TCF Financial Corp (NASDAQ:TCF) Q3 2020 Earnings Conference Call October 27, 2020 10:00 AM ET
Timothy Sedabres – Head, IR & Director of Corporate Strategy
Craig Dahl – President and CEO
David Provost – Executive Vice Chair
Thomas Shafer – COO
Brian Maass – CFO & Treasurer
Richard Meringolo – Chief Credit Officer
Conference Call Participants
Jon Arfstrom – RBC Capital Markets
Steven Alexopoulos – JPMorgan Chase & Co.
David Long – Raymond James & Associates
Ebrahim Poonawala – Bank of America Merrill Lynch
Terence McEvoy – Stephens Inc.
Nathan Race – Piper Sandler & Co.
Christopher McGratty – KBW
Jared Shaw – Wells Fargo Securities
Kenneth Zerbe – Morgan Stanley
Good morning, and welcome to TCF’s 2020 Third Quarter Earnings Call. My name is Chad, and I’ll be your conference operator today. [Operator Instructions].
At this time, I would like to introduce Tim Sedabres, Head of Investor Relations, to begin the conference call.
Good morning, and thanks for joining us for TCF’s Third Quarter 2020 Earnings Call. Joining me on today’s call will be Craig Dahl, President and CEO; David Provost, CEO-elect; Tom Shafer, Bank CEO-elect; Brian Maass, Chief Financial Officer; and Richard Meringolo, Chief Credit Officer. In just a few moments, Craig, Dave, Tom and Brian will make opening remarks and provide an overview of our third quarter results. They will be referencing a slide presentation that is available on our Investor Relations section of the website, ir.tcfbank.com. Following their remarks, we’ll open up for questions.
During today’s presentation, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We caution that such statements are predictions and that actual events or results may differ materially. Please see the forward-looking statement disclosure and our 2020 third quarter earnings release for more information about risks and uncertainties, which may affect us. The information we’ll provide today is accurate as of September 30, 2020, and we undertake no duty to update the information.
I would now like to turn the conference call over to TCF President and CEO, Craig Dahl.
Well, thank you, Tim. Good morning, and thank you to everyone joining us today. Yesterday, we released our third quarter financial results. And along with those results, we also announced that I will be retiring from TCF and stepping down as CEO. I’ve had the benefit of a long career in banking spanning over 40 years and with the most recent and most rewarding 21 years here at TCF. As we have successfully completed the integration from the merger of equals, I believe now is the right time to pass the baton and refocus my time with my family. Even in the midst of a pandemic, I could not be prouder of what TCF has accomplished and the strong outlook and opportunities that lay ahead. I am confident and proud of the strong bench strength we have post the merger, and I’m pleased to have Tom and Mike both step up into their elevated roles. I know that both of them are the right people for the job, and I’ve been impressed with their ability to lead their teams since the closing of the transaction.
Coupled with Dave’s focused role as CEO of the holding company, I believe TCF is in great hands to continue to execute on the strategies we believe the merger of equals brought to the combined banks. I will make a few comments on the integration and where we stand today, and then hand it over to Dave, Tom and Brian.
The highlight of the quarter was by far the successful on time completion of our merger integration activities that our team has worked hard to get across the finish line. As we laid out from the beginning, this merger has now positioned us with a common brand, expanded product set, significantly enhanced technology platform and improved efficiencies. Importantly, the cost synergies are on track for on-time achievement in the fourth quarter. The culture of One TCF has come together better over the past 1.5 years than I could have even imagined. I have seen first-hand how our experienced leaders across the bank have rallied together to support integration efforts, respond to challenges from the COVID pandemic, support our customers and team members affected by the flood in Midland and rally around a shared vision to respond to the civil unrest and calls for social justice in our communities.
Since closing the merger, I have seen the power that collaboration brings when we truly leverage the best of both things. The collection of talent here at TCF continues to amaze me with their level of expertise and dedication to doing the right thing for our customers, team members and investors. In closing, it is a proud day for me to look at where we are today and recognize the hard work of our teams to get us to this point. I look forward to seeing the continued success that TCF has in its future for many years to come.
