BankUnited, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank United Inc. Second Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Susan Greenfield, Corporate Secretary. Please go ahead, ma'am.

Thank you, Josh. Good morning, and thank you for joining us today on our second quarter results conference call. On the call this morning are Raj Singh, our Chairman, President, and CEO, Leslie Lunak, our Chief Financial Officer, and Tom Cornish, our Chief Operating Officer. Before we start, I'd like to remind everyone that this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, that reflects the company's current views with respect to, among other things, future events and financial performance. Any forward-looking statements made during this call are based on the historical performance of the company and its subsidiaries around the company's current plans, estimates, and expectations. The inclusion of this forward-looking information should not be regarded as a representation by the company that the future plans, estimates, or expectations contemplated by the company will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions, including, without limitations, those relating to the company's operations, financial results, financial condition, business process, growth strategy, and liquidity, including as impacted by the COVID-19 pandemic. The company does not undertake any obligation to publicly update or review any forward-looking statements, whether as a result of new information, future developments, or otherwise. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements. Information on these factors can be found in the company's annual report on Form 10-K for the year ended December 31, 2019, and any subsequent quarterly report on Form 10Q or current report on Form 8K, which are available at the SEC's website, www.sec.gov. With that, I'd like to turn the call over to Raj.

Thank you, Susan. Welcome, everyone, to our earnings call. Thanks for giving us your time. Let me make a few comments about the environment before we get into the quarter. You know, three months make a big difference. This is not a traditional economic downturn. It's not caused by anything other than, you know, the virus. It is still a very serious situation, but we feel a lot better today than we did 90 days ago. There have been some encouraging signs in the economy over the last three months, whether it's employment data from May and June or retail sales or home sales or capital markets generally, but there is still a lot of uncertainty. Unemployment is still very high. There are mixed signals about certain sectors in CREs. The virus, obviously, is still not contained, and there are a number of states that are reporting high levels, including Florida. The impact of all of this then gets further compounded by the fact that we are 100 days away from election, and the political, you know, scenario in the country will make it even harder to read where the economy is headed in the next 100 days and beyond. But overall, we are much more optimistic today, but I would still say we are cautiously optimistic than we were three months ago. When all this started, we started having board meetings early on. It was actually on a weekly basis to inform our board, but then eventually every two weeks. And in one of the early board meetings, a question was brought up, which I want to share with the shareholders. which was about, you know, how are we going to deal with this crisis over the course of the next year or so and what are the principles around which we will react to all this. And three principles were already laid on the table, which we have, you know, used in doing everything that we're doing in the bank. First is intellectual honesty with yourself, which is to say, you know, don't try and be overly optimistic and say, oh, this is okay, it will all be fine. So be intellectually honest with yourself. Second, be transparent with all stakeholders. That includes, of course, shareholders, but also includes our regulators, rating agencies, even our customers, our employees. Be transparent. Provide more information than usual. And don't try and hide anything. Third, be proactive. Or put differently, don't try to kick the can down the road, because eventually you're going to have to deal with the issues. So be proactive and deal with them early. Get in front of the issues rather than behind them. So we've used these three principles. in all the decisions that we've made over the course of the last three, I guess, four months now. And with that, let me quickly turn into what the earnings were for the quarter. We reported $76.5 million of earnings this quarter, 80 cents per share. This compares to 81 cents per share last year. This time, the annualized ROE and ROA was 11.6% and 90 basis points for ROA. We told you last time when we spoke to you that the PPNR would trend favorably. We told you that NIM will increase, the cost of funds will decline, will probably be the biggest decline in the history of the company. We told you operating expenses would trend downwards, and all of those things have happened. PPNR is up $37 million, or 44% quarter over quarter. Ten of that, $37 million came from net interest income, 15 came from non-interest income, and 12 came from expenses. Leslie will get into the details of all that. But overall, across the board, all P&L items went the right way. Unlike peers, most we have reported declines in NIM. Our NIM actually improved from $235 to $239, as we had indicated three months ago. driven mostly because of cost of deposits. Our total cost of deposits declined 56 basis points from last quarter. So we went from 136 down to 80. And on a spot basis, at the end of the quarter on June 30th, our APYR deposits was already down to 65 basis points, and into July it continues to drop. So next quarter you can expect another drop in cost of deposits. Maybe not 56 basis points, but it will be a nice drop again. And that trend, we expect that to continue into all of this year into early next year. Provision also declined to $25.4 million from $125.4 million last quarter. Leslie will get into all the details around provision and reserve. But at a high level, you know, I would say that our reserve bill from the end of December, so, you know, for the year, we have more than doubled our reserves. And then now, you know, I think this was 130% increase. We quickly yesterday looked at our peers, and we looked at banks between $10 and $100 billion to see just how much reserve bill people have actually done, and the average or the median was somewhere around 60%. So this is what I'm reporting to in terms of getting in front of these issues and taking your medicine early, which we did in the first quarter, which is what resulted in the loss that we posted last quarter. Quickly switching to some balance sheet items, non-interest DBA grew by $1.3 billion, 28% basically, not annualized, just 28% quarter over quarter. Now DBA stands at 23% of total deposits. Last quarter I think we were at 18%, so, you know, very healthy trend. Average non-interest DBA was up also by $944 million compared to last quarter. Interest-earning assets were also up for the quarter. Loans and leases grew by $656 million, and securities portfolio grew by $819 million. And again, Leslie will get you a little