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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to the Banner Corporation's Second Quarter 2020 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mark Grescovich, President and CEO. Please go ahead.
Thank you, Kate, and good morning everyone. I would also like to welcome you to the second quarter 2020 earnings call for Banner Corporation.
As is customary, joining me on the call today is Rick Barton, our Chief Credit Officer; Jill Rice, our Chief Commercial Credit Officer; Peter Conner, our Chief Financial Officer; and Rich Arnold, our Head of Investor Relations.
Rich, would you please read our forward-looking Safe Harbor statement?
Sure, Mark. Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives, or goals for future operations, products or services, forecasts of financial or other performance measures and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion.
These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available in the earnings press release that was released yesterday and the recently filed Form 10-Q for the quarter ended March 31, 2020. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning its expectations.
Mark?
Thank you, Rich. It has certainly been an interesting first half of 2020, and I hope you and your families are well, as we all battle the COVID virus and its effects on our communities and the economy.
Today, we will cover four primary items with you. First, I will provide you a high-level comment on the quarter. Second, the actions Banner continues to take to support all our stakeholders, including our Banner team, our clients, our communities, and our shareholders. Third, Rick Barton will provide comments on the current status of our loan portfolio and accommodations we have made to assist our clients. Finally, Peter Conner will provide more detail on our operating performance for the quarter and the continued build of our loan loss reserve associated with the estimated economic impact of the COVID virus on our clients, and capital actions taken in the quarter consistent with our longstanding strategic priority of having a moderate risk profile.
I want to begin by thanking all of my 2,100 colleagues in our company that are working extremely hard to assist our clients and communities during these difficult times. Banner has lived our core values, summed up as doing the right thing for 130 years. It is critically important that we continue to do the right thing for our clients, our communities, our colleagues, our company, and our shareholders to provide a consistent and reliable source of commerce and capital through all economic cycles and change events. I am pleased to report that is exactly what we are doing. I am very proud of the entire Banner team that are living our core values.
Now, let me turn to an overview of the second quarter performance. As announced, Banner Corporation reported a net profit available to common shareholders of $23.5 million or $0.67 per diluted share for the quarter ended June 30, 2020. This compared to a net profit to common shareholders of $0.47 per share for the first quarter of 2020, and $1.14 per share in the second quarter of 2019. This quarter's earnings were impacted by a number of items, including the allowance for credit losses billed based on the estimated impacts of the COVID virus on the economy, strong mortgage banking revenue, and a net change in the fair value of financial instruments. Peter will discuss these items in more detail shortly.
Directing your attention to pre-tax pre-provision earnings, and excluding the impact of the merger and acquisition expenses, COVID expenses, gains and losses on the sale of securities and changes in fair value of financial instruments, earnings were $57.9 million for the second quarter 2020 compared to $53.1 million in the second quarter of 2019, an increase of 9%. This measure I believe is helpful for illustrating the core earnings power of Banner.
Second quarter 2020 revenue from core operations increased 6% to $147.3 million compared to $139.4 million in the second quarter of 2019. We benefited from a larger and improved earning asset mix, a good net interest margin, and good mortgage banking fee revenue. Overall, this resulted in a return on average assets of 0.68% for the second quarter of 2020. Once again, our core performance this quarter reflects continued execution on our super community bank strategy, that is growing new client relationships, adding to our core funding position by growing core deposits, and promoting client loyalty and advocacy through our responsive service model. To that point, our core deposits increased 34% compared to June 30, 2019. Non-interest-bearing deposits increased 44% from one year ago and represents 44% of total deposits.
Further, we continued our strong organic generation of new client relationships again this quarter. Reflective of this solid performance coupled with our strong tangible common equity ratio, we issued a dividend of $0.41 per share in the quarter. Also in light of the uncertainty of the future economic climate, we have continued the suspension of our share repurchases. While we have limited operations in our branches, our workforce has been mobilized with nearly 60% working effectively remotely, and the remainder available for in-person meetings by appointment working our drive-throughs, ensuring our ATMs remain accessible and functioning, and others performing operational duties. We have also created special programs for employees deemed worksite essential, and we are providing additional paid time off for exposure or sickness.
To provide support for our clients, we have made available several assistance programs. These include waived penalties for early IRA distributions, up to $100,000, and CD withdrawals up to $25,000, and increased daily limits on mobile check deposits and ATM withdrawals. Further, Banner has provided SBA payroll protection funds, totaling $1.12 billion for 8,665 clients, and provided deferred payments or waived interest on 3,314 loans, totaling $1.1 billion. Finally, we have made significant contributions to local and regional nonprofits and provided financial support for emergency and basic needs in our footprint.
