FB Financial Corporation

Good morning, everyone, and welcome to FB Financial Corporation's second quarter 2020 earnings conference call. Hosting the call today from FB Financial is Chris Holmes, President and Chief Executive Officer. He is joined by Michael Mati, Interim Chief Financial Officer, Greg Bowers, Chief Credit Officer, and Wib Evans, President of FB Ventures, who will be available during the question and answer session. Please note, FB Financial's earnings release Supplemental financial information and this morning's presentation are available on the investor relations page of the company's website at www.firstbankonline.com and on the Securities and Exchange Commission's website at www.sec.gov. Today's call is being recorded and will be available for replay on FB Financial's website approximately an hour after the conclusion of the call. At this time, all participants have been placed in a listen-only mode. The call will be open for questions after the presentation. With that, I would like to turn the comments call over to Robert Helen, Director of Corporate Finance.

Thank you, Jamie. During this presentation, FBA Financial may make comments which constitute forward-looking statements under the Federal Securities Laws. All forward-looking statements are subject to risks and uncertainties and other facts that may cause actual results and performance or achievements of FB Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond FB Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in FB Financial's periodic and current reports filed with the SEC, including FB Financial's most recent Form 10-K. Except as required by law, FB Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events, or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to comparable GAAP measures is available in FB Financial's Earnings Relief supplemental financial information in this morning's presentation, which are available on the investor relations page of the company's website at www.firstbankonline.com and on the SEC's website at www.sec.gov. I would now like to turn the presentation over to Chris Holmes, FB Financial's President and CEO.