And with that update, thank you to all of our investors, analysts and team members listening today. I believe this is my 20th earnings call as CEO, and it has been a true pleasure to serve as your CEO for the past 5 years. When I joined TCF 20 years ago – 21 years ago, we had just under $10 billion in assets with a bright future ahead, from starting TCF leasing from the ground up to now having successfully created a leading Midwest bank with nearly $50 billion in assets, the opportunity ahead is greater today than it has ever been for TCF. It’s been an honor to serve as CEO of this great company, and I look forward to the future successes to come.
I will now turn it over to Dave.
Thank you, Craig, and good morning, everyone. We appreciate your passion and leadership that led TCF forward to where we are today. Let me make a few comments before passing it over to Tom to cover the third quarter highlights.
To start off, I am pleased to work with Tom and Brian as we move past the integration program and focus our efforts on continued organic growth and further improve profitability into next year. As Craig mentioned, we are pleased to have completed our integration program and are on track to deliver the expense levels we targeted for the fourth quarter. While we are on track to deliver our expense commitment, COVID and the environment around us has left us shy of our target revenues we expected when we announced the transaction. Lower Inventory Finance balances and certain noninterest income categories have seen revenue pressures.
However, we view these as near-term headwinds. These are great businesses and do not reflect permanent revenue losses. As a result, we are committed to managing through these headwinds, and we are prepared to take action. The company has a history of ensuring we produce an efficiency ratio and profitability profile that is attractive for investors. As Tom, Brian and I finalize our plan over these next 60 days, we will be able to update you with more details around what we believe is possible for both accelerated revenue opportunities as well as incremental efficiency improvements for 2021.
Now let me turn it over to Tom to cover our third quarter highlights.
Thank you, Dave. Our third quarter results continue to reflect the impact of the economic uncertainty. However, we are working hard to manage through this environment. As mentioned, the critical priority this quarter was the completion of our integration program and ensuring we deliver on the cost synergies for the fourth quarter we committed to. We saw modest loan balance declines in the quarter, coupled with a relatively stable margin and continued strength in capital and liquidity ratios. We recognized a lower level of customer and borrower demand in the current environment. However, our commercial loan pipelines are rebuilding from low levels earlier in the pandemic, and September pipelines for middle market, commercial real estate and capital solutions are gradually rebuilding and getting closer to comparable levels from a year ago. We continue to believe the teams that we have in place along with the comprehensive products that we have as a result of the MOE, positions us well to deliver strong loan growth as we exit pandemic.
TCF has a great opportunity to capture market share and grow organically. As our revenue synergies remain in front of us, growth in Minneapolis and Chicago are critical markets for us in 2021. On this topic, we are nearly ready to announce the hiring of a regional president from Minneapolis, who will lead our commercial banking expansion in this key market. Additionally, we are nearing the expiration of noncompete agreements for our Chicago commercial banking leaders we brought on last year. These 2 factors demonstrate our commitment to continuing our focus on revenue synergy opportunities and we continue to believe we have a large opportunity to expand our commercial banking capabilities in these 2 markets.
Mortgage is also a great opportunity for us to get our fair share. We currently have deposit market share of around 3% in our primary markets across the footprint compared to mortgage market share closer to 1%. We have a long runway to grow our mortgage share to close this gap. One of the easier revenue synergies to implement is our leasing products, which are ready to go to support deeper relationships with commercial customers. Before COVID hit, we had a strong pipeline of referrals from middle market to the leasing group. And we expect that as activity levels rebound, we will see that pipeline continue to grow.
We will be disciplined where we invest in 2021 to drive sustained revenue growth. And to fund this, it will likely require us to take a hard look at other expense and efficiency opportunities. From a credit standpoint in the quarter, we saw much lower deferral balances at quarter end of $404 million, which represents just over 1% of total non-PPP loans and were down nearly 80% from last quarter. Net charge-offs were 28 basis points along with $70 million of provision expense, which resulted in a moderate net reserve build. We’re taking a proactive approach on many of the more COVID-impacted portfolios such as motor coach, shuttle bus and hotels. And lastly, capital ratios are strong and increased with a common equity Tier 1 ratio of 11.5%.
With that, I will turn it over to Brian to further detail our third quarter financial results.
Thank you, Tom. Slide 5 shows total loan balance activity during the quarter. Overall, loan balances came in lower due to strong Inventory Finance sell-through and higher mortgage prepayments. In the commercial real estate and leasing portfolios, balances were relatively flat quarter-over-quarter. Consumer balances were down from the second quarter, with the majority of the decline coming from residential mortgage. Overall, our mortgage pipeline remains strong. However, originations for the balance sheet have not been able to keep pace with the higher levels of prepayments we have seen in the mortgage portfolio.