Let me now turn the call over to Rick to discuss trends in our loan portfolio and his comments on Banner's credit quality. Rick?
Thanks, Mark. Since our first quarter call, Banner's bankers and credit risk managers have done a superb job of dealing with the kaleidoscopic environment created by the COVID-19 pandemic. From handling the unprecedented volume of PPP loan requests to managing stressed existing client relationships, their work has been focused and executed with calm precision; and on top of those challenges, they have participated in a series of deep-dive loan portfolio reviews that have allowed us to gauge and measure the credit risk being created by the pandemic. It is a humbling experience to work with them each and every day.
With that said, the balance of my remarks this morning will include the usual recap of the company's credit metrics and loan portfolio and detail on our continuing response to COVID-19. When reviewing our second quarter credit metrics, it needs to be remembered that they have been helped by both the loan deferrals we have granted to many of our customers and the various fiscal stimulus programs enacted during the quarter. Delinquent loans in the second quarter decreased 31 basis points over the linked quarter and totaled 0.35% of total loans receivable. This compares to 0.40% as of June 30, 2019. This metric in particular has been the beneficiary of our deferrals and fiscal stimulus.
The company's level of adversely classified assets did spike during the quarter as we proactively downgraded loans in early impact sectors, and many of the loans that were put into deferral. This is in keeping with our culture of prompt risk recognition. Our non-performing assets decreased during the quarter from $46.1 million to $39.9 million, which is reflective of the continued strong collection activity by our seasoned workout group. Non-performing assets represents 0.28% of total assets as of June 30, and include $37.4 million of non-performing loans and $2.4 million in REO and other owned assets. At 03/31/2020, non-performing assets were 0.36% of total assets.
The second quarter loan loss provision was $29.5 million, compared to $21.7 million for the first quarter. The drivers behind this ACL provision were the already mentioned loan downgrades $12.8 million, changes in the Moody's economic forecast we use in our CECL model, $5.7 million, and management-driven qualitative adjustments of $7.4 million. After the provision, the ACL reserve totals $156.4 million, or 1.52% of total loans. Net of PPP loans and loans held for sale, the reserve is 1.71% of all remaining loans. This compares to a reserve of 1.41% for the linked quarter. The reserve for credit losses currently provides significant coverage of our non-performing loans at 425%, up to 299% last quarter.
Loan losses of $4.3 million during the quarter were partially offset by recoveries of $641,000. On an annualized basis, this equates to a loss rate of 16 basis points, when PPP loans are excluded. The size of makeup of Banner's loan portfolio changed a little during the second quarter of 2021 with PPP loans totaling $1.1 billion are excluded from total loans. Last quarter, we emphasized the pre-pandemic moderate risk profile of our portfolio that positioned us well for the emergence of a credit cycle. There is no need to restate those comments this morning other than to note that our approach to credit management and underwriting remains unchanged except for requiring a COVID-19 analysis for all credit actions.
The rest of my comments this morning will focus on Banner's response to the pandemic and provide details on higher risk portfolio segments. We have already discussed the PPP loans made, 90% of which were to existing clients. We're now preparing for the loan forgiveness stage of this program. And our anticipation is that this will be successfully executed. In response to the pandemic, we granted payment relief on 3,314 loans totaling $1.1 billion through June 30 2020. Almost all of these deferrals had a 90-day tenure. At quarter-end, 1,180 of these loans totaling $408 million have yet to expire.
Currently, the pace of new deferral requests is very modest. However, we do expect further requests for new deferrals given the current state of the pandemic and the slowing or reversal of phased reopening plans. That said, it is worth noting that as of June 30, we had only processed three requests for payment relief extensions. During July, the extension requests have increased slightly, and additional deferrals have been granted to 26 clients with loan balances totaling $32.7 million, and to clarify, that is 26 clients have been given a second or renewal of their loan deferrals.
In parallel with processing PPP loan requests and payment relief actions, our bankers and credit risk management teams completed the already-mentioned portfolio reviews, covering 86% of our commercial and commercial real estate power borrowing relationships. These reviews are focused on total client liquidity and cash burn rate, operating projections including underlying business assumptions of our clients, and current estimated collateral coverage. The reviews were designed to gauge both immediate and longer-term repayment risk. Deep-dive portfolio reviews have been an integral part of general and problem loan credit management at Banner since 2010. They served us well during the Great Recession and have been an invaluable tool to us in achieving and maintaining a moderate risk credit portfolio.