Thank you, Robert, and good morning. Thank you all for joining us this morning, and we do appreciate your interest in FB Financial. On last quarter's call, I highlighted the company's priorities and how they had changed in the face of these uncertain times. Those priorities were, and still are, first, the health and safety of our associates and customers. Third, our capital. Fourth, profitability. And then fifth, growth. I'll touch on each of these priorities in some more depth, but I want to start by saying how proud I am of our team for the level of execution that we achieved on those goals this quarter. A number of our associates listened to this call, and I want to congratulate them on a job that's been remarkably well done. Our financial performance this quarter was outstanding, including record revenue and pre-tax pre-provision earnings. We produced an incredible 3.29% adjusted pre-tax pre-provision return on average assets for the quarter. Our profitability was largely driven by our mortgage team producing a record $33.6 million pre-tax contribution. After a $26 million provision that moved our allowance for credit losses to 2.51% of loans held investments, that's excluding our PPP loans, we had an actual ROAA of 1.30%. The company's earnings power has allowed us to reinforce our balance sheet with fantastic a conservative allowance for credit losses, and an additional $23 million in tangible book value, all while operating in the middle of a pandemic. This demonstrates our business model's complementary bank and mortgage segments. We frequently describe the company as a great community bank with a great mortgage division, and this quarter exemplifies that description. Diving deeper now into our priorities, our focus remains the health and safety of our associates and customers. I believe we've entered a new normal for the foreseeable future. Approximately 700 of our associates continue to work remotely, and we have continued to see strong productivity under this environment. While our drive-thrus and our branches never closed, in March and April, we had suspended lobby access for all of our branches in line with guidance from our state and local governments. As stay-at-home orders began expiring in late April and early May, we moved to reopen our lobbies. We reopened our first branch lobbies on May the 7th with sneeze guards, hand sanitizer, masks, and social distancing markers in place. By the end of June, almost all of our branch lobbies reopened. As case counts have risen and many of our customers have shown a preference in recent weeks for drive-throughs, we have moved to make lobby access appointment only in some select branches. We continue to monitor case counts and will continue to take necessary safety precautions. As discussed on our last call, We've been very proactive in reaching out to our customers, and we provided first deferrals to everyone that requested one. This outreach resulted in $918 million in loans being granted a first deferral. Roughly 60% of our initially deferred loans are still in their first deferral period, which makes it a little difficult to get clarity on how those credits ultimately will turn out. Of those loans that have hit the end of their first deferral, roughly $138 million or about 38% of the balances that have requested, roughly 38% of the balances have requested and received a second deferral. The 38% of balances that have received second deferrals make up about 10% of the notes that have come out of deferrals. We've been in constant communication with our customers as our relationship managers check in and gather information. Anecdotally, we're hearing positive news from the field on our population of deferred loans. We provided a new slide in the investor deck that gives some feedback that we're receiving from our regional presidents. is that after a crop in April and May, many of our markets have been bouncing back reasonably well. A caution, we continue to monitor market activity in our customer base as the case counts have begun to rise in some parts of our footprint. Moving on to liquidity, we're thrilled with our $581 million of customer deposit growth. It's a little difficult to tell at this point how much of that will be sticky. The fact of the matter is that we're a trusted partner to our clients, but we don't grow $581 million in deposits in one quarter without some help from broader market conditions. We're going to do our best to hold on to as much of those deposits as we can, but it's difficult to predict at this point how much of that will stay with us past a couple of quarters. We believe we're well positioned. to take on Franklin Synergy's balance sheet, which has historically been more reliant on non-core funding. In our communications with Franklin over the past six months, we've identified approximately $415 million in FHLB, brokered, and other non-core deposit relationships with a cost of around 1.65% that we could exit by year-end. We'll balance that elimination and not core funding with our current priority of unbalanced sheet liquidity, but we believe that we have the opportunity to pay off some wholesale funding more quickly than we had anticipated. On our third priority, capital preservation, we increased our total risk-based capital ratio to 13.2% this quarter, up from 12.5% in the first quarter through strong provisioning and profitability. We believe that we have plenty of capital to manage through the downturn. We also maintain maximum flexibility as we currently have only common equity and trust preferred in our regulatory capital stack, and we have an investment grade rating from Kroll should we choose to access the debt capital markets for some additional capital cushion. We believe that our strong profitability and existing capital levels continue to support our dividend. Moving on to credit, so far we've not seen significant signs of deterioration in our portfolio. Given the economic environment, we expect some uptick in substandard loans over the coming quarters, and ultimately we expect some increase in our net charge-off to follow. We still feel very good about our underwriting standards in our portfolio. We continue to closely monitor our asset quality. Our message to our relationship managers has been that this is not the time to settle the problem. If you have a loan that needs some attention, then we want to know about any potential issues sooner versus later. And I'm sure we'll face some challenges over the next six to eight quarters, but we won't suffer from a lack of focus. Now on profitability, as I mentioned earlier, our pre-tax pre-provision earnings were $57.8 million, or 3.29%. as a percentage of average assets, which is a record quarter for us. As expected, the margin is facing some headwinds of the lower interest rate environment. Our headline net interest margin number would normally not be one that's acceptable to us. However, this has been partially the result of our on-balance sheet positioning. We've pruned some credits. and had prudent loan growth over the past couple of quarters while at the same time building our liquidity. We'll continue to keep an eye on how this recent influx of deposits behaves and how quickly PPP loans are forgiven. In the absence of record synergy, which will have, say, a 10 to 15 basis point impact on our core margin, the second and third quarters should be a draw for us. I expect our market to begin to bounce back in the second half. However, the same rate environment that's created the headwinds for our banking segment allowed our mortgage area to deliver $33.6 million in direct contribution. This was a Herculean effort from our team as they capitalized on strong volumes and above average margins while benefiting from the record low but steady interest rate environment from March through the end of the second quarter. We expect our mortgage team to capitalize on this environment for as long as it continues. I have a few other updates before turning things over to Greg and Michael. We've consistently been updating our technology over the past couple of years and consumer online and mobile banking was the last remaining significant platform that was due for enhancements. When we converted Farmers National Bank last quarter, we placed their customers onto our new system and we've had great feedback from those user experiences and from those capabilities. Later this week, we're converting the rest of our customer base onto that same platform and we're excited to provide an improved experience for our customers. On the Franklin Synergy merger, we anticipate closing in August and conversion before the end of the year. Dialogue between those two management teams has been consistent and positive since the announcement. We're hearing that their core credit portfolio continues to perform as expected. They continue to make progress on moving out of that non-core portfolio as well. We are eager to be able to officially join forces with those associates and begin taking advantage of the combined strengths of the team. With that, I'm going to let Greg go into a bit more detail on the credit portfolio.

