down a little bit as well.

So more on the deposit side in the funding side now.

Andrew Liesch -- Piper Sandler -- Analyst

Ok. Thank you so much.

Pete Chapman -- Chief Financial Officer

No problem.

Operator

Our next question comes from Jon Arfstrom with RBC Capital. Please, go ahead.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Thanks. Good morning, everyone.

Pete Chapman -- Chief Financial Officer

Morning.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Just back to credit. What's the message you're trying to send to us on credit. I understand the loan grading and all the changes that you've made, and I think you probably feel better prospectively in terms of -- Are you look at things but do you see things as better, or worse, Stable. But what's the message you want to send us on credit.

Steve Yose -- Chief Credit Officer

I would say our core portfolio outside of hospitality. I would say stable to improving as far as the outlook. As you look at Agribusiness, all the indicators are positive. If you look at all of the commodity pricing over the next six months most of the USDA and other reports show positive.

So I would see hopeful improvement in our agribusiness space. From the chief credit officer perspective, I do see uncertainty in our hospitality portfolio. That's just an area we're trying to focus look at closely and reviewing constantly. We're trying to make sure that we have our arms around it.

We're trying to see what we can do to carefully reduce that portfolio. So strategically going forward, our hope is to continue to be a strong community bank within our markets. As Mark emphasizes small businesses, we want to grow there. We want to grow and be open for business in the commercial space.

We are going to continue to focus on how we can deal with risk our portfolio in the hospitality, and to a smaller degree in the assisted care space. And that is really our focus. So I am overly in the long-term optimistic about us from an asset quality perspective. But in the short term, we have significant asset quality challenges within our hospitality space, and we are just watching that.

I would say daily to see how we can continue to work through those challenged parts of our portfolio.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Ok. And then the other thing that I think chronically is an issue in your numbers is the increase in non-performing loans each quarter. And I guess it's probably an impossible question. But do you have a gut feeling when you think that non-performing loans can start coming down.

Sounds like you moved some this quarter and backfilled. But any thoughts you have on that. That would be very helpful.

Steve Yose -- Chief Credit Officer

Well, once again the uncertainty I talked about gives me a little bit of pause. However this month, we see some positive movement in nonaccrual. So we'll have to see how this quarter goes. But I am hopeful that we're a stable place, but we're just watching that closely.

We just -- I just can't say which way we're going to go, but I'm hopeful at the moment.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Ok. And then if I can squeeze in one more in CECL. Maybe it's for you, Peter or Steve. But the messages Day one step up in the low 3% range you phase in the regulatory but the impact that essentially captures it all.

Is the message that the provision can start to come down because of that. Because you've captured everything, or is there a different message you want to send them on the provision outlook. Thank you.

Pete Chapman -- Chief Financial Officer

Look, obviously depends on the timing of Steve's comments around non-performing assets Jon. But based on where we are now obviously, CECL gives you the full look over the life of the portfolio. So if the environment stays as is and doesn't worsen that's what we would hope. But obviously, we need to roll that forward 90-days to see what happens there over the next 90-days.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Ok. All right. Thanks for the help.

Operator

Our next question comes from Damon DelMonte with KBW. Please, go ahead.

Damon DelMonte -- KBW -- Analyst

Hey. Good morning, guys. Everybody's doing well today. So it's a follow up on credit.

I think you guys had mentioned that you sold a larger loan in the secondary market, and it worked out favorably. What are your thoughts on trying to take a big step forward and de-risk the portfolio with the hospitality loan debt that is giving you guys some issues. Is there any thought about trying to do a book sale.

Steve Yose -- Chief Credit Officer

We are looking at every opportunity in our hospitality portfolio. This is the other thing we've learned is with the uncertainty with the hotel you can also maximize your losses if you're not careful if you do a bulk sale. If you look at our hospitality space, we do not have a large level of nonaccrual, or non-performing loans. We do not have a large level of specific allocations.

So, we are definitely looking at all options within our hospitality space, and we have looked at places here and there but we have not seen a bulk sell to be in our best interest at the moment from the -- just the view of the market.

Damon DelMonte -- KBW -- Analyst

Got it. Ok. Thanks. And if I could just squeeze in one more on just the outlook for loan growth.

It was down 9% this quarter. Do you expect it to reflect the trend to lower. But what kind of pace of the quarterly decline could we think about for loans. Thank you.

