Boston Private Financial Holdings, Inc. (NASDAQ:BPFH) Q1 2020 Earnings Conference Call April 30, 2020 8:00 AM ET
Company Participants
Adam Bromley – Director, IR
Anthony DeChellis – CEO
Steve Gaven – CFO
Paul Simons – President, Private Banking, Wealth and Trust
Jim Brown – President, Commercial Banking
Conference Call Participants
Michael Young – SunTrust
Peter Winter – Wedbush Securities
Chris McGratty – KBW
Christopher Marinac – Janney Montgomery Scott
Lana Chan – BMO Capital Markets
Operator
Good morning. And welcome to the Boston Private Financial Holdings First Quarter 2020 Earnings Call. [Operator Instructions].
I would now like to turn the conference over to Adam Bromley. Please go ahead.
Adam Bromley
Thank you, Andrew. And good morning everyone. This is Adam Bromley, Director, Investor Relations of Boston Private Financial Holdings. We welcome you to this conference call to discuss our First Quarter 2020 Financial Results. Our call this morning includes references to an earnings presentation and which can be found in the Investor Relation section of our website bostonprivate.com.
Joining me this morning are Anthony DeChellis, Chief Executive Officer; Steve Gaven, Chief Financial Officer; Paul Simons, President of Private Banking, Wealth & Trust; and Jim Brown, President of Commercial Banking.
This call contains forward-looking statements regarding strategic objectives and expectations for future results of operations and financial prospects. They are based upon the current belief and expectations of Boston Private’s management and are subject to certain risks and uncertainties.
Actual results may differ from those set forth in the forward-looking statements. I refer you also to the forward-looking statements qualifier contained in our earnings release, which identified a number of factors that could cause material differences between actual and anticipated results or other expectations expressed.
Additional factors that could cause Boston Private’s results to differ materially from those described in the forward-looking statements can be found in the company’s filings submitted to the SEC.
All subsequent, written, and oral forward-looking statements attributable to Boston Private or any person acting on our behalf are expressly qualified by these cautionary statements. Boston Private does not undertake any obligation to update any forward-looking statements to reflect circumstances or events that occur after the forward-looking statements are made.
With that, I will now turn it over to Anthony DeChellis.
Anthony DeChellis
Thank you, Adam. Good morning everyone. Thank you for joining us on today’s call and discuss first quarter 2020 results. We hope you and your families are well and staying healthy during these challenging and uncertain times. Before we discuss our first quarter 2020 results, I’d like to address a few topics related to our company’s response to COVID-19 and the broad impact of the pandemic thus far in our company.
My comments will begin on Slide 3. First and foremost, Boston Private has taken all reasonable measures to protect the well-being of its clients, employees, and local communities during a truly unprecedented moment. I think we might all agree that unprecedented it is an often overused word, not this time. A different environment — the current environment is obviously unlike anyone we have ever seen and its ultimate impact still remains very uncertain. What remains familiar is what is required to help our clients in times of crisis. This is when our clients need us most and this is the moment when firms distinguish themselves on either end of the performance spectrum.
On that note, I’m very thankful for the clients we have at Boston Private and for the partnership spirit they bring in our relationship. It couldn’t be more proud of the Boston Private team for the way they have managed a storm with multiple fronts. In some way it’s been the fabled perfect storm. From standing up at technology platform within days to very effectively managing the SBA PPP program where a vast majority of our clients completing loan applications have been successfully assisted to managing all aspects of our business remotely Boston Private team has successfully adapted in a manner that I could never have dreamed possible.
Every day our clients and our employees become more able and more adaptable to working within the current business constraints. On behalf of all Boston Private’s employees and clients, I would like to especially acknowledge the outstanding work of our operations and technology team. Thanks to their unwavering commitment and the technological enhancements to our platform, we have not only managed to continue our normal business functions but have been also able to add new capabilities to help our clients meet the demands and challenges presented as a result of the pandemic.
Boston Private team has remained unified with our clients during these challenging times. Relationships have strengthened and we are prepared to perform all functions of our business at the highest levels albeit through different means. Through the course of the recent events, our team has been steady and highly focused on the emotional, physical, and financial health of our clients, employees, and communities. Again, I’m extremely proud of the commitment and tireless dedication shown by the Boston Private employees to serve our clients. The response of our employees reinforces my great confidence in our ability to meet the challenges that may lay ahead. I’m also highly confident that we come through the other side of this crisis, Boston Private will have advanced its brand in the minds of our constituents.