I'll give my high level thoughts on the portfolio and then we'll be available on the question and answer section as well. For a refresher, we are at our core a community bank that makes loans to support the economic activities of our markets. This strategy means dealing with and putting our faith in local people we trust and know to be good operators. Our strategy has always been to focus on in-market lending while avoiding shared national credits and purchasing participations. for the sake of growing loan balance. Our portfolio reflects that bias. Since we last spoke, we have raised $315 million in PPP funding for customers that needed some help at the outset of this downturn. You can see the industries where those PPP funds went on page 11 of the presentation. We are also working through our deferral program. To echo Chris, Our relationship managers in the field are having positive conversations with our borrowers, but it's still too early in this process for us to really know what will happen with many of those credits. Of the roughly 920 million in loans that received a first deferral, we still have around 550 million that have not come out of that first forbearance period. At this point, 138 million have received approval for a second deferral. That number will increase as we continue to work through the remaining deferrals. Feedback from clients that received initial deferrals is across the board. With our open door policy, many of our clients accepted a first deferral based more upon uncertainty rather than actual business level. As such, that group won't be needing or requesting second deferrals. For those that are seeking second deferrals, some clients still have limited revenues such as restaurants and hotels. Others don't have an urgent need for a second deferral but still aren't back to 100% and feel that some cushion right now is prudent. In general, uncertainty reigns but anecdotally, the reopenings have provided a level of relief that has generated a modest increase in confidence for our clients. With that, we continue to monitor those loans and we feel positive about them but we cannot tell you how many will deteriorate. and how many will ultimately participate in a second deferral period at this point. We will look to continue to update our investors as we participate in investor conferences this quarter and on next quarter's earnings call. On overall asset quality, we did experience an uptick in substandard loans from $74 million to $88 million from the first to second quarter. The majority of this increase was related to four relationships with approximately $13 million in aggregate outstanding balances as of June 30th. Each of these loans had been marginal credits prior to the pandemic and have deteriorated with the economy, so this was not an unexpected increase. Moving on, on slide 12, we've laid out some of our specific industry exposures again. Before I give updates on those, each of those percentages use our total loans, help for investment as our denominator. If we were to exclude PPP loans, then those would read retail 8.3%, healthcare 5.7%, hotel 4.3%, other leisure 2.5%, transportation 2.2%, and restaurant 1.4%. These percentages are generally in line with where they were last quarter. Slide 13 reflects the largest segment within these industry groups, our retail portfolio. As reflected here, it is pretty much a portfolio split evenly between C&I, including owner-occupied real estate, and our non-owner-occupied CRE properties. This is a segment that has received a lot of attention nationally as the retailers have been forced to deal with closures and landlords have been impacted by tenants not being able to make their payments. For us so far, and we've reached out to our relationship managers on a property by property basis, our portfolio has fared okay. As we've discussed before, this portfolio is fairly well distributed across our footprint and across a wide variety of underlying sources of repayment. In other words, the retailers ultimately making the payments. For our CRE properties, this is a portfolio that looks like $2 million to $4 million local strip centers, not large power centers or malls. Our largest single loan is less than $8 million and is fully leased with a conservative loan-to-value and strong investor group. The CNI portfolio reflects the comments from our market leaders that you saw on one of the earlier slides. overall generally positive. Slide 14 shows our health care book. As we discussed in previous calls, this portfolio has an emphasis on the assisted living and skilled nursing side of the business. This too is a segment that has received a significant focus associated with the virus, but thankfully reports from our clients have been satisfactory with no known outbreaks in their facilities. Physicians too have continued to manage through the process and incorporated new protocols within their practices. On slide 15, we continue to monitor our hotels. The portfolio as a whole has about a 57% loan of value, and heading into this, we felt good about the underwriting of our portfolio and still do today. Hotels have become a waiting game as we know that people will start traveling again, but we just don't know when yet. As a result, we are inclined to work with our clients in this space and provide additional deferrals as requested or needed. Reports on occupancy coming back have been mixed across our footprint. For the week ending July 4th, total Nashville MSA occupancy, not just our clients in the area, was at 38%. Our largest client has seen similar levels on their Nashville properties at around 32% versus 70% occupancy back in February. However, we have a larger client who reports their property north of Atlanta being in the 80% range in June and July, so that's great to hear. As a reminder, we have not been responsible for all of the construction cranes building downtown Nashville hotels and only have one property there, which is to an operator we trust with a high-quality national flag. Two of the four loans that I mentioned moving to substandard this quarter were hotels. Those are properties acquired in previous acquisitions which did not benefit from our standard underwriting vent toward higher equity, national flags, and strong operators. Frankly, the properties weren't performing too well before the pandemic. It just exacerbated their issues. Our teams are addressing appropriate exit strategies at this time. Lastly, also within this segment is an approximately $5 million property which we've discussed previously in the Memphis market and its exit is being addressed by our teams and has significant reserves. As we note, the summary on this page says it all. We continue to remain concerned about the space and our teams are monitoring it heavily. Other leisure on slide 16. That's a portfolio that includes categories going into this that were highlighted as potential industries of concern. So far, we've seen satisfactory results here, too. As noted here, some areas, such as marinas, have actually seen a pickup in business associated with consumers looking for safe recreational activities. Segments such as