Pete Chapman -- Chief Financial Officer

A lot depends on how we go with the derisking that Steve just talked about Damon. So certainly if that works though I would still expect to see a slight contraction here for the next quarter. just based on the current outlook.

Damon DelMonte -- KBW -- Analyst

Ok. Thank you, very much.

Operator

Our next question comes from Janet Lee with JP Morgan. Please, go ahead.

Janet Lee -- J.P. Morgan -- Analyst

Good morning. My first question, just following up on hospitality in these three scores besides the risk rating adjustment by the third party do you guys perceive any change in changes in rests on that portfolio on a fundamental level versus what you saw in the second quarter.

Steve Yose -- Chief Credit Officer

Well if you notice our big increases and that wasn't driven by the third party. It was driven internally by our own front line and second-line review of what's really driven by the third party. We have them work out to confirm, but we don't have a higher level taking prudent measures and Special mention and Watch category. And it really just -- and we feel good about our footprint in the hospitality space compared to probable peers and other markets you could be in.

On the other hand, just the COVID uncertainty makes that difficult for me to answer. I would anticipate higher levels of classified loans over time to a degree, and we've recognized that in our CECL calculations. And the way we look at the allowance for loan losses, and our CECL going forward. But we are -- I would say taking measured steps but there is uncertainty as I said earlier in the hospitality space.

So, we don't see any significant changes from what we've -- what we've focused in on that's why we moved those to Special mention and to Watch. But we are like I said earlier, we're just looking at that. I would say every everyday monitoring monthly. Monitoring daily.

That's just one of those things we'll have to work through and really COVID impacts our portfolio more than anything else.

Janet Lee -- J.P. Morgan -- Analyst

And last quarter you pointed to the expected improvement in asset quality metrics and the Ag portfolio. Is it still the case and the migration we saw in the Darian and some other Ag portfolio in the quarter. Would you describe this as one-off blips.

Mark Borrecco -- President and Chief Executive Officer

I would say what you saw in the ag space was one-off there was a couple of relationships that had already been recognized as classified or substandard loans that ended up moving to not accrual every new case. We have been careful about how quickly we upgrade our portfolios. We want to recognize that we've had two or three-quarters of consistent cash flows. So our hope is that if those stay consistent, we'll see improvement there.

But we're just taking prudent steps on how we're looking at that. But yes, we don't see any like I'd say the deterioration in the portfolio to a significant degree of going into this quarter in the next quarter.

Janet Lee -- J.P. Morgan -- Analyst

And if you don't mind if I can squeeze in just one more. The fair value mark on loans obviously that line item is very volatile, and hard to predict this quarter that included about 12 million charges for credit risk on a portfolio based on the updated default risk assumptions. Is this fair to assume that as credit risks rise there will be increased losses coming from this line item. Just like provision except that it flows through the non-interest income on the P&L.

The other side of the PNL.. Or how should I think about the driver of that going forward.

Pete Chapman -- Chief Financial Officer

Yes. Good question. So there's a couple of things that impacted that this quarter. One was about a $9.0 million dollar charge on the disposal of that healthcare portfolio, Janet.

So we'd hope unless we're exiting other loans is at a significant discount that's elevated. And then also that credit charge we mentioned in relation to lost history, I'd see that as a significant step up for this quarter that I wouldn't expect to see next quarter as well. So that was a significant adjustment that we made this quarter that I wouldn't expect something of that magnitude next quarter for example.

Janet Lee -- J.P. Morgan -- Analyst

Ok. All right. Thank you.

Pete Chapman -- Chief Financial Officer

Thanks.

Operator

This concludes our Q&A session. I'd like to turn the conference back over to Mark Borrecco, CEO for any closing remarks.

Mark Borrecco -- President and Chief Executive Officer

Thank you, operator. Thank you all for joining us today. Again, if you have any follow-up questions please, feel free to reach out. Make sure you stay safe and have a great day.

Thank you so much.

Operator

[Operator signoff].

Duration: 45 minutes

Call participants:

Seth Artz -- Head of Investor Relations

Mark Borrecco -- President and Chief Executive Officer

Pete Chapman -- Chief Financial Officer

Steve Yose -- Chief Credit Officer

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

Terry McEvoy -- Stephens Inc. -- Analyst

Andrew Liesch -- Piper Sandler -- Analyst

Jon Arfstrom -- RBC Capital Markets -- Analyst

Damon DelMonte -- KBW -- Analyst

Janet Lee -- J.P. Morgan -- Analyst

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