I’d now like to move on to where Boston Private stands today operationally and financially. Like many other firms our company is operating primarily from remote working environments. Thus far, it has been a fairly smooth transition through a dramatic change in conditions. Thanks to a thoughtful business continuity plan that was refined in January as the threat of COVID-19 increased. We have temporarily closed select offices and reduced office hours and other — in others in order to ensure clients are able to execute banking services they need while simultaneously limiting in-person interaction. For those offices that remain open, we have enhanced hygiene practices, increased supplies of personal protective equipment, and installed plastic barriers to protect clients and employees.
Our recent technology investments have proved to be timely and shown immediate benefits as our new digital banking platform has enabled our clients to access banking services remotely. We have seen increased rates of enrolment, log-in activity, and mobile banking activity across both private and business clients. In particular, the rate of daily enrolment of our private clients has doubled since January and our business clients have increased their use of mobile deposit by nearly 40%. Likewise, the investments to improve our operations and infrastructure have improved process efficiencies and employee productivity.
While the current environment has continued to tax our energy and emotions in many ways, it has also served to renew our results and provide the new source of energy to fuel our commitment to being an unrelenting source of support and value creation for our clients and community, especially as they continue to navigate truly uncharted territory.
During the last few months we have made available a host of payment relief options for our business and private clients. Specifically, we are providing payment deferment, instituting debt reserve accounts when warranted, waiving late charges, and we have a foreclosure moratorium in effect. We have been actively helping our commercial clients access the SBA Paycheck Protection Program. We have helped 110 clients get approved for loans, totaling more than $425 million. Many members of our staff worked tirelessly and throughout weekends in order to deliver this much needed capital to our clients and our efforts have been aided by our technology.
We have been actively working with government agencies, municipalities, and other funding sources to ensure that community development and affordable housing projects will succeed, especially when construction has stopped. We have also expedited funding to community development organizations while investing in three community development non-profit organizations that have established COVID-19 funds.
As I think about pandemic’s impact on our company and the continuing challenges that may lay ahead, I am reassured and feel fortunate to have a senior management team with expertise, wide-ranging knowledge, and vast industry experience. The team overseeing the company’s credit review process has been in place for many years managing a conservative, disciplined credit culture that has led to top quartile asset quality ranking in seven straight years of net recoveries. Our CFO Steve Gavin will have more to say about our credit culture and the loan portfolio later on this call.
Finally, I don’t think it will surprise anyone to learn that the pandemic will impact our company’s 2022 strategic growth objectives. Even we anticipate a slower rate of advisors through hiring in the coming months. In the current — if the current environment persists and the slowdown is prolonged, our targets will need to be reassessed. However, our business strategy remains intact and we believe our competitive position will have improved in the future state of the financial services industry. We will address specific changes to targets and forecasts in coming quarters. Again, we remain committed to the core principles of the strategic vision we laid out in our 2019 Investor Day, which are that we will continue to build our platform to empower knowledgeable advisors who are better able by intelligent technology to deliver advice-based solutions.
We remain focused on recruiting, developing, and retaining the industry’s best talent. We will pursue a revenue profile that has higher relative contributions of wealth management revenue as a result of higher AUM. And we will continue to operate more efficiently in order to achieve higher returns on common equity.
Before I turn it over to Steve to walk through our first quarter 2020 results, I would like to close with a comment on one quality trait that helped inspire me to become the CEO of Boston Private. And that is that Boston Private’s core DNA has always been about client service excellence and working every day to earn the most trusted advisor role. I believe that a positive consequence of the current environment for our company is that our level of engagements with clients has never been higher. This has been an opportunity for us to reinforce our value to clients as we help them navigate market volatility, rework estate plans, and help them decide for quickly evolving government and regulatory programs. I have never seen clients more engaged in the topics of portfolio construction, financial planning, risk management, wealth transfer, and business succession. I have no doubt that this will result in deeper client relationships over the long term and clients will long remember those firms who had the capacity to step up and help them when they needed it most during a moment that is truly unprecedented.
With that, I will turn it over to Steve.
Steve Gaven
Thanks, Anthony. And good morning, everyone. My comments begin on Slide 4, where we show a summary of our consolidated financial highlights from the first quarter. This quarter we reported net income of $800,000 or $0.01 per share. Earnings were significantly impacted by the adoption of the CECL accounting standard on January 1 and includes $18.8 million of reserve building to incorporate the steep decline in the economic outlook that occurred during March.