Jill Rice, our Senior Commercial Credit Officer who is on this call, has been an active participant since 2010 in all of these quarter lead portfolio reviews, providing keen credit insights and leadership. Because of the current uncertainty surrounding the pandemic, these reviews will be repeated each quarter for the foreseeable future. The reviews will be central to setting future ACL provisioning and troubled loan management and loss mitigation.
I now would like to make some comments about those loan segments we have identified as having been most immediately impacted by the COVID-19 pandemic. The Hospitality segment is 2% of total loans, $166 million or 67% of this portfolio have been granted 90-day deferrals of which $43 million have not expired. As we expect the recovery horizon for hospitality will be measured in years. We do anticipate requests for both renewal and new payment relief. The majority of this portfolio is nationally flagged or strong regional brands. Pre-pandemic weighted debt service coverage and loan to value metrics of this portfolio were 2.5 and 50% respectively indicating that our clients do not need to return to historic norms to resume debt service.
The Recreation and Leisure segment is 1.5% of total loans with a concentration of approximately 60% in centers with most of those still closed. As of June 30, 2020 the $77 million or 59% in payment deferrals were granted in this segment of which $5.6 million have not yet to expire. Since quarter-end, 20% of the original deferrals have been extended. This portfolio segment also had strong pre-pandemic metrics with weighted average debt, service coverage and loan to value ratios of 1.9 and 60% respectively.
Healthcare exposure is 4% of the loan portfolio. Approximately $87 million or 18% in payment deferrals re-accredited in this segment through June 30. With $18 million of those deferrals yet have to expire. Our portfolio reviews to date indicate that these clients will not require additional payment relief. Restaurant and food services exposure is 2.5% of our loan portfolio of which two-thirds is commercial real estate security. The portfolio was diversified by both geography and type, and there is limited franchise exposure. 65% are classified as full service restaurants, 10% that's limited service. And another 10% is drinking establishments.
Banner initially provided payment deferrals of nearly $83 million or 36% of this segment, and of those referrals $12 million have yet to expire. While most clients have reopened in some fashion, it is too early to assess their longer-term operating viability. Accordingly, it is reasonable to expect new or renewed deferrals in this loan segment.
Our retail trade exposure that includes C&I as well as owner occupied investor commercial real estate is nearly 11% of the portfolio. This portfolio is diversified across our footprint and includes no mall exposure. Payment deferrals of nearly $257 million or 24.5% had been granted to this segment as of June 30, 2020. Of these deferrals, $142 million have yet to expire. With recent pandemic trends, we do expect to deferral extensions in this portfolio, but it is too early to gauge at what level.
Before closing my remarks this morning, I would like to reiterate that we entered into the pandemic induced economic cycle with strong credit metrics and an established credit culture. This will continue to be a source of strength as we deal with the inevitable deterioration in credit quality, and the emergence of loan losses as the pandemic continues.
With that, I will turn the microphone over to Peter Conner for his comments. Peter?
Thank you, Rick, and good morning everybody. As discussed previously and as announced in our earnings release, we reported net income of $23.5 million or $0.67 per diluted share for the second quarter, compared to $16.9 million or $0.47 for diluted share in the prior quarter. The $0.20 increase in per share earnings was driven by a combination of improved core earnings, positive fair value adjustments, and an adjustment to the effective tax rate. Core revenue excluding gains and losses on securities and changes in the fair value of financial instruments carried at fair value increased $2 million from the prior quarter, as a result of substantial core deposit growth, increased residential mortgage income, and PPP loan income.
Well, of course, [mortgages] [ph] declined $6.6 million from the prior quarter due to increase capitalized loan origination costs and lower provision expense for unfunded commitments. Loan loss provision expense increased $7.8 million due to additional reserve builds driven by further deterioration in the economic outlook, negative loaners grading migration, along with coverage of net charge-offs recorded during the quarter.
Turning to the balance sheet, total loans increased $1.1 billion from the prior quarter-end as a result of PPP loan originations. Excluding PPP loans and held for sale loans, held for investment portfolio loans declined $124 million due in part to lower line utilization and lower commercial loan production along with prepayments on the one-to-four residential mortgage portfolio. Held for sale loans increased by $76 million due to the large volume of residential mortgage loan originations produced in June carried over quarter-end. Excluding the AltaPacific acquisition and PPP loans, loans held for portfolio grew by 1% over the prior year quarter.