more detail on that. We also saw a very substantial recovery in the unrealized loss on securities in the second quarter. So if you remember, in the first quarter, we had a $250 million mark, a negative mark, obviously, on the securities portfolio. And we had... talked about how that was recovering nicely and that over the course of months we expected to claw all of that back. We're happy to report that we've clawed most of it back. We're down to only 2.6 million, so from negative 250 to negative 2.6, that's almost a 99% comeback in a three-month period. Now, there are still some unrealized losses in the CMBS and CLO asset class, and they're continuing to get better. and all this have been very comfortable with the portfolio. Book value increased by $2.59 this quarter. So, you know, overall, couldn't be happier with the performance. Capital, our capital position remains robust. Our set fund ratio is 12.2 at the Holco and 13.4 at the bank. Oh, yes, we did issue $300 million in Holco sub-debt this quarter, at 5 and an 8, and, you know, that helps our total capital ratio, which now stands at 14.3%. The dividend, we, in evaluating our dividend, we, of course, look at two things. We look at our capital adequacy, and we look at our sort of medium-term or near-term and medium-term earnings. We feel good about both those things, and so we paid out a 23-cent dividend in the second quarter. And management at this time expects to recommend the same going forward. A few remarks about credit. And Tom and Leslie will get into it more deeply. But as we discussed with you, you know, we've been very proactive in identifying the subsegments and the borrowers that will, in our estimation, be impacted by COVID-19 more than others. So that strategy has not changed. Our ratios, NPAs, NPLs, are basically flat to prior quarter end, down marginally compared to December 31st. At June 30th, NPA ratio was 60 basis points, but again, if you exclude the guaranteed portion of XPA loans, it was 47 basis points. NPLs were at 86 basis points, but again, if you exclude the guaranteed portion of XPA loans, then it's 67 basis points. The efforts we've made to assist borrowers with PPP loans and all the deferrals are likely helping to mitigate and keep these numbers down. Annualized charge-off for the quarter was 20 basis points. The majority of this was linked to one loan in the franchise portfolio. This loan had been showing weakness before COVID. but it got resolved or worked out in the middle of the pandemic. You know, they filed for bankruptcy just before, I think it was in February, so just before the pandemic kicked off, the worst time to work out a loan, which limited our workout solution. So that's actually a large part of the charge of just that one loan. As you know, we've been very accommodating in granting 90-day deferrals. We had started to do that in the last week of March. Most of our deferrals came in over a three-week period from last week of March and the first two weeks of April, and then it really tapered off after that. We initially granted deferrals on $3.6 billion in loans, about 15% of our portfolio. However, far fewer people are asking now for a re-deferral. So the requests that we've received so far for re-deferrals is only $748 million. So think of it as early on, 15% of our portfolio or 3.6 billion asked for a deferral. And now when it comes time, because we only did 90-day deferrals. We did not do anything more than that. So now that 90 days are expiring or have expired for a lot of these, the requests are coming in at a much lower clip. Only 748 million or 3%. So that's a big drop. And this is a very important number. I want to stress on this because these are hard numbers. This is indicative of customer behavior. These are not our estimates or a model telling us anything. This is actually what customers are doing. So I see that as a very positive number. Of course, it changes. But, you know, where we are at the end of July, this is actually a very good place to be. with the re-deferral rate. We did see an increase in special mention and substandard accruing loans. We did a deep dive in the commercial portfolio this quarter, and we reached out to individual borrowers, especially those who we thought were impacted. And we've increased monitoring of the portfolio to a totally different level, something we had never done or never thought of doing. until three months ago, but now we're monitoring this on a weekly basis, a monthly basis. And we use all this information to relist the portfolio. So this increase, think of it as lagging the CECL numbers, because while CECL is essentially a modeling exercise, which we did at the end of March, this is a very manual exercise. This is literally, you have to pick up a loan file, read it, analyze, make a judgment about whether the risk has gone up or not, and then re-rate. So this happened over the course of the quarter, and in some ways it's catching up to the reserve that we put up at the end of the last quarter. So going forward, strategy, quickly. You know, this quarter, let's talk a little bit about this quarter. You know, our safety and wellness of our employees is a primary, you know, the number one focus, and I'm happy to say everyone is fine. There have been some cases of COVID positives, but, you know, nobody is seriously ill, and the bank operationally is working just fine. There are no issues on liquidity. There was a lot more focus around the entire system last quarter, but I think the Fed and everyone else has done a great job. Liquidity is not an issue at all anywhere. We directed much of our efforts this quarter towards PPP. And to say that it was a Herculean task in the month of April would be an understatement. We did do 3,600 loans in a month. Just thinking about it, I even get surprised now, even though we have achieved that, it was just an unbelievable task. The BU 2.0, which has been an ongoing initiative for the last year and a half, continues to move forward. As we told you last quarter, we are going to overshoot on the expense side, and on the revenue side, there will be some delays simply because launching some of these new efforts, new revenue efforts, does become a little hard when everybody's locked down, and it's hard to get in front of new clients. But in terms of expenses, I think our target was $40 million. We're already at $47, and there's probably still some more that will come. And in terms of revenue, our numbers are still pretty good in terms of what we are shooting for, $20 million, but the timing is delayed. We are, just to talk about some of the high-level initiatives, we are launching the commercial credit cards this quarter. The small business initiatives are also proceeding. We are going to launch automated underwriting platform later this year. That was a little bit delayed. and other initiatives include we did sign a fee-generating agreement with Goldman Sachs this quarter just a few days ago, and also a strategic shift in direction towards more treasury management and enhancing those products is all on track. We've also launched a new customer derivative program, which also will generate revenue on the commercial side. So overall, very happy with where we are. Let me turn it over to Tom, who can walk you through in a little more detail loans, deposits, credit, and so on.