theaters have not been as fortunate, but as noted, we've been in close communication with that operator. and guarantor group, and they've developed a plan and have the resources to carry out. Moving on to slide 17, transportation and warehousing. Similar story here. A segment for concern, but overall has performed okay. On the larger end of the business, it looks like the operators are reporting good results. On the smaller side, this seems to vary by company. We had one of these smaller operators with loans with us under $1.5 million. filed bankruptcy this quarter and moved it into substandard. This is an industry that has more than its share of undercapitalized operators, and it's not unusual, frankly, with or without a pandemic to see things like that pop up. We do like to point out that within this segment, we're glad to report that we have no exposure to commercial airlines or cruise lines. Lastly, on slide 18, we break out our restaurant exposure, We're hearing mixed results from these customers. As a full service, operators are struggling more with the closures along with costs and issues associated with reopening at reduced capacities. But the quick service side seems to be surviving and in some cases doing better than prior years as they've adapted their drive-through business. As we note here, one of our largest clients reports good results and has benefited from their model which includes more of a fast casual and sports bar combination, as well as benefiting from being an overall lower leverage operator. We do highlight here also a larger relationship that's not in the 1.4% of restaurant exposure that is not performing to par, and without further improvement, we could see a future downgrade on this one. Overall, a segment that we will continue to monitor closely. I'll close by saying that for our entire portfolio, we're working with clients and frankly seeing positive direction with the reopenings in our markets. We're thankful for the diversification of our footprint across both metropolitan and community markets, as well as diversification of the size of our transactions. However, it is still early. Overall, like most banks in these times, we have some noise in our engines, isolated, not systemic. and not any more or less than the rest of the industry at this point, but we're managing for a conservative position and hoping for the best. Our future results will ultimately be affected by the length and depth of the downturn. As governmental assistance programs run out or new ones are developed, our customers will be impacted. With that, I'll turn things over to Michael to talk more about our profitability. Thank you, Greg. I know that we've covered a lot so far, so I'll give some brief color on CECL, margin, and mortgage, and then be happy to answer any questions after our prepared remarks. First, on CECL, we used a blend of the economic forecast that Moody's put out in late June. With our markets generally open since early May, the pre-downturn strength of Tennessee as a whole and the pre-downturn strength of Nashville, which is one of the hottest job markets in the country pre-COVID, We did not feel that weighting 100% baseline made sense for us at this point. The resulting economic inputs of that blend are laid out on slide 19. The largest drivers of the increase this quarter were the CRE index and the unemployment rate, which you can see both deteriorated from last quarter's forecast. These inputs and adjustments ultimately led to a 2.51% allowance for credit loss, which we believe is hopefully higher than any losses that we'll see over the cycle. but we don't mind carrying that given the levels of uncertainty going forward. Moving on to margin, which, as Chris mentioned, is facing some pressure due to both balance sheet mix as well as lower yielding assets. On the balance sheet mix, we've been trying to nail down how much of the increase in deposits is related to PPP funding and other government stimulus programs to determine how much liquidity we can expect to retain. However, depositors' cash is fluid and comes from many sources. Deposit balances of customers who receive PPP funds from our origination are up $250 million from March to June. If you dig deeper and cap the increase by the amount of PPP funding that they receive from us, that only accounts for $138 million of deposit growth. We'll continue to stay short and liquid with these funds from excess deposits in the near term as we determine how the recent influx will behave. For some site guidance on our yields and costs, Contractual yield on loans excluding PPP loans is 4.59% for the month of June as opposed to 4.75% for the quarter. Cost of non-time interest-bearing deposits in June was flat at 0.55% versus 0.56% for the quarter, and cost of customer time deposits is 1.7% in June versus 1.78% for the quarter. We have cut RAC rates on deposits about as much as we intend to cut them. So to execute on bringing down our liability costs, we'll need to continue to work some of our higher-priced money market accounts down. As a reminder, we have $560 million in CDs with a weighted average cost of 1.75%, repricing in the second half of 2020. The weighted average rate that those products would roll into is currently 38 basis points, so we have real opportunity on the time deposit front as well. Mortgage served as a strong counterbalance to the declining yields that the bank faced in the second quarter. The group benefited this quarter from strong origination volumes and capacity constraints in the industry that led to higher margin on loans in our pipeline and ultimately on our gain on sale margins late in the quarter. These capacity constraints have extended the amount of time it takes for mortgage to sell to be originated and it's contributed to higher than typical margins. You probably noticed that in our mortgage banking revenue components, fair value changes were $34.8 million for the quarter as opposed to $3.2 million in the first quarter, which is obviously significant. As you recall, mortgage revenue is recognized at the time of interest rate lock, and subsequently the interest rate lock pipeline has been hedged. The gain on sale line item is a bit of a lagging indicator, and our current fair value is more indicative of where our gain on sale margins came in during the month of June and where we would expect gain on sale to be in the first half of Q3. Timing also plays a part in whether the gains sit in gain on sale or fair value mark, and the large value percentage drop in the first quarter was indicative of market dislocation in the mortgage markets. Ultimately, with the help of Fed intervention, mortgage secondary markets returned to pre-COVID levels and led to wide margins and robust demand. We also have a continued focus on expense control. Our core banking expenses were slightly down from the first quarter. We completed the conversion of Farmers National Bank of Scottsville on May 17th, and we have finalized our planned reductions in force for that acquisition and should be at a full run rate of expense savings in the third quarter. With that, I will turn the call back over to Chris.