Our on balance sheet liquidity improved during the quarter as the average loan to deposit ratio dropped from 103% to 99%, a year-over-year deposit growth of 5% outpaced year-over-year loan growth of 2%. Total AUM as of March 31, 2020 was $14.5 billion, declined linked quarter and year-over-year, primarily driven by lower equity market values at the end of the quarter.
Total net flows for the first quarter were positive $150 million, $176 million of which were attributable to the wealth management & trust segment. The Tier-1 common equity ratio was 11.2%, while tangible book value per share increased 10% year-over-year and 3% linked quarter to $9.31 per share.
During the quarter, we repurchased 12.8 million shares, which reflects the completion of our existing $20 million program that was initiated in 2019. Going forward, we do not anticipate repurchasing common shares while the uncertainty of the current economic environment remains.
Slide 5 shows consolidated income statement. Pre-tax, pre-provision income for the first quarter of 2020 was $17.9 million, a $6.6 million decline linked quarter. Some of the primary factors contributing to the decline include $1.8 million of provision expense related to unfunded commitments, which is captured in total non-interest expense and total other income which includes $1.4 million of negative marks on derivatives and securities related to the company’s deferred compensation plan. And finally, $1.1 million gain during the fourth quarter of 2019 related to the reevaluation of a receivable of a divested affiliate.
Pre-tax income was negatively impacted by the loan reserve building. The effective tax rate for the quarter of 11.2% was lower than previous quarters as a result of lower levels of taxable income during the quarter. The effective tax rate going forward will depend on taxable income. But we anticipate the second quarter effective tax rate to be approximately 18% and for the full-year an effective tax rate of approximately 16%.
Slide 6 shows consolidated revenue trends. The company’s primary sources of earnings, the sum of net interest income and total core fees and income declined 1% linked quarter. Total core fees and income declined linked quarter as result of lower investment management fees in the first quarter and higher fourth quarter private banking fees that included revenue associated with residential loan sales.
Net interest income increased linked quarter as a decline in funding costs outpaced a decline in non-interest earning assets. The linked quarter decline of $3.4 million in miscellaneous income was primarily driven by $1.1 million gain in the fourth quarter related to the revaluation of a receivable for a divested affiliate and $1.4 million of negative marks on derivatives and securities in the first quarter.
On Slide 7, we show a detailed breakout of our non-interest expense. Total non-interest expense for the first quarter of 2020 was $60.9 million, which includes the $1.8 million of provision expense related to unfunded loan commitments categorized as other expense. Excluding the impact of provision expense, first quarter total non-interest expense was $59.1 million, 1% increase linked quarter primarily as a result of seasonal compensation expenses.
Slide 8 shows the past five quarters of average loan and average deposit balances by type on balance sheet liquidity increased as the average loan to deposit ratio declined to 99% during the quarter. However, end of period deposit balances declined linked quarter as temporary deposits we had on the balance sheet as of the end of the year left in the first quarter as we anticipated and communicated on our previous earnings call. As you may recall, our business has historically experienced seasonal outflows during the second quarter related tax payments. Although, tax filing deadlines have been delayed, we anticipate similar outflows to occur in the upcoming quarter.
Total average loans during the quarter increased 2% year-over-year to $7 billion. Overall loan growth was primarily driven by commercial real estate and commercial industrial growth. Although, the decline for the residential loan category over the prior two quarters were driven by loan sales in the third and fourth quarters of 2019.
Total average deposits during the quarter increased 5% year-over-year and 2% linked quarter to $7.1 billion. Average deposit growth was primarily driven by 12% growth in money market accounts and 4% growth in demand deposit accounts partially offset by a decline in certificates of deposits related to the run off of brokered CDs.
Slide 9 shows a five-quarter trend of consolidated net interest income and net interest margin. Core net interest income, which excludes interest recovered on previous non-accrual loans, increased 2% linked quarter as a decline in funding costs outpaced the decline in interest on earning assets.
On the bottom of the slide, we show a net interest margin table including changes in earning asset yield and funding costs. The core net interest margin increased 6 basis points linked quarter to 2.76%. The factor supporting lower funding costs include lower money market rates and lower borrowing volumes as a result of stronger average deposit balances during the quarter. Linked quarter, the cost of deposits decreased by 14 basis points and the total cost of funds decreased 16 basis points.