Inventory Finance balances, which totaled $2.1 billion at quarter end, declined $447 million during the third quarter. This decline is the third – this decline in the third quarter was less than the level of decline we saw in the second quarter. Dealer activity remains strong, but we continue to wait for inventory levels to refill to pre-COVID levels following the closure of many manufacturing plants. In addition, the third quarter is the typical seasonal trough for inventory balances. And while lower balances are a near-term revenue headwind, it has had a positive credit impact with no Inventory Finance net charge-offs in the third quarter and no balances currently on deferral status.
Looking ahead, we believe we reached a crossover point in late September as shipment levels began exceeding liquidation levels. However, it may take a few quarters for inventories to return to more normalized levels. We are optimistic that balances could begin to grow in the fourth quarter of 2020 and in the first quarter of 2021, given the typical seasonal build.
Our overall loan growth outlook for the fourth quarter and into 2021, will be largely dependent on the level and pace of commercial loan demand. While demand continues to be modest overall, we are seeing positive signs as commercial loan pipelines have been building including CRE and certain C&I sectors, such as manufacturing. We continue to believe we have the ability to generate stronger than peer loan growth as we get back to a more normalized environment and as customer demand returns, given the revenue synergies we have yet to realize following the merger.
Turning to Slide 6. Deposit balances remained flat from the second quarter despite the continued runoff of CD balances, which declined $808 million during the quarter. Meanwhile, trucking balances including noninterest-bearing, increased $971 million. Non-CD deposit balances have now grown $4.6 billion over the last 2 quarters. A portion of this growth continues to be transitory, given the impact of stimulus payments, PPP and reduced spending. While we have not seen these balances decline yet, we would expect runoff of a portion of these transitory deposits in the coming quarters. Given the recent growth of deposit balances, we have seen the loan-to-deposit ratio decline from 100% in March to 88% in September. With our excess liquidity, runoff of CD balances and improved market pricing, our cost of deposits declined 17 basis points from the second quarter. We believe there remains opportunity to further bring down our cost of deposits in the fourth quarter. For example, we still have over $6 billion of CDs at a cost of 1.1% with renewal rates of 20 to 30 basis points. This should help to drive overall deposit costs even lower.
Turning to Slide 7. As we indicated last quarter, we were able to hold net interest margin relatively flat with the second quarter, with adjusted net interest margin declining just 1 basis point to 3.19%, excluding accretion and PPP. As a result, net interest income remained relatively flat at $377 million. Excluding accretion and PPP income, adjusted net interest income was $344 million in the third quarter. As we look ahead to the fourth quarter, we expect a decline in excess liquidity, deposits to continue to reprice lower and the potential for seasonal growth in our higher-yielding Inventory Finance business to provide tailwinds for the margin. We believe these tailwinds could more than offset the headwind of lower loan yields and drive a stable to increased margin rate for the fourth quarter.
PPP forgiveness in the fourth and first quarters of next year could drive accelerated recognition of fees. As the PPP fees run off, we are hopeful that incremental loan growth will help stabilize and potentially grow core net interest income going forward. Loan growth will be the key to supporting this as continued deposit repricing is helping to counter asset yields given the low rate environment.
Turning to Slide 8. Noninterest income totaled $119 million for the quarter. We believe we have seen the low point for noninterest income as several drivers are now showing positive trends heading into the fourth quarter. We also saw a $2.6 million unfavorable interest rate swap mark-to-market adjustment for the quarter, which lowered the other noninterest income line. Fees and service charges on deposits came in at $25 million, up slightly from the second quarter. This reflects the start of a rebound from the second quarter trough, which was due to higher balances from stimulus payments. Despite the rebound, we remain at relatively low fee levels due to the continued excess liquidity on customer deposit accounts.
Card and ATM fees of $23 million saw a similar rebound in the third quarter as transaction volumes increased in the third quarter. This level of fee income is approaching pre-COVID levels. Gain on sale of loans decreased from $29 million in the second quarter to $23 million in the third quarter, but remained strong overall. With a continued strong pipeline in mortgage, it is possible we may see continued gain on sale strength into the fourth quarter. This remains a key revenue synergy for us as we are operating with one mortgage team and platform across our footprint. Leasing fees declined $5 million to $32 million in the third quarter. These fees continue to be impacted by the levels of customer-driven activity. Given the current environment, we are seeing lower customer activity levels given the uncertainty. That said, the fourth quarter is typically the strongest for leasing fees, so we would expect to see an increase late in the year.