Tom? Great, Raj. Thank you. So just to amplify some of the comments Raj made earlier, excellent quarter overall for deposit growth. Total deposits were up $1.1 billion for the quarter. And as Raj mentioned, non-interest DEA actually grew by $1.3 billion today. So looking into those numbers a little bit, while it's difficult to be exact about this, as we finished the quarter, we estimated that we had somewhere between $400 to $600 million of non-interest EDA on the balance sheet that was related to the PPP loan proceeds that were still residing in the operating accounts of the clients. Remember, we funded a little bit over $800 million. So, you know, while that was... A part of the growth, we still saw strong overall growth in NIDDA across all geographies and business lines. And a significant portion of our deposit growth this quarter actually came from new client relationships. We had over 700 new business relationships generated over the quarter. And remember that this was a very different quarter for us in terms of generating, you know, business in a remote environment. We were learning how to do that, and I think we did a really great job of it. We had close to $500 million in deposit growth that came out of those 700 business relationships. Again, each line of business contributed to that significantly. With this growth in our liquidity position, we were able to let some higher cost deposits run off during the quarter. Total time deposits actually declined by $811 million in the quarter as we reduced our CD rates. We do believe that some of that money moved into the money market product. As Raj mentioned, we continue to very systematically reduce our deposit costs. The spot rate on total deposits declined by 47 basis points for the quarter and 77 basis points year-to-date. And still there are 2.3 billion CDs that have not yet repriced since the last Fed rate cut with a weighted average rate of 1.91. So you can see from that we still have of significant opportunities as we renew CDs at substantially lower rates. Loan growth, let's talk about loan growth just a bit. Loan growth primarily was concentrated in the PPP loans, in the mortgage warehousing area. We had $827 million of growth in PPP and $308 million in mortgage warehouse. Our C&I business was down by $317 million in the quarter, mostly due to lower than normal production. And also, we have seen fairly substantial reductions in line utilization as we got into the second quarter, you know, well below what we saw pre-COVID sort of line utilization numbers. And most of the categories experiencing the marginal increases or declines for the quarter, those are really the three big change items for the quarter. From a PPP perspective, as Raj said, we did over 3,500 loans, totaling $876 million. Almost all of these loans were made to existing clients of the bank, and we were able to accommodate all existing customers who came to us for a PPP loan. So that was a particular source of pride for us in the quarter, making sure that we took care of our clients. Our average loan size was $245,000. As of today, we have not yet started starting processes for forgiveness applications yet, but we expect to do that starting shortly. Just a few comments on growth and short-term growth opportunities from a strategy perspective. Obviously, the first half of Q2 was focused on PPP loans. As Raj mentioned, it was a Herculean effort to essentially do, you know, 3,500 loans over a couple-a-week period of time. But we also saw good growth in the mortgage warehouse and some opportunities existing on the residential side. Pretty much everywhere else, we're taking a cautious stance. We're focused on the existing client base right now. And I would deem our overall current strategy to be strategically selective. We do have a number of clients that we're looking at increasing credit facilities where they have resilient business models and are actually seeing growth. In revenue, we're also starting to see some M&A opportunities within our client base and valuations that are pretty attractive to what we've seen them on a historic basis. So we do expect to see some opportunities there. And we're looking at new client businesses with companies that have strong financial conditions and operating performance and industry segments that are part of our longer-term strategic growth plan. So we've identified some areas even prior to COVID where we wanted to grow and we're still looking for new opportunities there. Beyond that, we're being cautious at this time until we can see some longer-term stability in the economy and a trajectory of where the health care crisis is going in the markets particularly that we're in. It's likely overall excluding any forgiveness activity with PPP, which we think will be more of a Q4, Q1 2021 type event, that we'll see the loan portfolio down just slightly for Q3. We continue to see opportunities onboard new deposit relationships across all business lines. Our pipelines from, you know, all of our teams and our treasury management business is very strong. We're seeing movement of relationships to the bank in very significant numbers. We expect deposit growth in Q3 again, but probably not to the extent we saw this quarter. Our emphasis continues to be on creating full banking relationships that include non-interest EVA. So to shift from that a little bit and talk about loans on the deferral basis, slide 21 in the supplemental deck provides more detail around this as well. You know, again, to emphasize what Raj said, our deferral rate has dropped significantly from the initial deferral rate that we saw. So we look at different parts of the portfolio In the commercial portfolio, we granted 90-day deferral loans for the first time, totaling $3 billion, which represented about 17% of the total commercial book. At this point, we've received second deferral requests on loans, totaling only $696 million, or 4% of the commercial book through July 17th. So that's a very strong and promising reduction in the level of second deferrals. that we've seen. Our initial deferral requests were mostly heavily concentrated in the Cree book with 29% initial deferral rate in Franchise Finance with an initial 74% deferral rate. The re-deferral rate in those segments are now as of the 17th down to 6% for the Cree portfolio and 25% for Franchise. The CREA initial deferrals were mostly concentrated in the hotel and retail property types. So, again, substantial improvement in both of those numbers. I also want to emphasize that the re-deferral rate on the C&I portfolio was only 1% of the portfolio. So that was not large to begin with, and it's very, very minimal at this point. So in each of these cases, also, when we look at second-level re-deferrals, you know, the initial deferrals we basically gave fairly, you know, readily. These, for the most part, we're looking at improving our collateral position, you know, guarantees or other credit enhancements that we're looking at as we're going forward through the second level of deferrals. The substantial majority of the initial deferrals were processed in late March and April. so have recently reached or are coming to the 90 days. While more second deferral requests may still come, and there's obviously some changes going on in different parts of the economy, we think we've probably received most or all of them at this point. New first-time deferral requests trailed off materially after April, and have really been pretty negligible since June the 1st. Switching to the residential portfolio, we granted approximately $594 million initial 90-day deferrals excluding the Jenny Mae early buyout portfolio that represented about 13% of the overall portfolio. Of these, 42% or $252 million have actually continued to make payments during the deferral period. $52 million or 1% of the portfolio have been deferred for another 90 days either by request or automatically by operations of the new regulations. I want to give you a little data on rent collections, particularly within the CRE portfolio in terms of what we're seeing. And this will take you through June. It's not 100% of the portfolio, but it's representative of a very large percentage that we're reaching out to and collecting this data. So if you go by product category, in the office segment, Florida's collection rates were in the 80%. New York was in the 70s. Multi-family in Florida was in the 90s. New York was in the 80s. Retail overall average was 62%, a little bit more dispersion of the mean in the retail area depending upon the product and where it is, but 62% was the average, generally higher in Florida. And in our warehouse and industrial segment, really minimal. Collection rates have been, you know, in the 90% range. I want to talk a little bit about hotel occupancy and the hotel market. Right now, substantially all hotel properties in both Florida and New York are open. There's a couple still closed, but the majority are open. Florida expected occupancy for June, for July, I mean. We're seeing ranges from 30% to close to 60%, trending up since April, where it averaged about 20%. Having seen a number of occupancy around holidays, weekends, where numbers have been, you know, higher than that, the summer season in Florida does tend to be the slower season. So, you know, we're tracking that carefully to see you know, how occupancy moves up as the fall and winter seasons start to come into play. But, you know, this is an area that will be challenged, and this is one area where we expect to see some restructuring that's longer than the typical 90-day deferral. We don't have any occupancy data for New York yet. These hotels have just really opened up recently. Our largest one opens up tomorrow, as a matter of fact. Once in a while, I'm on the franchise side. Franchise restaurant, a fairly wide range of performance there, but some good news overall. And it really is based kind of more on operating model. To the extent you're open and have an established drive-thru and delivery model, results have been pretty favorable. In many cases, we've actually seen year-to-year increases in safe store sales revenue for the April-May timeframe. Full dine-in concepts, which is a much smaller portion of our portfolio. has struggled. That is a tougher recovery from an all in dying type concept. But in all cases where we have data, May results all showed an improvement over April results. And while trends are still looking better, it's a bit early to see that the second level of deferral requests have dropped dramatically in that portfolio as well. Fitness is another portion of what's in our franchise business. stores are beginning to open up in many of the markets that we lend to. So it's still a little bit early to state that. But overall, the re-deferral rate in franchise is 25% compared to the original 74% for the first level of deferrals. So we're seeing much better performance than we could have even hoped for at that point. 25% I think is really excellent. So We'll turn it over to Leslie now to get into a little more detail on CECL and quarterly results.