As we move to Slide 10, which include the discussion of the bank’s loan portfolio, I would like to discuss a few key aspects of our credit culture. We have historically managed to a disciplined mid-single digit organic loan growth rate, so we are not forced to reach on asset quality or terms to achieved outsized growth rates. We focus on relationship lending in our geographic markets, New England, Northern California, and Southern California.
For those of you who are less familiar with the company’s history, our company has evolved considerably since the 2008 financial crisis. Going into that financial crisis, Boston Private Financial Holdings was a bank holding company that owned five separate bank affiliates operating in a decentralized manner and each maintaining separate risk appetite and credit approval processes. In 2011, we merged the banks and consolidated our credit function under the legacy Boston Private Bank & Trust Company team, which has been in place for over 20 years and is led by Bob Buffum and Jim Brown who is joining us on the call today.
Boston Private Bank & Trust Company recognized a total of $13 million of gross charge-offs from 2007 until the bank affiliates were merged in 2011. Following the integration, this team was responsible for remixing the loan portfolio and working out loans, bringing criticized and classified assets down from $360 million in the first quarter of 2011 and ultimately helping drive net recoveries for the past seven years.
Another key difference with respect to credit is the balance sheet composition of today’s consolidated company. Today’s balance sheet profile reflects more conservative and disciplined underwriting. In the third quarter of 2007, construction loans represented 16% of total loans or 414% of tangible capital, a larger percentage of our balance sheet compared today which represents only 2% of total loans and 31% of tangible capital. In addition, today’s construction and land loans include government-supported multi-family development projects with inherently lower levels of risk.
Slide 10 shows an overshoot — overview of our balance sheet profile as it stands today. Our four largest loan types represent 93% of our total loan portfolio. Our largest loan category includes residential loans, which comprise 40% of our total loan portfolio. These are primarily jumbo loans to high net worth clients in our primary geographic markets. These loans carry a weighted average LTV of 66%. We have recognized cumulative losses of $5 million in this portfolio since the beginning of 2007.
Our second largest loan category includes commercial real estate, which we detail further on the next slide. Our commercial real estate loan portfolio reflects diverse collateral types and conservative underwriting practices. Commercial industrial loans represent 10% of the total balance sheet and these clients include high quality segments such as private equity, professional services firms, and privately held businesses while the fourth largest category includes commercial tax exempt loans. These are loans to non-for-profit private schools, colleges, and public charter schools. We have experienced low losses in our history in the commercial tax exempt loan segment.
Slide 11 contains a breakdown of our commercial real estate portfolio. As of March 31, we had $2.6 billion of commercial real estate loans. Our commercial real estate loans are underwritten as stabilized properties, primarily in our geographic markets to strong sponsors that are well-known to our bankers. Some of the key takeaways in our portfolio include, multi-family represents our largest exposure with the highest growth rate since the end of 2016. Our retail exposure has declined 1% annually since the end of 2016. Collateral types are diversified by region. We have no hospitality exposure in Southern California.
Slide 12 contains a breakdown of our overall exposure to industries and client segments that are likely to be most impacted by the COVID-19 pandemic. While the pandemic’s ultimate impact on our loan portfolio remains highly uncertain, we have limited exposure to several industries that may be most immediately at risk. We do not have material exposure to energy, airlines, cruise lines, movie theaters, and casinos and we have limited consumer exposure outside our residential loan portfolio since we do not have any credit cards or auto loans. We are closely monitoring potential exposure within the CRE portfolio related to retail and hospitality. While we believe our exposure is underwritten conservatively and secured by real estate in our geographic markets, we certainly do not expect our clients to be immune from the pandemic.
Our total retail exposure is $632 million. The average loan size in the portfolio is $3.8 million and the weighted average LTV factoring current portfolio balances is approximately 48%. Our hospitality portfolio represents $144 million of exposure. We have downgraded independent boutique, locally-owned hotel properties that we deem to be high risk, which partially caused our criticized and classified loans to increase during the quarter. Though all of these loans continued to pay as agreed and remain current, the weighted average LTV factoring current portfolio balances for the hospitality portfolio is approximately 51%. The third area of exposure includes restaurant loans, which totals $16 million or less than 1% — or less than 0.25% of total loans.
On Slide 13, we review the implementation of CECL accounting standard, which we adopted on January 1, 2020. Upon adoption, we realized initial reserve release of $20.4 million. This was primarily based on our low loss history impacting the quantitative nature of the CECL model. The subsequent reserve building of $16.6 million through the provisioning was primarily driven by deterioration in the economic outlook as a result of the pandemic rather than net loan charge-offs, which remain low at $300,000 during the first quarter.