Ending core deposits increased $1.7 billion from prior quarter-end due to a combination of new account growth, PPP loan proceeds and a continued increase in overall client deposit balance liquidity. Excluding the AltaPacific acquisition, core deposits grew 30% over the prior year. Time deposits decreased by $124 million due to a decrease in brokered CDs, while retail CDs remain flat. FHLB borrowings declined $97 million as a result of deposit growth.
On June 30, we closed on an offering of $100 million of subordinated notes that adds to our regulatory capital position and to act as a source of strength to our bank subsidiary during a period of increased economic uncertainty. Once a sustained improvement in economic conditions has occurred, the additional parent company liquidity will provide enhanced capital management optionality.
Turning to the income statement, net interest income remained even with the first quarter at $119 million as substantial growth in core deposits and PPP loan outstandings resulted in a 9.4% growth in average earning assets for the second quarter, offset by a 51 basis point decline in average earning asset yields. Compared to the prior quarter, loan yields decreased 50 basis points due to a combination of low yielding PPP loan growth, declines, and existing portfolio loan yields as a result of the decline in market index rates during the quarter along with a lower contribution from acquired loan discount accretion.
Of the quarterly loan yield decline, PPP loans accounted for 15 basis points, lower loan accretion accounted for 4 basis points. You know the remaining 32 basis points was a result of loan repricing driven by the reduction in average market index rates compared to the first quarter. Securities yields declined 24 basis points due to acceleration of prepayments on mortgage back securities. Total cost of funds declined 15 basis points to 31 basis points as a result of lower deposit costs and wholesale funding costs.
Total cost of deposits declined from 35 to 23 basis points in the second quarter due to declines in retail deposit costs and a larger mix of non-interest bearing deposit balances. Brokered CDs accounting for two basis points of total deposit costs, compared to four basis points in the prior quarter. The ratio of core deposits, the total deposits increased 91% in the second quarter, up from 89% in the first quarter. The net interest margin declined 35 basis points to 3.90% on a tax equivalent basis of the total decline the PPP program accounted for eight basis points acquired loan accretion at three basis points and the increase in core deposit liquidity not associated with it the PPP program accounted for six basis points.
With respect to the margin outlook, we anticipate an increase in effective loan yields generated from the PPP program to begin having a positive effect at the end of this quarter and ramp up in the fourth quarter commensurate with an increase in loan forgiveness activity, along with some corresponding outflow of deposit, the positive liquidity build-up we saw in the second quarter.
Non-interest income increased $8.7 million from the prior-quarter. Non-interest income excluding losses on sale off and changes in securities carried at fair value increased $1.9 million. Deposit fees declined $2.3 million due to lower transaction volumes and Fee Waiver accommodations in response to the pandemic.
Total mortgage banking increased significantly by $3.9 million due to an increase in residential mortgage gain on sale driven by record volume and strong gain on sales spreads. The percentage of refinance volume increased to 58% of total volume up from 46% in the prior-quarter with overall gain on sale spreads in the high 4% range similar to the level in the first quarter. Within this line item, multifamily contributed less than $100,000 due to a decline in secondary market liquidity and reduced loan production in the second quarter.
Miscellaneous fee income decreased $1.1 million due to declines in SBA and swap fee income along with lower gains on other real estate assets sold. Turning to expense,
total non-interest expense declined by $5.6 million from the prior-quarter. Excluding acquisition costs and pandemic specific operating costs, core non-interest expense declined $6.7 million. Salary and benefits expense increased $3.5 million due to normal merit related salary increases, lower position vacancy rates over time and mortgage commissions. The credit for capitalized loan origination costs increased by $5.3 million in the second quarter, due to the PPP program and to a lesser extent a modest increase in normal portfolio loan production PPP originations represented $2.9 million of the total capitalized loan origination costs in the second quarter. Marketing and advertising expense declined $1.2 million as direct mail and marketing campaigns were curtailed in response to the pandemic. Provision expense for unfunded loan commitments declined $2.6 million due to a release in the unfunded commitment reserves driven by a shift in the mix of unfunded commitment balances by loan segment.
Miscellaneous expense declined $1.2 million due to employee conference travel and training costs. Acquisition costs declined $800,000 from the prior quarter to $336,000 and COVID related costs increased $1.9 million principally comprised of premium pay for essential frontline staff, remote work environment setup costs and community donations.