Good morning, everybody. Before I dive in, we're not really doing a walkthrough of our deck today with you, but we did put a supplemental deck out there for you that updates a lot of the information that we had given you at the end of the first quarter, so it's there for reference. And so now diving into CECL and the allowance for credit losses. There are a lot of moving parts to the reserve estimates for the quarter, and I'll try to walk you through the more significant ones. So for your later reading pleasure, slide 15 in our supplemental deck walks through the changes to the reserve by major portfolio segment. You can look there as I'm talking if you want to. But let me speak first to the economic forecast assumptions. So the loss estimate is impacted by economic factors in two different ways. One is it takes into account economic conditions as they existed at the balance sheet date, which were significantly worse at June 30th compared to the model inputs at the prior quarter end. The second way is the forward path of the economic forecast, which was in some respects worse and in others better compared to the March 31st forecast. And one thing to note here is that at June 30th, unlike at March 31st, The worst point of the forecasted trajectory of the economy was behind us, whereas at March 31st it was in front of us. To give you a few high-level data points, the forecast for this quarter incorporated unemployment starting at 13.4%, declining to 9% by the end of 2020, and to 7% by the end of 2021. Annualized GDP growth started at a negative 27%. recovers pretty significantly in Q3, and ultimately returns to pre-recession levels by 2023. The VIX trailing average started this quarter at 32. It stayed elevated through 2020 and moderates from there, although it remains pretty choppy throughout the forecast horizon. The S&P 500 started at about 2,900, declined to about 2,700 at the end of 2020, and and ends 2021 over $3,000, again, kind of choppy. This quarter was a tale of three cities, so to speak, with respect to the reserve. At a high level, we used three different models to estimate expected losses, and we do that at the loan level. We used one model for residential, one for Cree, and yet a third one for CNI, and each of those models works a little differently. and has greater sensitivity to different economic variables and factors. And I'm looking now at slide 15. If you want to go there, if not, just listen and you can look later. So let's start with the easy one, residential. There wasn't a material change in the level of residential reserves this quarter. The residential model is most sensitive to HPI, which actually improved in the June forecast compared to the March forecast. The model is also pretty sensitive to unemployment. which was worse in the June forecast, so those factors moved in opposite directions. An update to expected prepayment speeds also reduced the residential reserve marginally this quarter. In the aggregate for the CRE portfolio, the reserve increased from 57 basis points at March 31st to 1.54% at June 30th. The CRE model is highly sensitive to unemployment, as well as to commercial property forecasts by property type and geography. Both of those deteriorated from the prior quarter's forecast in terms of the starting point and the forecasted trajectory. So as a result, the economic forecast increased to the Cree Reserve by $48 million this quarter. Additionally, we applied a qualitative factor of $24 million, increasing the reserve based on data collected from individual borrowers that reflected a deterioration in current revenue levels or financial condition as compared to the most recent financial statements that were housed in the model. We collected this information from a substantial representative sample of borrowers, and we extrapolated the results across the relevant population in coming up with the qualitative factor. In contrast, the reserve on the C&I portfolio declined from 2% to 1.38% this quarter. The CNI model is very sensitive to changes in the volatility index and to the S&P 500. While it's also sensitive to unemployment, this model is less sensitive to unemployment than the CRE model. And while the starting point of all of these variables was worse at June 30th than at March 31st, the forward path of the VIX and the S&P 500 actually improved in the June forecast compared to the March forecast, as did expectations for credit spreads. So that offset the deterioration in unemployment. Similar to the pre-portfolio, we made qualitative adjustments, increasing the commercial reserve based on data collected from a representative sample of our borrowers. One other thing that affected the commercial reserve this quarter, at 331, we made an assumption with respect to prepayments, effectively assuming zero prepayments for a period of time. Sitting at March 31st, our thought process was kind of, you know, no one's going to prepay a loan in the middle of a pandemic. So we set prepayments to zero. Under CECL, the reserve is very sensitive to prepayment expectations, irrespective of the state of the economy because it's a lifetime reserve estimate. That zero prepayment assumption turned out to be very inconsistent with our actual experience for the second quarter. Prepayments for the quarter actually picked up from our historical averages. So we removed that zero prepayment assumption from for the quarter, and that did have the impact of bringing the reserve down some, particularly in the C&I segment. That affected all segments, but the C&I segment was much more sensitive to it or much more impacted by it. The franchise portfolio continues to carry the highest reserve level at 3.12%, followed by CRE and then C&I. The franchise reserve is a little bit down this quarter as a percentage of loans, but that's mainly because of the large charge-off that Raj referred to that we took that reduced the reserve this quarter. These relative reserve levels, higher in franchise, increase, and lower in C&I, are consistent with our deferral rates, our re-deferral rates, and our other observations about relative levels of stress being exhibited in those different portfolio segments. I would also like to point out that at June 30th, our reserve was sitting at 60% of 2020, the best severely adverse losses. And under stress, our capital ratios remain comfortably above well capitalized levels. As to expectations about the provision in the reserve going forward, There are a couple things that could lead to additional reserve build other than new production. One would be if the overall economic outlook deteriorates materially from what our current forecast would suggest. The main catalyst we can see to that happen is some sort of return to widespread shutdowns or loss of confidence related to spread of the virus. Our reserve levels at June 30th aren't predicated on an expectation of a widespread return to shutdowns of the economy. We could also have some more granular borrower-specific or sub-segment-specific individual bills if response of individual borrowers to the pandemic differ from, you know, our current expectations or what our model is currently projecting. But outside of, you know, a significant deterioration in the economy, I wouldn't expect material reserve bills. Any of these things could also, in theory, move in the other direction. Next, I'd like to give you a little bit of color around risk rating migration. There are some slides in the deck on this. Let me start by restating the guiding principle that Raj called out. When it comes to risk rating, we call it the way it is, and we attempt to be both proactive and objective. We started the downgrade process early. We called out any weaknesses that we saw. We believe that calling it what it is and recognizing an increase in risk when we see it is the only way to do this. I think it's difficult to... conclude that given the current state of things with the pandemic, that credit not increased, and we believe our risk rating methodology reflects that. Comparing risk ratings from bank to bank can be pretty difficult, particularly in this environment, because every bank takes a different approach to this. You know, we know there are some banks that have decided to wait to re-risk rate their portfolio, for example, until all their deferral periods are over. but that is not the approach we decided to take. Another thing I'd like to say real quick about risk ratings in relation to the reserve, we believe that the risk rating distribution of our portfolio is reflective of where our reserves sat at 331. In effect, our risk rating process is kind of catching up this quarter with our reserves. Having said that, to get into some of the details, Total special mention loans increased significantly from $288 million to $1.3 billion during the quarter. The segments where we saw the most significant increase were those where we expected to see it, Cree Retail and Hotel. Within CNI, we saw it in the cruise line credits, in retail trade, food services, and also we saw it in franchise finance. You know, Cree... Increase in special mention was $527 million. Most of that was in retail at $168 and hotel at $270. CNI, we saw an increase in special mention of $329. We saw that, as I said, mostly in the cruise lines, retail trade, and food services franchise. It went up $147 million, not unexpectedly. We consider special mention ratings to be a transitional rating for loans that have potential weaknesses that could result in deterioration of repayment prospects at some future date if not checked or corrected. Total substandard accruing loan increased from $239 million to $561 million this quarter. Again, the segments with the largest increases were CREE, primarily hotel and retail. And within CNI, the most significant increase related to a couple of borrowers who supply or operate airport shops or concessions, which, of course, six months ago looked like a great business. Let me shift now and talk for a minute about the NIM. The NIM increased by four basis points this quarter from 235 to 239. To get into the components of that, the yield on interest earning assets declined by 44 basis points. reflecting a decline of 47 basis points in the yield on loans and a 33 basis point decline in the yield on investment securities. Reset of the coupon on floaters was the most impactful contributor to the declines in yields on securities, and overall the decline in asset yields resulted from declines in benchmark rates, including turnover of the portfolio at lower prevailing rates. The cost of interest-bearing liabilities declined by 60 basis points quarter over quarter, with the cost of interest-bearing deposits down by 65 basis points and the cost of borrowings down by 54 basis points. Our expectation currently is for the NIM to be relatively stable for the third quarter. We believe both deposit costs and the yield on interest-earning assets will decline further, but on balance, the NIM will remain stable. We don't expect to see much recognition of fees from PPP forgiveness in the third quarter. We don't really expect to see that start to happen before Q4. Some specific items that impacted non-interest income and non-interest expense, securities gains were $6.8 million this quarter compared to a loss of $3.5 million last quarter. Last quarter, if you recall, we had an unrealized loss of $5 million on marketable equity securities that ran through the P&L. This quarter, that component was a gain of $1.1 million. Other securities gains arose from just our ongoing management and positioning of the portfolio. Deposit service charges declined a little bit compared to the preceding quarter and the comparable quarter of the prior year. There was some forgiveness of service charges this quarter related to COVID, and there was also just lower volume of activity in some fee areas this quarter, which we believe was related to the pandemic as well. Employee compensation and benefits decreased by $10 million compared to the immediately preceding quarter, Some of that is seasonal payroll taxes, 401K contributions, and HSA seating are always elevated in the first quarter. And additionally, variable compensation costs were lower this quarter, reflective of lower levels of production and earnings resulting from the pandemic. Probably a more valid comparison, because there's a lot of quarter-over-quarter noise, is the six months into June 30, 2020, compared to the prior year, where we saw comp and benefits decrease by $14.7 million. We're really starting to see here the impact of all of our Bank United 2.0 expense initiatives. Non-interest expense for the quarter does include $1.5 million of costs related directly to the pandemic. That could be everything from equipment to facilitate people working from home to some costs we encourage standing up our PPP program, supplies, equipping branches, things like that. There will probably be a little bit more of this to come. Our expectation is that operating expenses will be relatively flat for Q3 compared to Q2. And with that, I'm going to turn it over to Raj for some closing comments.