All right. Thanks, Michael, and thank you, Greg, for that color. So we know that challenges are coming as we manage through economic uncertainty, the Franklin merger, and the continued impact of the pandemic. That being said, we executed well on our stated priorities and had a very strong performance this quarter. We're coming off a quarter with exceptionally strong earnings and moving forward with our reinforced balance sheet positions us for success. Our complementary business segments of the strong community bank and the strong mortgage segment also position us for success in the current low-interest rate environment. Our credit portfolio is behaving normally today, and we're brace-free headwinds in the coming quarters. Moving forward, we positioned ourselves for a good combination with Franklin Synergy, and we're excited about the closing of the transaction. Pandemic notwithstanding, we're ready and excited for the balance of 2020. With that, I'd like to open it up for questions.

Ladies and gentlemen, at this time, we'll begin the question and answer session. To ask a question, you may press star and then 1. If you are using a speakerphone, we do ask that you please pick up your handsets before pressing the keys to ensure the best sound quality. To withdraw your questions, you may press star and 2. Once again, that is star and then 1 to join the question queue. At this time, we will pause momentarily to some of the roster. Our first question today comes from Steven Scouten from Piper Sandler. Please go ahead with your question.

Hey, guys. Good morning.

Good morning.

So I wanted to get one point of clarification, if I could. On the loans that are in deferral currently, I think if I heard you right, from the $918 million, it sounded like 550 million were still on deferral. And then I think you said 138 were requested a second deferral. So ballpark, does that mean about 250 million have already fallen out of that 918 million in total initial deferrals? Is that close to correct there?

Yeah, that's, that's right. It's in the 240, 250, something like that. Yes.

Okay, great. Great. And so I know you said a lot of your customers felt like they were doing this as a, on a proactive basis and probably wouldn't need a second deferral. But, um, what's your feeling with the two 50 that came off? Maybe do you have any indications on what type of industries? Is there any concentrations there that could glean any, um, give us any color as to how the overall market is performing there?

Yeah. Um, I'd say it's across the board. There's no industry concentration. Some of it's, uh, some of it's actually consumer. and so you've got a consumer piece of that, and there's not a lot of industry concentration. It'd be representative of the community bank that we are. Greg made reference to the fact that we're a community bank, and we're kind of a reflection of the communities. I would say, it's not exactly your question, but I think it may help a little bit. If you notice, 10% of the If you notice, there was a bigger percentage of dollars than number of loans. And so you do see some where, you know, Hotel would probably be a good example, where they're probably going to request a second deferral, but they're going to have a higher balance. And so you're going to see some smaller ones particularly that just don't ask for a second deferral and keep going. We see some with more balance that ask, but we have seen no concentration. I would say this too, as we look at larger balances, We know we do have some that are still out there that we're already talking to about a second referral. Again, hotels would be a good example where we may have a $25 or $30 million credit. Really comfortable with the collateral, really comfortable with the owner, and really comfortable with the investors. And as Greg said, it's just a matter of time.

So, you know, and one thing also, Chris, we have seen some customers go from a deferral that's complete for P and I payments to just interest only now as well.

So as they manage through this. Yeah, that's a good point.

Okay. That's very helpful. And it seems like you guys are pretty well ahead of the game from a reserve standpoint, at least to me here, and should be in the top kind of decile, quartile maybe of your peers relative to reserves to loans. So can you talk a little bit more about that? I know you've laid out the CECL math in that one slide, but talk about the quantitative versus qualitative factors there, and then maybe also with that one larger credit, I think it was a $25 million relationship you mentioned, if that has specific reserves, and if so, if you have that number of specific reserves related to that credit.