Our economic forecast is based on a probability weighted composite scenario primarily comprised of the Moody’s COVID-19 baseline and the Moody’s S3 downside scenario. The baseline scenario assumes a sudden sharp recession catalyzed by the COVID-19 crisis, turmoil in the equity markets and the plunging global oil prices. Notable economic data from the baseline scenario includes U.S. GDP contracting 18.3% annualized in the second quarter and an unemployment rate of 8.7% in the second quarter. The addition of the S3 scenario negatively impacts the composite scenario to reflect an environment where COVID-19 deepens and persist longer than expected resulting in a double-dip recession.
After the first quarter provision doubled our reserves as a percentage of loans declined slightly from 103 basis points to 97 basis points. Our reserves as a percentage of loans under CECL are highest on construction and land, commercial and industrial, and commercial real estate, while the lower rates on residential and commercial tax exempt portfolios and the higher rate of residential loans resulted in a lower consolidated coverage ratio.
Slide 14 provides detail on our adversely graded and non-performing loans. Overall non-accrual loans remain low at 35 basis points of total loans. The increase in criticized and classified loans reflects the downgrade of performing loans to special mention and accruing classified categories. The special mention increase was the result of downgrading the previously mentioned independent boutique hotel CRE loans that were deemed to be at higher risk and the $30 million increase to accruing classified loans was primarily driven by a single relationship that experienced credit deterioration, which we believe to be an isolated incident.
On Slide 15, we show the private banking segment including — excluding the wealth management & trust portion of our bank. The private bank efficiency ratio increased to 72% driven by negative revenue categorized as other income coupled with provision expense related to unfunded commitments.
I will now turn it to Paul Simons to discuss our wealth management & trust segment.
Paul Simons
Thank you, Steve. And good morning.
Slide 16 shows performance highlights for the wealth management & trust segment. The segment’s EBITDA margin for the quarter was 22% reflecting a slight decline in revenue and seasonal compensation expenses. AUM for the segment was $13.5 billion. Lower equity market values as of March 31 caused linked to quarter and year-over-year comparisons to be negative. Continued strength in new business source both from new and existing advisors combined with a reduction in outflows led to positive net flows of $176 million for the first quarter of 2020. At the same time, we added seven advisors in the quarter while experiencing no attrition.
That concludes our prepared comments on our first quarter 2020 reported results. We will now open the line for your questions.
Question-and-Answer Session
Operator
[Operator Instructions]. The first question comes from Michael Young of SunTrust. Please go ahead.
Michael Young
Good morning. I wanted to just start on the downgrades. We’ve seen most other banks not necessarily move forward with downgrades this quickly as they’ve been either deferring payments or allowing borrowers into forbearance. So just curious if there’s a reason why these were specifically downgraded as opposed to looking at some of those other mitigating factors, and just any other color you can provide on location, size of these loans?
Steve Gaven
Sure, Michael. This is Steve. I think, to start off, it’s just kind of revisit the Boston Private credit culture and how we approach these type of situations. Our goal is to identify pockets of risk early, rate those pockets of risk appropriately and then manage those pockets of risk in a way where we minimize loss. And the key to that last part minimizing loss is really identifying problems early and that’s what you see here. So we had those three hospitality loans that we downgraded from past the special mention. Those three loans, two of which have LTVs in the 50% range, the third below 65% and low 60% range all backed by a very strong sponsor with strong liquidity, but nevertheless obviously that segment is experiencing challenges.
So we thought it was appropriate, as we typically do, to identify that problem and downgrade it as appropriate. I would point you to the slide in our investor presentation, Slide 45, where we kind of layout between 2017, 2018 where we downgraded $100 million of loans, upgraded $110 million of loans or had payoffs in that bucket, and I think that it just is a really strong example of how we approach this and I think that’s what you’re seeing this quarter.
Michael Young
Okay. And a quick credit follow-up. Do you-all have any shared national credits or any leveraged lending on the books?
Steve Gaven
Leverage lending, no. Shared national credits, I’ll have to come back to you with that detail, it’s a small number.
Michael Young
Okay. Assumed so. And then, Anthony, maybe a bigger picture question just on kind of the updated outlook and kind of road map that was originally laid out. I know you’re still kind of reevaluating that. But essentially, what you’re trying to communicate is that the hiring pace and/or I think at one point, there was some hope for some acquisitions of RIAs is likely to be much slower this year. So maybe that kicks out things, adds an additional year to the time line. Is that kind of the right way to think about it?