Thank you, Leslie. The problem with transparency and providing you a lot of information is that these calls take forever. So sorry for taking so much of your time, but we'll open it up for Q&A.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by. We'll compile the Q&A roster. Our first question comes from Steven Scotton with Piper Sandler. You may proceed with your question.

Yeah, good morning. Thanks. I'm curious maybe first on the expense run rate. I mean, a really impressive quarter-over-quarter change there. I know your guidance kind of previously, which, you know, Obviously, no one could be too specific, but it was just for expenses to be down year over year. So I'm wondering if you could dig deeper into the salary migrations and what really caused that, if it was FTE reductions or more just the things you noted in the release. And then just lastly, if there was a FAS91 impact within salaries as well.

Yeah. So I think the salary reduction, the most significant component of that, Stephen, is in fact FTE reductions year over year. There's a little bit of an element of that, as I mentioned in my remarks, that's reduced variable compensation. As to the FAS91, if you look at Q2 compared to Q1, yes, there were a little bit more FAS91 costs deferred in Q2 because of PPP. However, year over year, that actually went the other way. There were significantly more FAS91 deferrals in 19 than in 20 because loan growth was higher in 19. And I don't have – I'm sorry, I don't have those exact numbers in front of me.

No, that's okay. Yeah, no, that's really helpful. Okay, and maybe just the one other question really I have is, so you guys gave a ton of detail on the migrations and the movements in the loan loss reserve, which is extremely helpful, but I guess maybe generically, how would you respond to kind of maybe a feeling if somebody looked at your reserve on a standalone basis, call it the 127 without the PPP and the mortgage warehouse, that that on an absolute basis may look below peers? Would you just kind of highlight, I guess, all that you already said and say that you believe the risk rating changes are the lagging indicator, or how can you maybe frame that, of course?

I think you have to take into account the portfolio mix. So, when you compare bank A to bank B, there's often a very big difference in portfolio mix. You know, we have a big REGI portfolio. We have, you know, other large portfolios that are not really impacted by this. So, You know, a municipal portfolio, there's hardly a reserve against that. That's a billion and a half. So if you normalize for those things, then you will – that explains it more than anything else. We've always said our portfolio was never really created for high yield. You know, it doesn't have the high yield components. In other words, it doesn't have the high risk components, which is why, you know, you see that difference. If he had, you know, a couple of billion dollars of construction loans or some other, you know, leverage loans, a couple of billion of that, he would see a much higher reserve.

Yeah, I would echo that. I think it's largely reflective of what we believe to be the quality of the portfolio. And, Stephen, yes, I do think the risk rating migration is a lagging indicator. I think the risk rating distribution... at 630 is much more reflective of where the – I think the reserve at 331 a quarter ago was more reflective of the current risk rating distribution than of the risk rating distribution at that date. It's kind of catching up.

Yeah. Okay. That makes a lot of sense. Thanks for all the color, guys. Appreciate it.

Thank you. Our next question comes from Brady Davey with KBW in the preceding question.

Hey, thanks. Good morning, guys.

Good morning.

So if you look at the Bank United 2.0 plan, I mean, clearly you're coming ahead of where you thought you'd be on the expense side. I think you said you're already at $47 million versus I think the initial estimate was around $40 million. How much better do you think you can do on the expense side? It feels like, you know, the world has changed and there's probably some more, you know, branches and maybe people that weren't planned, you know, back when BKU was initially established.

Yeah, Brady, we have not gone back and majorly redone the initiatives to say, okay, let's take a second look at this and, you know, a 3.0, for lack of a better word. We haven't done that because, you know, the last two, three months have been rather sort of, you know, we've been focused tactically on everything PPP and everything else that we're doing in this environment. But we will take a look at it. As the business model changes, as customer behavior changes, If there is an opportunity to look for more stuff, you know, branch is a simple example of that. We are going to look at that, but that's not going to happen in the next quarter or two. Those will be longer term because any decisions you make that are meaningful do take a year or two to really, you know, not to analyze, but to operationalize, right? If you decide there's one more branch you could close, if you decide today, you're not going to see the impact of that for at least a year, if not longer.

Okay. And then looking at the cost of funds or the cost of deposits, and it's a nice reduction there, but you have a cost of deposits that's still 80 basis points, which feels like there's definitely room to move that lower. How low do you think you can get the cost of deposits in this kind of zero interest rate environment?

Well, we're kind of showing you a little bit of what it's already looking like by telling you June 30th, it was down to 65 already, right? It was 80 for the quarter, but a point in time in June 30th is 65, and it's already down from there in the first three weeks of July. I think we bottomed out in the high 50s basis points. Last time, Fred was at 0%. we're pretty confident that we will go well past that. Now, do we bottom out in the 40s or the 30s? It's really hard to say. What we are focused on is basically bringing in operating accounts. And that actually, more than anything else, more than any of the highlight numbers, that's really the driver of long-term value. And we're having a lot of success. PPT, was a gift, you know, as faithful as it was to go through it. But looking back at it, it was such a big gift. And the reason it was a big gift is a lot of big banks really, really ticked off their clients. And that has given an opportunity for us to go in. Even though we didn't do their PPP loans, but if you were not treated well by a bank in April, And even if you got a PPP loan eventually, but you have to go through a month of not knowing whether you'll get the money or not and not getting phone calls returned, that creates an opportunity for banks like us. And we're already capturing that. Some of the numbers you see here, some of the growth that we've gotten is because of that. And the pipeline, as Tom said, is robust, is because of that. So that will be a gift that will keep giving for the next few months into next year.

Perfect. Got it.

Thanks, guys.

Thank you. Our next question comes from Jared Shaw with Wells Fargo. You may proceed with your question. Hi, good morning.

Good morning. Just wanted to circle back on the allowance and credit. First, I guess, you know, on the deferrals, what percentage of the portfolio has already gone through that first 90 days? I see, you know, we're down to 4%, but, you know, is that 4%, you know, a good indicative level of the whole thing, or that's just where we are right now?

Yeah, most of those first-round deferrals happen in a three-week period, which was last week of March and the first two weeks of April. So here we are sitting at the end of July. So I don't have the exact numbers, but I'd say a pretty large majority has already hit the 90-day window. And remember, they start talking to us about asking for another deferral not on the last day. Those conversations generally start at sort of the two-month or two-and-a-half-month periods. So we feel that we have fielded a lot or most of what has to come in terms of re-deferrals. But there may be still some that trickle in, but a majority of it. And by the way, what we're showing you is actually not approved deferrals. What we're showing you, these re-deferral rates are the requests because they're still, some of them are still in process. And not every one of them will be granted. Most of them will be granted, but some may not be granted. We're showing you the requests that are coming. That's actually a larger number than what will actually get processed.

Got it. Okay. And then just looking at the allowance and the provision level, I'm looking at slide 14 where you have the reduction in allowance of 8.4 from the economic forecast. That's definitely not what we've seen with the other banks. And, you know, I haven't really heard other banks focus on the VIX and the S&P. And, you know, when I look at, like, the baseline Moody's GDP expectation for 2021 from March to June, it's actually gotten worse. So, I guess, was there a change in methodology from first quarter to the second quarter on CISO? Or can you just give a little more color on, you know, that broader economic view? Yeah.