Yeah, so I'm going to take the first part of that, and then I'm going to let Michael comment on CECL and Greg comment on the credits. And I would say this, Stephen, and look, CECL is still, while we've been talking about it for a long time, we're two quarters in, and I think we're all still learning some things about it. And one of the things that we've – we have probably – and this is my impression, and Michael may slap me on the hand here, but I do – and you may remember this, I did start my career in public accounting with Ernst & Young, so I do actually have an understanding and appreciation for the theory behind some of these things. And so, we've stepped pretty closely and have made as many, my perception is we haven't made as much in terms of qualitative adjustments as many of our peers. Because we look at the numbers and we look at what comes out on ours, and we stick pretty close to what it says, even though I would tell you we don't think we need all that, frankly. But, you know, bankers are often the last to know. And so we don't actually think we need all that, but – But that's what the numbers say, and so we stick pretty close to the numbers because it's new, and I think there are a lot of folks out, a lot of banks, and I'm not being critical here, that are making a lot of qualitative adjustments, and probably more than we are, and I think that probably sticks us in the higher tier. So that's just some of my analysis. Michael, feel free to correct me if I'm wrong.

Yeah, I think that's well said. I can't clap your hand since we're socially distant, but... Steven, from an overall CECL model perspective, Chris is right, we did take the model output, but we adjusted our assumptions last quarter. We were 100% baseline. Quite frankly, the economic forecast varied pretty widely this quarter, and from a Stratton Moody's perspective, deteriorated significantly depending on which scenario you were looking at. Our forecasting committee looked at that and we saw some green shoots in the economy. You saw non-farm payroll number improve. Retail spending during the quarter set an all-time record of 17% on one print. That had us change our forecasted assumptions a bit. to a more positive outlook than a baseline or a consensus. That being said, as you can tell on the slide, the numbers were still worse. GDP was worse. Unemployment for 2020 and 2021 was higher. As we mentioned, commercial real estate, which is a major driver in our model because of our construction and that non-under-occupied exposure was worse, the price index. So that all spit out a higher number. And then qualitatively, we looked at that. We looked at a Tennessee-only run and said, hey, you know, we feel like we're in a better spot. And we did make some adjustments down, but to Chris's point, it was not, you know, materially. I think we have some wiggle room there. We also got some really good feedback from our markets that said, you know, Things are looking pretty decent, but we don't know. Greg mentioned government stimulus, a second wave, other factors that kind of go into that. So we're cautious, but we feel it's appropriate at this time. Like I said, we don't plan on actually realizing $115 million in losses.

Greg, you want to comment there?

Steven, I think you had two other specific questions. That $25 million referenced on the slide, that is on our watch list at this point. And as far as the $5 million property you're asking about reserves, those reserves, not to be too specific, are in that 30% range.

Okay, so with that watch list credit, no reserves against that yet today?

Just our standard model. Yeah, just what spits out of the standard formula for all of the watch lists.

Okay, perfect. That's always helpful. Maybe if I could squeeze in one last one. I'm curious if you could comment on the Nashville residential real estate market, obviously based on your mortgage results, which obviously is not Nashville only, but it seems like the environment is good, but with FSB's concentration there in construction, I'm just curious how that's holding up.

Yeah, sure. Greg and I both comment on that. Yeah, so residential real estate has been, for me anyway, surprisingly strong nationally, given, again, the fact that we're in a pandemic, and even stronger locally than nationally if you take Nashville. Inventories are low. Builders are humming. And And we see that reflected in our portfolio. So it's quite strong. Sales activity is strong. And so it continues to go, especially at certain price points. And I'd say the mid-level price points, it's really, really strong.

Greg? Yeah, I agree. And I echo the surprising comment. They have continued to do well, and I think the interest rates help on that. You know, one thing you might be interested in – For our one-to-family construction, our group that is focused in the Middle Tennessee area led by Bill Wallkirk, who does a great job with this group, has approximately 225 million plus or minus in commitments with around 120 plus or minus in outstandings. You've got, and that's spread out, Davidson, Williamson, Rutherford, Sumner County. Davidson's 27%, Williamson's 33%, Rutherford 17%. All of those markets are just doing great. When you look at that portfolio, specs are around 23%. Pre-sold is 40% of the total. So it is, it's just done very well.

That's great, guys. Thanks so much for the color, and congrats on a phenomenal quarter.

Thanks, David. And our next question comes from Catherine Miller from KBW. Please go ahead with your question.

Thanks. Good morning.

Good morning, Catherine.

There's a couple of nitty follow-ups just to – I want to confirm a couple things. So you mentioned in your slide deck that you expect for the PPP loans to have $5.5 million of fee income. So are you bringing this revenue through spread income or through fees?

It'll go through spread income.

Okay, perfect. So I just wanted to confirm that. And then on – if we look at your – a reserve build slide, you see a pretty big jump in your construction. ACL, the loan category, goes from 3.8 to 6.4. Is the jump there really more of a factor of the CRE price index declining, as you mentioned before, or is there anything specifically in that portfolio that you're more worried about today?