Anthony DeChellis
Yes. I mean whether it adds a year or not, I think we’re all trying to figure out how long this lasts. So the two activities you just referenced, whether it’s hiring or firing an RIA, obviously those are two things that require a lot of in-person contact. It wouldn’t surprise anyone to know that we’re not going to buy anything or not going to hire anybody unless we’ve spent a considerable amount of time in their presence. So that’s really we felt getting out in front of that and saying even though we were able to add seven advisors in the first quarter, a lot about was a build-up of the meetings we had obviously in that third and fourth quarter with lots of face-to-face meetings us getting to know them and them getting to know the firm.
We clearly can’t do that as actively now, but we will clearly resume it as soon as we can. And so we were thinking that at a minimum it kicks back things six months, whether or not it’s a year, we’ll just see how long this lasts, but you’re — you’ve got it right, that’s really the basis of us thinking things will be pushed back because growing our business has a lot to do with hiring and if we’re going to acquire something due diligence has clearly been hampered.
Michael Young
Okay. And maybe just one last one, just on the dividend. Obviously, I understand the reason for the suspension of the share buyback. But earnings maybe a little bit lowered depressed here for a quarter or two with reserve build, but just how are you thinking about the dividend in that context?
Steve Gaven
Yes. So right now –
Anthony DeChellis
Yes. So…
Steve Gaven
Why don’t you go ahead, Anthony, on that? So right now we saw —
Anthony DeChellis
Go ahead, Steve. This is the difficulty of doing a call where we’re not in the same room, but go ahead, Steve.
Steve Gaven
So you saw us obviously suspend the share repurchases. We continue to pay the dividend as we have in previous quarters. We’ll continue to look at all our capital return options and see what makes sense as we work through the crisis. This all happened pretty quickly. So we’ll continue to analyze our forward outlook, get a better sense of how the economy is going to develop over the coming quarters. We’ll continue to re-evaluate whether or not the dividend makes sense. But I think it’s too early to make a definitive decision on that.
Anthony DeChellis
I don’t have anything more to add to that.
Michael Young
Okay. Thanks.
Operator
The next question comes from Peter Winter of Wedbush Securities. Please go ahead.
Peter Winter
I was wondering can you talk about what you’re seeing in terms of loan deferrals and forbearance and what the plans are?
Steve Gaven
Sure. So we have a couple of different programs in place. Residential, there’s been about — the program there is a three-month deferral with option extend for three months, so that’s about $162 million of loans or 5.7% of the portfolio. On the C&I portfolio it’s a six-month deferral principal, and that program’s been about 12.5% of the total portfolio.
And then with CRE, we did something a little different. We were — we took a more proactive approach where we went out to our clients and we set some qualifiers that would enable them to take a second mortgage out for the lesser of basically LTV going to 75%, combined LTV with the first and the second, or one year’s worth of P&I. So that’s been well received obviously by clients. About 51% of our commercial real estate clients qualify for that program and accepted it. About 21% qualified and did not accept. And the disqualifiers that would kick you out of being qualified were basically if that LT — if your LTV was above 75%, which is not a loan policy. If there’s already existing liquidity support in place, so if there is an LOC in place that they can draw on. If it was loan participation or if it was a community development project where there’s other ways of support in place already.
Peter Winter
Got it. That’s very helpful. And then you had a nice drop both in interest bearing and deposit costs and liability costs. I was just wondering, did you have what that level is potentially in March. And secondly, what the outlook is for the margin in the second quarter?
Steve Gaven
Yes. So I think we’ll continue to see deposit cost push lower. We’re probably a little late when rates started to get cut when this first happened last year. So we’ve been pushing through catching up. And obviously with the zero-bound environment back there’s more room to push those rates lower. I think as we look at margin in the second quarter, I think NIM’s probably in the 2.65% to 2.70% range. And really the reason for that is we’re going to be entering our seasonally weak period where deposits, on balance sheet liquidity will be a little challenge. We’ll be borrowing more to fund the balance sheet.
Now, there is a chance that just given the delay in tax day that seasonality isn’t as pronounced right off the bat in the second quarter, so that can extend a month or two. That’s really the main driver of that short-term NIM compression. And then longer-term, as you get to the back half of the year depending on the shape of the curve and how on balance sheet liquidity recovers you could see additional NIM compression. At some point probably towards the third or fourth quarter you probably get deposit cost to maybe as low as they can get and maybe that pushes into next year, but then you still have assets re-pricing lower, so 2.65% to 2.70% for the second quarter and then a downward bias for the back half of the year.