Finally, we're resuming efficiency initiatives that have been postponed due to the pandemic. Among these initiatives are the consolidation of the Islanders Bank Charter into Banner Bank in the first quarter of 2021 along with ongoing retail branch rationalization, and completion of the streamlining of the commercial and small business delivery platforms over the next 18 months, we believe these initiatives align well with the recent acceleration in client acceptance of digital delivery channels and the percentage of workforce that will work remotely as a residual impact of the pandemic.
This concludes my prepared remarks. Mark?
Thank you, Rick, and Peter for your comments. That concludes our prepared remarks, and Kate, we will now open the call, and welcome your questions.
We will now begin the question-and-answer session. [Operator Instructions] The first question is from Jeff Rulis of D.A. Davidson. Please go ahead.
Thanks. Good morning.
Good morning, Jeff.
I guess, first question could be for Rick on the deferrals. Just I think if you're on 12% of loans on deferral as of 6/30, I wanted to just clarify that the 62% of those deferrals that had expired, that's fully baked into the 12% number, is that correct, As in those that perhaps did not re-up that's reflective of the 12%?
Thanks for the question, Jeff. As we've gone through the deferral process, I've asked Jill Rice, our Senior Credit Officer for commercial loans to be the keeper of statistics as far as deferrals are concerned. So, I would like to have her answer that question for you. Jill?
Thanks, Rick. Good morning, Jeff. Yes, the 12% was the original deferrals, and then the remaining unexpired are net of that. We do expect that there will be increased extension requests coming in this quarter.
Okay, just trying to net that out, I guess those that don't request extensions on net. In other words, maybe a simple way of asking, do you think that 12% is going to be the peak, and while you might get a handful of extension requests, are you still getting some that do not therefore, the 12% comes down, or maybe I'm missing the message.
No, absolutely that's correct. Based on what we know today from our deep portfolio reviews, we would expect that number to come down. It will increase from the 3% to 4% that are currently unexpired by virtue of expired coming back in, but it will, it's expected to be below that 12% original.
Okay. And as Rick outlined, just in higher risk, maybe hospitality and other, those are the areas that you'd expect extension requests?
Absolutely. The extension requests, hospitality, fitness centers, restaurants, retail trade, and it really depends on the reopening of the economies, again our footprint and the level and trend of the buyers, but those are the four primary areas we would expect to see extension requests come in at this point.
Thanks, and maybe…
Jeff, this is Mark. Let me just add to that, that recall that our policies that we put in place as we started the deferrals was a 90-day deferral, right? So, even though we may get some extensions, they are still not going past the 90-day, or the 180 days.
Thanks. Question on the expense side, Peter, I think if you back out the COVID costs and merger costs, you get to about $87 million, and then if we think about the provision recapture, maybe not recurring, then what was the capitalized benefit from PPP, was that in -- I think it was $2.9 million, is that what you said?
Yes, that's right, Jeff. Yes, that $2.9 million is a non-recurring benefit to expense really tied specifically to the PPP program, and the flurry of originations we did in originating 8,600 PPP loans. So, that piece you could assume will go away in future quarters.
Okay. So, that kind of gets me to about a $91 million basis, does that sound roughly correct?
Yes, that's roughly correct. I think the other dynamic going forward is going to be a couple of things; one is the pace of just general portfolio originations for the rest of the book, which are really tied to the pace of economic reopening, and over time we should see that the volume of capitalized loan origination expenses on the existing portfolio continue to improve as reopening occurs. And then secondly, as you might expect, a lot of our travel and conference and employee business development expenses have been muted in the remote work environment, and in some of the reopening the limits of traveling and reopening. So, we'd expect again as the economy reopens we'll see some of that employee and travel and marketing expense begin to resume normal levels that we've seen in the past.
Okay, great. Maybe one last, well, I got you. Peter, on the tax rate, was that kind of a higher than normal sort of tax efficient investment, or any thoughts on the tax rate ahead?
Yes, there was a catch-up effect really related to the tax exempt revenues as a proportion of total revenues, and capturing that in the quarter. Going forward, we expect the effective tax rate to resume more of a 20% flat rate going forward. So, that will be our guidance going forward.
Okay, I'll step back. Thanks.
Thank you, Jeff.
The next question is from Gordon McGuire of Stephens. Please go ahead.
Hi, good morning.
Good morning, Gordon.
Peter, I appreciate the commentary about resuming the efficiency initiatives, I guess, particularly with the consolidation of the subsidiaries, but I'm curious if you could give us a little more color around what that looks like in a COVID world, maybe size up whether you think the magnitude of what you can do over the near term is different from where you would have thought in January, or just how that process takes place compared to what you would have thought heading into the year?