Yeah, I would ask you to flip to slide 15, which I think is going to answer your question better than slide 14, because it really breaks it down. Like in my remarks, I kind of said it's a tale of three cities. And you can see that the impacts were very different in the Cree portfolio than in the CNI portfolio, where the economic forecast really was punitive to the Cree portfolio. I can't speak to what other banks are doing or what models they're using. but I can say that the model that we use for our CNI portfolio, which is one of the suite of Moody's models, is very sensitive to the VIX and the S&P. I know a lot of other banks aren't talking about that. Maybe they don't have a lot of those types of loans in their portfolio that would run through that model. I can't speak to that, but... you know, that's really what's driving it. So, no, there's no change in methodology whatsoever. Those particular economic variables in the June forecast actually improved compared to the March forecast.

Okay. All right.

Thank you.

Yeah.

Thank you. Our next question comes from Stephen Alexopoulos with T.P. Morgan. You may proceed with your question.

Hey, good morning, everybody.

Good morning.

Good morning.

Before I start, I just have to say your credit-related disclosures, both the slide deck and on this call, are really top-notch. I think the best I've seen in the industry, so thank you for that. To follow up on Jared's questioning, I tell you, I think we're all staring at this slide 15 and looking at the reduction tied to the economic forecast and CNI and scratching our heads saying, how would the market volatility in the S&P 500 impact Bank United's credit quality on CNI, it just doesn't seem to make sense to us.

So it's a correlation. I can send you the Moody's 1,000-page white paper on the risk-out model, but you probably don't have time to read that. But, you know, what Moody's has determined is that with middle market CNI modeling, that those are the two factors that are most highly correlated to credit performance. You know, I think there's probably a whole lot of complicated math behind that. This may be over my head in some respects, but those are the factors that Moody's has determined are most, you know, this is from their credit research database with millions upon millions upon millions of observations, and these are the factors that they've determined that losses for those types of loans are most highly correlated to. Mathematically, that's how I answer your question, but to take a step back from that, I will tell you that we feel really good about where the reserve is sitting on our particular C&I book right now. We think it's in the right place. We know what's in that book. We know the quality of those borrowers. We understand their businesses. We understand their performance and their financial condition. We've spent a lot of time understanding how they're being impacted by the pandemic. And we really feel like the reserve on that particular portfolio segment is right where it needs to be. And I think that's the more important thing than trying to have You know, we can have a long conversation about the math and the Moody's models, but I think that's really the more important observation, Stephen.

So I think the 1% deferral rate is a factor.

Supports that. Supports that.

Yeah.

Okay. There's another mechanical factor which also went in, which is we had made assumptions around prepayments at the end of March, which were a little too draconian. We had assumed that, you know, like it generally happens during recessions, that prepayments would come to a grinding halt. and there would be no prepayments for the rest of this year. And now we look back at the last three months. If anything, prepayments actually picked up. So it surprises us. That's usually not what happens. But we have to then react to the actual data as it's coming out, and we're seeing prepayments across all asset classes, by the way, not just one, that are at least as much as they were before. In some cases, they're actually higher. So these models are also sensitive to prepayment assumptions, which, like I said, we have to dial back. after more realistic numbers than the draconian ones we used in March.

Okay. And I'll also remind you that we did spend a lot of time in the month of June reaching out to our individual borrowers to find out, you know, not as of December 31st or as of March 31st, but today, how's your business performing? What do your revenues look like? What do you, you know, and all of those observations at the loan level informed our reserve estimates. So we feel very good about the CNI portfolio and the current reserve levels.

That's fair. If I could just follow up, too, on Bank United 2.0 and looking at the $47 million of expense reductions so far, which is obviously better than expected. Maybe, one, where are you coming in better than expected? And, two, have you now realized all of the cost saves, or are there still more to come as part of that plan?

I would say a lot of it's comp, and a lot of it's comp, Stephen, just because that's the biggest expense line on the P&L. I mean, you know, if you're going to save money, you're going to have to save it in comp because that's where the dollars are. So that's where most of it is. We've had some of it, obviously, in the real estate spend has come down. Some of our technology spend, some of the things we've done, some of the investments we've made in technology are actually reducing our operating cost levels. So it's all of that. As for future opportunities, I'll echo what Raj said. I think there are future opportunities, but you're going to see them not all next quarter because they would, you know, be predicated on decisions that we would make about the real estate footprint, some things that are still to come in the technology area, and some things that I still think are to come in the vendor spend area. But all of those are going to take time to materialize and, you know, really have an impact on the bottom line.

Steven, I do want to make a point here. Please do not think that this is coming from starting the franchise from investments that we also are making as part of 2.0. So the number of 40 million is a net number. There is stuff that we're investing in which will pay dividends, you know, in the years out. It's not like we've decided let's just not do those things. So those, you know, because on one hand we have to tactically fight the fire But at the same time, you have to keep building the franchise. And you cannot just keep fighting the fire and then have no franchise two years down the road. So those investments are still moving forward because once you make a decision on making the investment, it may take two years to do it. And you don't stop in the middle because that does a lot of damage. It may make you feel good for a quarter or two, but you really – it's the wrong thing to do. So those investments are happening. Like I said, the automated underwriting on the small business front, that was an investment. It took a year. of technology spend and training and hiring people, all of that, we haven't made a single loan on that. It will go live. Unfortunately, it's about three or four months later than we had originally wanted it to be. But we are going to move forward. That's the direction we're going in. In fact, PPV was a nice little test for us. We had to do automated underwriting on a on a very high level for PPP, and we learned a lot from that, and we're using it to invest in that platform, and we will launch it. Like I said, maybe a three, four-month delay, but we're not pulling back. That's not where the dollars are coming from. Some of it is, to be very honest, when we tell you $40 million, we internally are shooting for a higher number, as you would expect us to do, right? And it just becomes easier to achieve that, you know, when everything is locked down and people are generally, you know, become a lot more sensitive to expenses. So it's a little easier to achieve.

Okay. Thank you. And maybe just one final one for Tom. You talked about all these commercial relationships that you're moving over to the bank. I think Leslie made the comment that we didn't expect anybody to prepay their loan in the middle of a pandemic. I wouldn't expect many commercial customers to move their account in the middle of a pandemic either, but you're doing it. Maybe give us some color on how you're, I mean, are these moving over Zoom meetings? Like, how are you moving all these relationships over?

They're Zoom meeting driven, as I said when I made my comments. We're learning how to sell. Well, I do think Tom's been out on the golf course. Well, maybe I'll admit to that. No, but as Rod said, the PPP process, it's not all of it, but it, also compared to where others failed. You know, we have picked up new relationships that have been with other major banks for 30, 40, 50. We got one that was there for 70 years that are very substantial relationships, and I think that our, you know, each of our business units that are focused on kind of the niche market segments that they are focused on, you know, have good reputations in those markets, and I think our overall done it in a Zoom, you know, non-contact environment. We've done a lot of internal training around how to do this better and, you know, getting people to be very comfortable with the technology. And clients have become, you know, as comfortable with the technology as well. So it's worked very well.

See, for example, PPP loans, you know, there's two rounds of PPP, round one and round two. it's important to actually understand how many of your clients were taken care of in round one and how many in round two. Because anyone who got put to round two was probably not happy because they had to wait and they didn't know if there would be a round two or not. So if you look at a bank and figure out that 10% of customers were done in round one and 90% in round two, you have a lot of unhappy customers, even though everybody got the loan they were looking for. But it speaks to that one month of actually, you know, being on pins and needles trying to figure out if your bank can do for you what, you know, other banks are doing for their clients. Our numbers were, I think, 85% or so of our clients were taken care of in the first round. And we had about 15% or roughly that many who fell into round two. And customer satisfaction with those is absolutely lower than in round one. Now, if there's another bank which has the numbers flipped, you have a very unhappy customer base, even if they eventually got the loan, they haven't forgotten the number of times they have to call you and the number of times that, you know, you basically said, I don't know, but we can help you. And that creates the opportunity for banks like us to be proactive and gather their business.