Operator
The next question comes from Chris McGratty of KBW. Please go ahead.
Chris McGratty
Steve, I just wanted to come back to the dividend question for a moment. Understanding like most banks reserve built probably heavy for a quarter to couple more quarters. But then kind of exiting this year, it would seem that you could earn the dividend. Again, is the dividend discussion more about how long this goes or perhaps managing to a payout ratio, a manageable payout ratio? Because it seems like the interest rate environment that’s pretty challenging for the banks and profitability is going to be lower even when we emerge from the credit crisis. Any thoughts would be great.
Steve Gaven
Yes. I think, Chris, we’re trying to assess kind of how long this goes because obviously dividend is a source of capital. And while we think we’re well-positioned from a capital perspective and where we feel good about our underwriting, as I mentioned earlier this just happened so quickly and it seems to be changing kind of every day. So as we work through the second quarter, we’ll be spending a lot of time on scenario analysis updating our forecasts and seeing what that means from the forward earnings outlook to the forward credit outlook and then we’ll make a decision based off that. But right now, I would say it’s too early to tell just given it was only about a six weeks ago where I was still sitting my office in Boston, thinking that I’d only be out of work — or not out of work, but out of the office for two to four weeks, and here we are probably not returning until sometime in June. So just too early to tell and this is just moving so quick.
Chris McGratty
Okay. Great. Thanks. And then maybe as a follow-up. Just kind of combining the comments about slowing the pace of hiring, how do we think about expense progression in this environment for the rest of the year?
Steve Gaven
Yes. I mean, I’m not comfortable kind of talking too far out, but I think going to next quarter probably $60 million to $62 million of operating expenses. And that range will be dictated — where we fall in that range will be dictated kind of on pace of hiring, as well as on some of the other initiatives we have undergoing. We haven’t seen too much delay on our tech platform, in our tech development, maybe push back a couple of weeks here and there in certain initiatives, but we’re largely on page there. Really be the pace of hiring because as you can imagine just the on-boarding process right now it’s challenging and I think things are just a little slow given the environment.
Chris McGratty
Yes, great. And then one more, if I could. Even if you have any drawing out the attention of what’s different about this balance sheet today versus 12 years ago, if you kind of separate the two portfolios, the resi book is obviously stood on its own and the loss content is very low, how do you think about ultimate loss content for your commercial portfolios? Maybe just talk about how you guys have been running, perhaps, internal stress tests on some of these commercial books and where you think losses could trend over the next couple of years if this environment persisted? Thanks.
Steve Gaven
Yes. I mean, again, I think it’s tough to say with much precision where losses trend over the next couple of years just given where we are. I would say that we’re comfortable where we’re positioned with Tier-1 common equity and that low-to-middle 11s. We’re comfortable with how we’ve underwritten these loans and that we can manage the credit portfolio effectively. So again, tough to say where what happens as thing plays out over the next couple of years, but we do feel comfortable that, putting aside that, that resi portfolio has demonstrated real strength over time. The commercial tax exempt, I would put it in kind of that same bucket, has also demonstrated real strength over time, but we feel good about where CRE is today.
Operator
The next question comes from Christopher Marinac of Janney Montgomery Scott. Please go ahead.
Christopher Marinac
Hey, thanks. Good morning. I missed it if you said earlier about deferrals and sort of where those are going and if those may change further.
Steve Gaven
Yes. So Chris, I’ll just run through that again. So residential, that’s a three-month deferral, three-month option at the end of three months to extend, so six months in total, its $162 million, which is about 5.7% or 6% portfolio. C&I was a six-month principal deferral and that’s about 12% of the portfolio. And then we talked a little bit about the CRE program that we have in place, which is a little different and that was a proactive program that our commercial banking team executed against where we went out to our clients and offered them a second mortgage if they qualified to cover up to one year’s worth of P&I, which in effect enables them to really focus on their tenants and making sure that they’re able to plan to come out the other side in good standing.
So about 70% of the book qualified, 51% the qualified accepted, 21% of the qualified didn’t accept. And the disqualifiers for that program was that combined LTV had to be 75% or less. You couldn’t have an existing credit facility in place that was already providing liquidity support like an LOC. It couldn’t have been a participation or couldn’t have been a community development project. But if your combined LTV is 75% or less and didn’t have those other features, you qualify for that program.