Yes, Gordon, it's Peter. So yes, I think to your question on how has our outlook changed on efficiency opportunities given the pandemic, I think one thing you'll see is that we're going to be able to be a bit more aggressive on branch rationalization than we would have assumed in January. We've all gotten a good lesson in client behavior and limited branch operation environment, and been able to identify some additional locations that represented opportunities for consolidation. So, I think we're going to be in a position to accelerate some of what we've contemplated would take perhaps longer in a shorter period of time with respect to our branch network.
And then, two, I think our employee expenses, especially the travel-related costs, and perhaps some of the business development-related costs used to tie to physical presence and travel in terms of meetings, client-facing activities, and conferences. I think we'll see a reduction in that. Some of that will not come back, and we'll see a permanent run rate that's somewhat less than we've seen in the past. So I think we'll see some benefits there. And then, we're also wrapping up, you know, we've discussed streamlining the commercial and small business platform in prior calls, and that's been going on all along, but we still have some efficiencies to capture that will manifest over the next 12 months on that side of the business. And so, those are -- it's a collection of initiatives that go on, you'll never see a stair step and a big reduction of expense, but these will accrue over time to generate scale, we grow assets, and continue to create operational efficiencies for the company on an incremental basis quarter-to-quarter.
Okay. And then, the timeline for the consolidation of the banks, how you expect the merger charters to flow through over the next couple of quarters, and then the progression of cost saves there?
Yes, with respect to the Islanders merger that we announced last night, so that's planned and scheduled to close in the first quarter of 2021. So, both the closing, integration, and conversion activities will all happen on the same date. Since that bank is already part of the Banner family, we can close it that way. We anticipate $2 million of integration and conversion-related expense to consolidate that charter. And going forward, we anticipate about the same number, $2 million a year in expense efficiency saves on a fully annualized basis.
Okay. So, the merger costs should all occur when it's consolidated in the first quarter, and that's presumably when the savings would be flushed out as well?
Yes. So, you'll see most of the $2 million were closed in the first quarter, there might be a little bit either side, but the majority of it was closed in Q1, and the efficiencies will be rendered beginning in the second quarter of 2021.
Okay. And then, the balance sheet, I saw had a $340 million of equity securities that looked like they popped up towards the end of the quarter. What is that?
Yes, we've continued to invest some of the excess liquidity in shorter duration securities, you know, given that the surge in deposit liquidity, we've taken the position that that surge in deposit liquidity may not last long-term, some of it will, but some of it will roll off balance sheet, and a lot of what came from the fiscal stimulus programs, the PPP program itself in this general flight to quality and liquidity build-up across our client deposit base. So, we've taken the position of keeping that excess liquidity invested in short-term securities with the expectation that some of it will roll back off balance sheet. So, we don't want to take any duration risk that's excessive, assuming that some of that deposit liquidity will flow back out into the economy as the pace of reopening continues.
Understood. I appreciate it. I'll step back. Thank you.
Thank you, Gordon.
The next question is from Andrew Liesch of Piper Sandler. Please go ahead.
Hi, good morning guys. Thanks for taking the question. I'm just thinking on the securities portfolio here, just curious what do you have been buying a recommend you want to keep it portfolio pretty short here just given some liquidity needs, and some of the excess liquidity, and probably flow up, I'm curious what do you have in mind?
Yes. Andrew, we've been buying a mix of -- we've got money markets, investments, fund that we've been putting the really short-term funds in, that we expect that from a week-to-week liquidity perspective, that's obviously got yields below 1%, and then the rest of it's been laddered into our more traditional mix in the portfolio of amenities, some CRA investments, some MBS, but in general, obviously the yields we're getting today are below the average portfolio yield. So, we try to keep it short, but also balance some duration with what's available out there, but it's -- I would characterize it as being shorter than -- the new investments are have a shorter duration than the legacy portfolio.
Thanks. And then, just curious how the mortgage business is trending this quarter versus what you had to be the strong, the strong performance last quarter, any update on how refi and the purchase segment is performing in your market?