Yeah, Catherine, it's not credit. It's more of the price index and CRE outlook.

It's not credit specific at all. It's actually totally driven by the outlook. That's right.

Okay, great. And then one NIM clarification. You mentioned that you expect Franklin to be 10 to 15 basis points impact on the core NIM. Is that excluded? You also talked about Is it FHLB brokered and non-core funding coming off by year end? Is that inclusive or exclusive of what you can do with the funding once the deal is closed?

Yeah, that's exclusive of that. We've been expecting about a 10 to 15 base point impact on our margin, and as we're working through here, we're looking at things that we can do to lessen that impact, and this excess liquidity helps

Okay, great. And then I know I'm doing four questions, but my first two I'm going to argue were little ones. So I'm going to ask one more and then I'll be done.

We don't have a limit. I guess we would have to call it a limit at some point, but Catherine, you can go right ahead.

Other analysts can throw tomatoes at me. So my last one is just on Franklin. If you could just provide an update on how you're thinking about the loan mark and your ability to exit some of their non-CORB loans as was the original plan with that deal. Thanks so much.

Yeah, so loan market, if we think about, we thought about it in two segments. Core portfolio, which is a core portfolio is performing as expected. It's very similar to our portfolio, perhaps a little more real estate weighted, but in terms of underwriting, it's similar to our portfolio. And so we'd say it's behaving not unlike ours and not unlike what you expect in this market. So, you know, there's some unknowns there, but we'd say it wouldn't be much different than the outlook for our own portfolio. And the outlook has changed because the world is different, but not materially there. On the institutional portfolio, which was when we announced the transaction back in January, it was about $430 million. That portfolio has been a little more volatile as we continue to monitor the valuations on that. It probably had dipped more earlier. We've seen some some some some some of that So the values on some of that come back and so it's it's I'd say I don't know what the mark was the mark would be bigger right today than what it was in in January But it's also a smaller portfolio and so As we have sort of ridden the waves up and down on that over the last three or four months. It's probably substantially higher than where it was in terms of valuation, less marked. When I say we're optimistic, as I mentioned, they continue to work that portfolio. There were a couple loans in there that they had that they had identified that they were taking some write down on. They've already done that. But most of what they're getting out of today, they're getting out of it par. And so we continue to be optimistic and I can't give you too much more color on that because we're not sure where it'll be when the transaction closes. Greg? I'll tell you one thing we could add.

I don't have any specifics but in my conversations with them, As you mentioned, they have a significant real estate portfolio and they've shared in the robust Middle Tennessee results and sales activity with their builders. I think on the deferral program, they've had similar numbers as to ours as far as how that has worked through. I echo your comment.

They continue to really work that down. If they had that strategy in place to work that down, just we'll work it down more quickly together than they would have been able to work down on their own. Their chief credit officer, Eddie Maynard, and David McDaniel are doing a really good job of just working, continuing to work that. So it'll be even less when we close things that work in there.

Great. Really helpful. Thank you so much.

Thanks, Kevin. Our next question comes from Brock Vander Vliet from UBS. Please go ahead with your question.

Hey, good morning, guys. Good morning. You gave some color in your opening remarks, and I can see the slide on the mortgage results. just trying to get my head around what happened this quarter with the gain on sale and, as important, what you're thinking kind of going forward, whether it be seasonality and kind of what we should look for in terms of the profitability of the mortgage area in the future.

Yeah. Michael has a very deep knowledge in the mortgage part of our business. I'm going to let him comment on that, Brock. I will just reiterate, great quarter. As you said, strong gain on sale, strong margins, strong production, etc. You want specifically to answer those, Michael?

Yeah. Good morning, Brock. I think part of the variability, you know, and one reason we added the fair value piece is to kind of demonstrate, you know, if you remember at the end of the first quarter, we were a little uncertain as to what, you know, what the world looked like. So we had to reserve. We adjusted some pull-through assumptions. And so that created some variability between the two quarters. But overall, you know, that 380-ish number, you know, in our fair value markets, it's more indicative of where we've been executing. Some margins are materially higher than where they were in the first quarter, and quite frankly, historically. Do we expect them to remain elevated? Yes, at the same level, likely not. As capacity comes in, we'll certainly see margins lower, but we expect a strong third quarter. Is it going to be the second quarter? I'm not going to say it. Our team can execute, but it's not likely. September is a short business month, and it's just not likely. And, Webb, I don't know if you have anything to add there. I'll say this going in.