Yeah, I think if I look back on it, we had a really nice blend of an automated technology that worked well, but we also combined it with high-touch personal communication. And it took, you know, a lot of hours. We were all on conference calls until midnight every night doing this. But I think the communication that went back and forth to the clients in terms of keeping them informed and making it feel like a high-touch automated combination really worked out well for us.

All right. Thanks for all the color and taking my questions.

Thank you. Our next question comes from Ibrahim Kunawala with Bank of America. Good morning.

Good morning. I just had a follow-up, I guess. Most of my questions have been asked and answered. Around the margin arc, you mentioned expected stable NIM looking into third quarter. I guess beyond that, I think just listening to Tom around deposit growth feels like You expect to retain the deposits that you got this quarter and then grow some as we look out. Where do you think the margin goes? Like, can the margin actually expand in this environment if the yield curve stays where it is? Or is the best-case outlook for the margin to remain steady-state?

So, I think looking out beyond the third quarter, there are just a lot of moving parts. So, I'm hesitant, you know, to give much more guidance than that. You know, the PPP forgiveness will be a factor. Our level of success in continuing to push deposit costs down will be a factor. How much we're able to grow the non-interest-bearing DDA book over the course of the rest of the year will be a factor. And another factor will be what opportunities we're able to identify to put interest-earning assets on the balance sheet and at what spread. And so all of those things right now I think are just difficult to predict, so, you know, hate to not answer your question, but I'm hesitant to put a forecast out there for much beyond a quarter ahead.

Got it. And now, if you can remind us, Leslie, what's the PPP fees that you expect to accrete?

I'm sorry, could you repeat that?

The PPP origination fees that you expect to accrete?

Yeah, I've got that number here somewhere. Let me just grab it. I want to say there is $21 million as of 6-30 remaining to be recognized and You know, like I said, we don't really expect much forgiveness activity in Q3. I don't expect that to start hitting until Q4, Q1 timeframe realistically. But there's a total of $21 million.

And the entire PPP loans are funded by the Fed funding. That's correct? So that goes away when the loans go away?

Yeah, most of it. Right now we've got $651 million in PPPLS borrowings on the balance sheets. Where we plan to position ourselves, though, by 930, if any of the PPP loans that are left on our balance sheet, we'll pledge up there and we'll have them fully match funded.

Great. That's all I have. Thank you.

Okay.

Thank you. Our next question comes from Brock Vanderveen with UBS. You may proceed with your question.

Hey, good morning, guys. Morning. Good morning. Just to follow up on Ibrahim's question, it seems like if you line it out, you've got three catalysts on the funding side. You've got BetterMix, you've got CD repricing continuing, and you've got this operating account growth focus. And on the asset side, how close are we really to kind of the burnout on resetting on the on the asset yields. I feel like that's really the question because I think you've got it on the funding side. It's really how much incremental pressure you see on the asset side.

Yeah. Everything held constant. I would say this would be the last quarter of that repricing down. The wild card here, though, is prepayments. And if we continue to experience prepayments, of the higher-yielding assets in the portfolio, that could also put pressure on asset yields, and it's difficult to predict how long that goes on.

Okay. Okay. Oh, that's helpful.

So that's the wild card in that equation, I think.

Okay. And on the expense side, you've got the – you know, BKU 2.0 saves juxtaposed with, you know, hopefully more normalization in the economy and an upward bias in some of those expense figures. How does that, how do you see that shaking out? Or I guess put another way, in terms of a, you know, in terms of the core pickup in expenses with higher activity, how much You know, could you dimension that at all?

You know, we really haven't put any guidance out there beyond 2020, and I'm not quite prepared to do that yet. I think things are just in too much of a state of flux. You know, for Q3 and Q4, I would expect the run rate sitting here today to be relatively flat, and as we get a little deeper into the year, I'll be in a better position to really answer that question intelligently. I just don't feel equipped to do that today. Okay, okay, but basically a flat run rate for the next couple quarters, and then, you know, by then we'll have a better idea of what, you know, what the glide path in front of us is. Got it.

Okay, thank you.

Thank you. Our next question comes from Dave Bishop with DA Davidson. You may proceed with your question.

Thank you. Good morning, guys.

Morning. Morning.

Hey, question for you. I know it was just announced, but the fee income initiative, the partnership with Goldman Sachs, how should we think about that? Any guidance you can give in terms of what the revenue opportunity is from that?

Yeah, I would probably say it's too early to think about that. But, you know, as we look at the opportunity overall, this is a standoff. and did not have a product offering. And we have, you know, a large client base in the corporate, commercial, not-for-profit areas. So the 401K, 403B, and, you know, retirement services planning area, there are, you know, clearly substantial opportunities in our portfolio. And I think that this partnership will allow us to kind of unlock those opportunities in this alliance that we announced. training processes and whatnot, it'd be a little bit too early to put out a target on it.

Got it. And then, Leslie, I know... It could be important. Got it. Thank you. And then, Leslie, I know in the preamble you gave some good detail in terms of the granularity regarding the uptick in special mention loans. Curious if you could just walk through that again. It looked like there were some upticks in some of the more...

More granular areas in terms of... Okay, special mention. In the aggregate, it went from $288 to $1.3 billion. We saw in Cree, that was up $527 million. $168 of that was in retail. $270 of that was in hotel. Only $50 in multifamily, and the rest just kind of dribs and drabs. In the C&I book, it went up $329 million. $60 million of that was cruise lines. $54 million was in the retail trade sector. Food services was $53 million, and the rest is onesies, twosies. The franchise book went up by $147. And there's some detail on that, too, in the deck if you want to, you know, towards the back. But those are the high-level numbers.

Got it.

It was concentrated in those areas where you would think it would be, which was, you know, the Cree retail, the hotel, the franchise, you know, a couple isolated credits in the C&I book that are connected in some way to those stressed industries. So exactly what you would have expected.

And if I recall, the deck cruise line exposure, right, they have not asked for a deferment yet?

Correct. We actually think the cruise lines are pretty well positioned. They've all been very successful in raising cash in the capital market. Back to Roger's point about intellectual honesty, we think it's intellectually dishonest to pretend that the risk profile of that industry has not increased, and so it just seems the right thing to do to move those credits to special mention, even though we believe they are in a position to continue to serve us with debt.

Got it. And then maybe just commentary, I know there's some energy exposure through the operating leases. I don't know. What's the credit outlook there currently?

I think, you know, similar to what we said last quarter, you know, oil prices actually seem to have rebounded some from last quarter. I know they're awfully volatile, though. Rail card lows are down. So what we really think is going to happen there is as these assets are released, they're going to be released at lower rate. So I think we'll see that leased rental income kind of trend downward for the foreseeable future. It's difficult to say longer term what's going to happen, but these are very long-lived assets and are, by definition, you know, having the path withstood multiple cycles. So we'll see how it plays out. And I think what you'll see, it's not really credit exposure. It's really this rental income that is probably going to trail down some for the foreseeable future.

Got it. Thanks for that, Heather.

Thank you. Our next question comes from Steven Long with RBC Capital Markets. You can proceed with your question.