Christopher Marinac
Got it. That’s helpful. And some extent the CRE initiative on the P&I sounds a little bit more proactive than we’ve heard from other banks, which is a positive. So it kind of lead to my other question, which is do you think some of these deferrals ultimately lead back to higher criticized assets or would you think that the criticized level actually sort of backs down on that some of the churns that you keep at a similar level as what we have now?
Steve Gaven
Yes. I think they go together, right? I don’t think that just because something is deferred that the underlying risk of that relationship is necessarily inflated, I think it buys time. But in a lot of respects I think you have to separate out whether something is in deferral and whether or not there’s real risk to that credit. And I think you should risk rate accordingly. And I think that’s what you — exactly what you saw this quarter with us is that you have three credits that we — or three loans that we downgraded that have really strong LTVs, really strong sponsor support with strong liquidity behind it, but at the end of the day, boutique hospitality is under a lot of pressure. So it’s tough to sit there and call something a four-rated loan when you think about that backdrop that they face. So I don’t think they can be exclusive, I think you still have to rate the loans appropriately even if there’s deferment programs in place.
Christopher Marinac
Yes, because the cash flow is negative, it may change, but it is negative at the moment. That goes back to the fact patterns.
Steve Gaven
Correct.
Christopher Marinac
So good. Okay. That makes sense. And then just back to the dividend question and that we’ve kind of beat on it a couple times. But it would seem to me that your pre-tax pre-provision is still strong enough to more than cover the dividend. So I guess I’m curious do you envision changes in margin and non-accrued interest that are big enough to kind of lead to that strategic change or is it that do you have to have more evidence?
Steve Gaven
I think we have that more evidence. Like I said, this happened so quickly. And we’ll continue to look at it until we get a better sense of how things play out over the next quarter. I mean I think second quarter is going to reveal a lot and that’s going to give us a lot better information as we try to manage that going forward and make a decision, but I just think we need more evidence, more information before we really firmly commit to anything at this point.
Operator
The next question comes from Lana Chan of BMO Capital Markets. Please go ahead.
Lana Chan
Just a follow-up question on the CRE modifications or the second mortgage. Pretty unique that you guys are doing that. How much did it actually generate in terms of new loans?
Steve Gaven
That’s about $86 million of new loans.
Lana Chan
Okay, great. And within the C&I deferrals, were there any particular industry segments in C&I that accounted for most of the deferrals?
Steve Gaven
So the data line that I talked to you, that’s the total C&I book, that includes commercial tax exempt. Most of it, as you can imagine, was in our small business and kind of lower middle market business client base where it’s been most acutely hit during the pandemic thus far.
Lana Chan
Okay. And just —
Steve Gaven
No specific end market, but just broadly speaking that bucket of clients.
Lana Chan
Okay, got it. And my third question was around the margin. Did that guidance for the second quarter include the impact of the addition of PPP loans which are lower yielding?
Steve Gaven
No. If you bear with me one moment I can get you the PPP impact, but, no, that margin does not include that. Lana, let me get back to you after the call.
Lana Chan
Okay.
Steve Gaven
I had that somewhere, but I can’t — don’t have it right now. I’m sorry. 21 basis points, if you include PPP.
Lana Chan
Okay. And that’s in —
Steve Gaven
And the assumption — and that doesn’t assume the origination fee, that’s just we’re going to — we’re getting 1% on these loans and we’re assuming in that analysis that we’re funding fully with the facility that Fed set up.
Lana Chan
Okay. That was my second question. Great. Thank you very much.
Operator
This concludes our question and answer session. I would like to turn the conference back over to Anthony DeChellis for any closing remarks.
Anthony DeChellis
Thank you. I think as we’ve all probably heard on this call we kind of continue to hear regardless of who we’re talking to in the industry is that few models incorporated a scenario like the one we’re all managing. And so we continue, like all of you, to try to forecast what the immediate quarter looks like I mean out to the end of the year. But as I said in my earlier remarks, we’re more than steady through the current crisis and truly believe that when we come out the other side there will be even more opportunities available to us, especially given how I think we were able to adjust to this crisis.
I want to thank you all for taking the time to join us today regardless of what the next quarter or two brings. I hope it’s a safe journey for you and your families. And we certainly look forward more than ever till the next time we get to all see each other in person. So thank you again. And I wish you all a great day.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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