We haven't looked at any commentary, but I'll say the seasonality factor does come in. Brock, you mentioned that. It'll come in September, which is usually a lower month for us. And so in the quarter – You know, we had three really great months all stacked together, and September is a lower month. And so that will be one impact seasonality. And then the fourth quarter, of course, seasonality will really come into play.

Yeah, there's several things that play, obviously, a factor in it. Capacity is certainly one of them. The industry is at capacity right now. And I guess when you start talking about these elevated margins, as Michael said, you know, we've had – an opportunity across the industry to elevate the margins. Is that sustainable? Likely not, but we don't see it changing much in Q3. But as we get into that seasonality part of Q4, which would be traditional, we expect to see some of that come down.

Okay, and I can tell from the disclosure your channels, you know, retail correspondent, wholesale really haven't changed. Is there anything you're doing differently with respect to the products? Is this all vanilla conforming or are you doing any non-QM?

Yeah, so we're in the consumer direct and retail space. We exited correspondent wholesale reverse early to middle last year, but we are – 100% QM product. We don't operate in kind of that non-QM space. We do some general lending, but primarily conforming. We aim to sell every loan we originate in the mortgage division, and so it's prime product.

Got it. Okay. Thanks for the call.

Thanks, Bob. Once again, if you would like to ask a question, please press star and then one. To withdraw yourself from the question key, you may press star and two. And our next question comes from Amar Sama from Raymond James. Please go ahead with your question.

Hey, good morning.

Good morning, Amar.

I think the kind of big topics have been hit, but just circling back to expenses, you've got the F&B financial franchise, you know, coming on and and then the cost savings coming out next quarter. You've got Franklin coming on as well. So how should we think about kind of the core bank expense run rate, you know, maybe the next couple of quarters and then when all the cost savings are out?

Yeah, so the core bank run rate has been, actually it's been flat for the year, and we really like to keep it in that flattish kind of way for the rest of the year. We We've completed the FMB, Scottsville transaction, and converted it, so we'll have a little bit come out there. We'll also have a little bit of just natural increase, so I think of that as more flattish. Then, of course, when Franklin comes on, we'll have that increase in expenses, but as I think about just the

legacy core bank it should be flat okay i appreciate that um and then on margin um you gave the commentary on the 10 to 15 basis points from franklin are you able to strip out your kind of core xppp margin right now and then how we should think about that core moving forward yeah i mean xppp is probably

five to seven bits higher and really, you know, carrying excess liquidity is another, you know, 10 or so, 10 to 15. So, um, as we deploy some of that liquidity and kind of work through that, you'll see some stabilizing in them.

Okay. And then, uh, last one for me, bigger picture. Has the pandemic provided any opportunities to maybe rethink the business model? You know, that could be from a branch perspective, a headcount perspective, internal processes, et cetera. Thanks.

Yeah, I think the pandemic caused you to rethink everything. And so we, you know, our branches, we've got some, If you look at bank branches today, I mean, you see, I think you could park in front of some meaningful percentage of bank branches and watch, and if you just put them under surveillance Monday through Friday for the eight hours that they were open, you'd probably be amazed at the lack of traffic for some reasonable percentage of bank branches in the country today, which tells you that you don't, need necessarily the transaction capability of those branches. We already had been thinking that way. That being said, we have some very, very busy branches that have been around for decades and decades and decades and get heavy lobby and transaction traffic. We've got them on both ends of that spectrum and everywhere in between. It does cause, we have seen transaction activity drop, at least live across the counter transaction activity drop and not return at this point. And I think that probably doesn't ever return at the same level that it did. Because we've seen folks use remote channels even more than they were before. So yes, It causes you to rethink your branches. It causes you to rethink your non-branch facilities as well because we've got 700 people working remote and expenses are completely in check, maybe even going down a little bit. It causes you to think about what kind of other office space you need going forward and how you react to that. And so it also causes, you know, everybody's already thinking about their investment in technology, the technology that they deploy, and how they make sure that their customers are able to completely transact business in an efficient way. So it does cause you to rethink all of that. It's not that we weren't thinking of that because we were, but it gives you some new perspective and it makes you, and it maybe moves your plans into a faster, it probably speeds your adaptation of some things that you've been thinking of.

I appreciate that. That's it for me. Thanks, guys.

All right. Thanks, Mark. And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back over to Chris Holmes for any closing remarks.

All right. Thank you again, everybody, for joining us today. We really appreciate your support. We're grateful for a great quarter, and we look forward to the next one. Everybody have a great day. Thanks.

Ladies and gentlemen, with that, we'll conclude today's conference. We do thank you for attending. You may now disconnect your lines.