Hi. Good morning, guys. Good morning. Hey. I'm sorry. I apologize if this has been answered or jumped on late. But what are you guys seeing in your overall business activity in your Florida and New York markets, say, from the reopening through mid-June versus the recent spike in cases in Florida?

Well, let's start with Florida. You know, I would say that while the caseloads are definitely up and it's created a heightened sense of issues in the marketplace, the commercial market continues to move forward. Companies are operating, you know, for the most part. and distribute goods or manufacturing and distributing goods and the overall market continues to, you know, to move forward. It's almost a parallel kind of issue when you look at what's happening. You see certain health statistics that are coming out and numbers that are obviously concerning, but at the same time, businesses that are essential businesses that are shipping food and components and, you of the myriad of industries that were in healthcare, you know, are continuing to operate. Food services continue to operate. The franchise businesses that have good drive-through models and delivery models are continuing to operate. Occupancy, you know, remains strong in the Cree markets in Florida in the office. things of that nature. So overall, it's not, you know, and we see it in the flow of business that we're getting and the flow of opportunities that we're seeing. It's not a negative scenario at all. New York has opened up obviously slower because It was early identified as an essential industry. We have a number of significant construction relationships in the New York market. They're up. The businesses are running. You know, they have projects underway. We're seeing, you know, operating businesses in the food and beverage distribution area, just like in Florida, continuing to ship goods. You know, we're seeing, again, office, particularly Class A office, our exposure is a bit more in the Class A office side than it would be, you know, collections being very high, multifamily business. We're also seeing, you know, rent collections at acceptable levels right now. So, you know, the economies are functioning. There are, you know, opportunities, and we're seeing business revenue increase. You know, every business is different, obviously. We're in a lot of different businesses with a lot of different companies, but the overall, you know, financial results, I think, are playing out fairly well, and that's what we see in the deferrals. You know, again, comment. Deferrals are the real test of payments.

Yeah. The Florida economy, despite all the negative news over the last three weeks or so, at least to us, it doesn't feel like it has slowed down. So the numbers are obviously bad on the healthcare front. They are beginning to level off, or at least, you know, keeping our fingers crossed over the last 10 days or so. We're seeing them level off at still pretty high levels, but it has not impacted, at least from what we can see, the economic activity in Florida. And New York has just been more careful and slower with opening up the economy. The healthcare numbers were great, and the economy is slowly opening up, And I think the trajectory will just be – the slope will be much less than Florida. Florida was a very steep increase starting in May 1st. It just went straight up. But we don't see signs of slowing down. Maybe a few bars will be closed here and there, but we're not seeing any signs of some kind of a, you know, let's go back to a shutdown or slow everything down. That is not the sentiment on the ground.

When you look at the CNI business, particularly in either Florida or New York, but even more so in Florida, what is happening in Florida individually is important, but if you're doing business with a company that's a $500 million company shipping goods around the U.S. and Canada and Europe, what happens in Florida is not necessarily the only driver. While the businesses are located in Florida, they're national and international businesses. Got it.

So let me ask it this way then. If the spike in cases never happened, would you say that business wouldn't be that much better and just be similar to where it is now for Florida?

Who knows? It's kind of hard to say. That's a tough one to call.

The hard thing to measure is the impact that that has on confidence. Would more people be traveling to Florida and staying in hotels if it hadn't been for that? Maybe. but it's really difficult to know.

Right, so have you guys been seeing anything? Yeah.

Have you guys been seeing anything as far as the consumer confidence goes?

Our evidence is more anecdotal, and maybe it's a little too early, but from what we see from talking to our clients, we haven't yet seen, and I think your question is a good one, that if this had not happened, would the slope of this recovery looking forward have been better? I would think it would have been better. I think more people would go to Disney if there weren't 10,000 cases a day in Florida. And so I'm sure that has an impact on Disney and Universal in Orlando. So it does have an impact, but it doesn't have a level of impact where things would backtrack that we go back to numbers in, you know, May or April. No, we're not seeing that. But I'm sure if Florida is not able to control this, you will have, on the margin, it will be a slower recovery. The healthcare situation has to improve. And if it really gets out of hand, then, you know, it might even go back. But we're not, you know, I think the numbers we monitor very, very carefully, as you can imagine, there is some optimism that the numbers aren't getting worse over the last 10 days or so, and not just in Florida, but I think all the other, the Sunbelt states that got hit hard in the last month are beginning to curb their numbers somewhat.

Right. Yeah, I guess it's always hard to try to assess the economic impact when these cases rise, and so just trying to separate, you know, understand the news versus what you guys are actually experiencing.

And I can tell you that on the street, you know, and again, to Raj's point, it's anecdotal. Tom gave you some really good data points, you know, things we're hearing from our customers. I will tell you that, you know, I belong to an organization called the Florida Institute of CFOs. And when we meet and we speak, and this is CFOs from businesses all across the state of Florida, all different types of industries. You know, it's an optimistic group. You know, none of these people are saying, oh, my gosh, I think my business may not survive this. You know, you're not hearing that at all. People are out and about. People are doing things. The level of activity is strong. Now, all of that is anecdotal, not statistical, but, you know.

Now all we have to do is get the Floridians to wear masks and everything will be fine. Okay.

Well, just a final one on this one. So let's just say, like, you know, we were just to make some risk assessment here. If the economic recovery stalls, flatlines through the end of next year, would that make you reassess your reserves?

Well, of course. I mean, you know, I kind of outlined for you what, you know, what the assumptions are that are built into our economic forecast is that unemployment doesn't go down between now and the end of next year, and GDP doesn't improve, and, you know, if nothing improves, if there is no trajectory of recovery whatsoever, then, yeah, of course, not only ours, but everybody will have to reassess their reserves. I have not seen one bank whose economic forecast thus far does not include some trajectory of recovery from here. So if that is erased, Sure. I think everybody will have to reassess the level of their reserves.

All right. I appreciate all the color and excellent slide deck.

Thanks. Thank you. Thank you. Our next call, the question comes from Chris Maranek with Kenny Montgomery. You may proceed with your question.

Thanks. I can keep this brief since it's been a long call. I know there was a lot of focus on slide 15 on earlier questions. I was wondering if we shouldn't just focus on slide 10 in addition to 15. just because your capital is strong. Leslie, doesn't that play into the whole reserves and capital question? I mean, to me, together, they're very strong, and it really gives you a buffer because of the CECL. I think you gave a lot of discussion about that. I just kind of wanted to ask that question on how you think of capital here.

Yeah, no, absolutely. I mean, I think slide 10 is very illustrative that our reserves sit at 60% of 2020 defense severely adverse losses, which A lot of our specific peers don't disclose because we're no longer required, you know, to run that DFAS scenario and disclose the results publicly. But when I compare it to what's coming out for the regional banks, you know, our reserve is sitting at a higher level of 2020 DFAS severely adverse than a lot of the regionals are sitting at. You can see clearly that even with that level of stress, you can see where our capital ratios land and it's, you know, comfortably above. you know, any well-capitalized minimums. So I think there's plenty of capital cushion, even if we have further stress from here.

Great. Thank you very much for all the time this morning. We appreciate it.

Thank you. Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Raj Singh for any further remarks.

Thank you, everyone, for giving us time. Sorry it took so long. I wait for the day that we can go back to normal and don't have to provide a 50-page deck. But until things get normal, these calls will be a little bit longer. Our disclosure will be a little more extensive. But appreciate you spending time with us, and we'll see you in three months. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.