Yes, we had a record year. We will have very closer record year here coming up in a third quarter, even before we end the year in mortgage. So we had a very strong first quarter. We had even stronger second quarter, and obviously some of the improvement has been due to the increased refinance demand. It's now well -- it's almost a 60% of the volume, but we've also seen resilience in the purchase volume as well. So in the spring we've seen strength in purchase related mortgage volume, along with a big increase in refinanced volume that follows the 10 year yield down. We continue to see very strong pipelines going into the third quarter. Our general expectation is -- we have a fairly seasonal mortgage business normally that slows down and Q4 and Q1, and this stage we would anticipate a reasonably strong Q3, and then a traditional slow down, we get into the fourth quarter and as the refinance line begins to add, we'll see some of the effects of that lower line going into the second-half of the year as well.
Great, thanks for taking my questions. I'll step back.
Thank you, Andrew.
The next question is from Jackie Bohlen of KBW. Please go ahead.
Thank you for all the color on that. And just said that I understand, are you looking at it, the combination of all of those items? Are you looking at them more as cost reduction strategies or as something that will slow the pace of other growth?
Yes, Jack. It'sPeter. I would characterize, we do have some offsetting investment infrastructure of the company that we've discussed previously. So there'll be some -- obviously -- and continuing investments in our digital banking platform, a mobile banking platform, some of the residual branch delivery platform in the form of automation and improved client experience solutions that will show some increase, but those will be offset by these other reductions we're discussing. So we - again it's going to be in the long-term a play around scale, where we - as continue to grow assets, we put the infrastructure in to add another $5 billion of assets with a much smaller increase in expense than we would have had otherwise. So I would characterize the efficiency initiatives are going to basically act as an offset to the other infrastructure investments we've been discussing that will enable continued revenue growth and scale for the company.
Okay, thank you. That's very helpful. And I mean not to beat a dead horse here, but I just want to make sure that I understand on the deferrals, and I wanted to talk about it from a dollar value perspective rather than a percentage, since I apologize that I was a little unclear on the prior discussion. So if I look at that $1.1 billion, and you talked about $408 million that are not expired, if I just do the math there, that tells me that roughly $700 million of those have expired. Number one is that the proper way to think about it, and number two, when you talked about the three in June, and I think it was 26 in July for the $33 million that leaves over $600 billion in expired deferrals that have not requested a renewal again. Is that the right way to think about it?
Jackie, this is Jill. That's absolutely the right way to think about it.
Okay. So the vast majority of your deferrals are now having returned to payments status?
Yes. They have returned to payment status or they're coming up on their first payment after the expiration. So they expired in July and a few of them will have a few more days to make payments, but…
Okay, great. Thank you. Oh, sorry. Just one last quick one, can the average balance for PPP loans in the quarter?
Yes, for the second quarter, Jackie?
Yes.
Yes. I believe it's about $750 million on average for the quarter.
Okay. Thank you.
[Operator Instructions] The next question comes from David Feaster of Raymond James. Please go ahead.
Hi, good morning everybody.
Good morning, David.
I just wanted to follow up on Jackie's question on the re-deferrals and ultimately the implications for the reserve build. I mean, that level of -- the low level of re-deferrals is tremendous. I'm really happy to see that, but I guess, the reserve build came towards the low end of the range as core. And if we're looking at a continued low level of re-deferrals, maybe it accelerates a little bit from here, but it's still ultimately sounds like it's going to be pretty low. I guess, do you think most of the heavy lifting is largely done with the reserve build and that there might only be some modest builds in the second half of the year as maybe you get some risk rating downgrades from re-deferrals.
David, this is Rick Barton. Let me take the first swipe at answering your question, which is a good one. I think, as I mentioned it in my comments, we've been pretty candid about risk recognition in the high impact industries and those loans that are under deferral. And if we have made the judgment that they should be downgraded, we have already taken those downgrades rather than allowing the deferrals to run their course both Jill and myself have been at this for quite some time in our careers, and I think we are a good judge of credits that are going to have a longer term rather than just a short-term operating issue. So we have identified and taken those downgrades as we've identified the weaker loans in the portfolio, and it is safe to assume that, as we go forward and the course of the pandemic becomes more clear, that has credits seek additional deferrals or new deferrals come in, which demonstrate operating weaknesses in the core business that there will be a continuing stream adversely classified assets being identified, but to end on how I began, we feel on based on what we know today, that much of the heavy lifting in terms of adversely classifying loans has already been accomplished.
Okay. That's extremely helpful. And then I just wanted to get your thoughts on organic growth going forward. Loans, ex-PPP you highlighted were down, it seems like this was partially a function of declining C&I utilization, but I'm just curious as to what trends you're seeing, how much of the decline quarter-over-quarter was maybe strategic, where you're tightening the credit box versus payoffs and pay downs, assets sales or simply just limited or less demand for new credit and just how your pipeline might be heading into the third quarter?
This is Jill, David, and…
Yes, Peter -- go ahead, Jill.
I'll start by saying that the loan growth we would expect continue to be flat in the near term. The pipelines are okay, but there has been less activity overall in the new loan book, any future growth guidance that we would be able to be based on the economic recovery that we see in the market.
Yes. And let me just add, David, this is Mark. As we dissect some of the loan portfolio, a bulk of the decrease in the loan portfolio has been the result of line utilization decreases. So, as business -- as economies come to a grinding halt, obviously working capital needs are diminished. So, we would suspect that that's going to continue for a period of time. So, our projection is that we are going to have pretty much a flat balance sheet for a period of time.
Okay, that's helpful. And then last one from me. And you touched on it a little bit. Just curious to get your thoughts on the overall expectations for the levels of forgiveness and maybe the timing of forgiveness, you touched on it a little bit but -- and then maybe just the overall fees net of like the origination expenses that you would expect going forward? Thanks.
Yes, David, it's Peter. Yes, so we based on the new guidelines from SBA which have evolved as you know over the last couple of months and the forgiveness timeline that they have guided to, we think we will see the bulk of our forgiveness occur in the fourth quarter of this year, but maybe you will see a bit of it begin from the third quarter. So, the bulk of the forgiveness pay downs will we anticipate impacting us in Q4 and spill into Q1 to a lesser extent. And then, the as we saw the mix of our PPP loans is fairly granular. So, the average loan processing fee on the entire portfolio is about 3.6% which is roughly about $40 million entirety of the portfolio. So, we would expect an acceleration of a portion of that $40 million really show up beginning of the end of third quarter, but end of the fourth quarter, and then we do expect residual balance.
At this point, it's challenging to predict client behavior, but we anticipate there will be a residual balance that will not be forgiven or paid down. It will carry through it's 24 maturity. And we are assuming around 20% or so -- 15 to 20% of the balance will continue out through the remaining amortization period after the bulk of the forgiveness activity occurs.
Okay, that's helpful. And that $40 million book that you referenced, is that net of the expenses like the net NII impact from the PPP coming through?
That's a gross number. So, I didn't adjust for the loan deferral origination cost against that.
Okay, got it. Thanks, guys.
Thank you, David.
The next question is from Tim Coffey of Janney. Please go ahead.
Hi, thanks a lot and good morning everybody. Most of my questions have been answered, but I just want to make sure I understood kind of all the comments you made. So, if I look at the capitalized loan expenses, it seems like those might come back -- run a little bit below normal for the next couple of quarters given the level of activities you are expecting on the loan portfolio. Would that be accurate?
Hi, Tim. It's Peter. I think you certainly suggest the PPP component of the capital as loan originating cost. In Q3, that's at a new baseline. So, I would characterize part of it that some of the activity we had especially in the mortgage side is likely to come back down a little bit. So, I think it will be above what we saw in Q1 which very -- we had a relatively slow quarter of just traditional production as the pandemic became apparent. So, it would be somewhere between the Q1 levels and somewhat below the PPP adjusted level that we had in the second quarter. So, obviously I am not going to give you specific, but I would guide it will be somewhere within those two brackets.
No, that's really helpful, Peter. Thank you. And then on a -- I think that's it. Those are all my questions. Appreciate it.
The next question is a follow-up from Jackie Bohlen of KBW. Please go ahead.
Sorry, I am having a conversation with myself. Thank you for taking my follow-up. I just wanted to do a double check on what -- if you have this fees that were realized through 2Q 20, I am assuming that you amortized some of that. And then obviously there is the 1% interest that was earned. So, I wanted to see what the impact to interest income was from those loans in the quarter?
Yes, Jackie, it's Peter. So, for the second quarter, the PPP loans generated by the 2.75% all in interest yield. So the re-amortization of the fees we did have against the coupon is about 2.75% against the average balance I gave you earlier was about $750 million.
Okay, perfect, again back into the income. Thank you.
Thank you.
There are no other questions at this time. This concludes our question-and-answer session. I'd like to turn the conference back over to Mark Grescovich for closing remarks.
Thank you, Kate, and thank you everyone for your questions. I would like to say that we are very proud of the Banner team as we continue to do the right thing as we battle this pandemic and its effects on the economies, communities, and our own lives.
Thank you for your interest in Banner and joining our call today. We look forward to reporting our results to you again in the future. Have a great day everyone, and please stay safe.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.