Overall, while we have seen pressure on fee income from the current economic environment, we believe we have hit our trough as we are seeing several positive trends.
Turning to Slide 9. We continue to execute on our integration cost synergies and an adjusted noninterest expense of $319 million, again, came in below our fourth quarter target of $321 million. This excluded $54 million of merger-related expenses. Occupancy and equipment, compensation and employee benefits and leasing, financing, equipment depreciation, all declined from the second quarter. Other noninterest expense increased $9.9 million, which included higher advertising and marketing expense and outside processing, up from the low level in the second quarter. This also included a $1.8 million federal historic tax credit amortization expense, and we could see higher tax credit expense in the fourth quarter tied to completion of various projects. As a reminder, these tax expenses generate associated tax credits, which come in through the income tax line and more than offset the related expense.
As we enter the fourth quarter, we still have cost synergies yet to realize, the majority of which will come from vendor and systems. We expect to see adjusted noninterest expense below our $321 million target in the fourth quarter. Our adjusted efficiency ratio for the quarter was 61.2%. We continue to target an adjusted efficiency ratio below peer median. We have demonstrated a commitment and ability to manage our expense base. Through the completion of merger synergies, we will have $180 million of recurring annual expense benefits, and we now have a leading technology stack that will pay dividends for years to come.
We are working through our annual budgeting process and we believe there are opportunities to further align our expense base with the current revenue environment. Many of these items required that we first complete our integration and system consolidation. We are looking at the items that you would expect, including rationalizing real estate, including branch and other office space and incremental process improvement and optimization opportunities. The goal of this review will be to lower our expense levels to improve overall efficiency while freeing up investment dollars for revenue growth opportunities in 2021. At this point, our review is in flight, and we expect to have more detail to share with you in the next 60 days.
Turning to Slide 10. We remain well positioned in this environment from a capital standpoint with a CET1 ratio of 11.5% at the end of the third quarter. Given the economic uncertainty, our primary focus from a capital perspective will be maintaining robust capital levels while continuing to serve our customers. We declared our quarterly stock – common stock dividend alongside our earnings announcement that will be payable in December. I believe we are positioned to continue our dividend at this level, given the earnings power we see on the horizon once we get past the end of our merger-related expenses. However, this will depend on economic conditions as we move throughout the coming quarters. We also want to ensure we are in a position to take advantage of any platform or portfolio opportunities that may become available as the macro outlook stabilizes and improves. Buybacks under our share repurchase program continue to remain suspended.
Turning to credit on Slide 11. Net charge-offs were $25 million or 0.28% of average loans. Over 90-day delinquencies remained very low at just 2 basis points while nonaccrual loans and leases increased $85 million from the second quarter. $78 million of this increase came from the commercial portfolios, including $47 million related to the motor coach and shuttle bus portfolio which we have previously identified as a COVID-impacted portfolio.
Turning to Slide 12. We had $70 million of provision during the quarter, down from $79 million in the second quarter. As a result, allowance for credit losses increased to $549 million as of September 30. Allowance for credit losses as a percentage of loans increased from 1.42% to 1.6% in the second quarter. Excluding our $1.8 billion of PPP loans, our allowance for credit losses was 1.69% of loans. In addition to our allowance for credit losses, we also have a $131 million fair value discount on acquired loans.
The higher allowance levels are primarily driven by the commercial portfolios. We saw reserves in the lease financing and C&I portfolios increase by 64 basis points and 26 basis points, respectively, from the second quarter. Both of these increases were due to higher reserves in the Capital Solutions business, primarily from motor coach and shuttle bus, 2 of our most heavily impacted COVID portfolios. Reserves on the CRE portfolio increased 37 basis points to 2.06%, driven by various risk rating migrations in the third quarter as well as changes to the CRE price index outlook. Looking ahead, we are seeing stabilization in the economic forecast, which should indicate that future allowance activity will be more closely tied to changes in loan mix and credit quality. We are seeing the benefits of the diversification the merger of equals brought together with no large lending concentrations.
Turning to Slide 13. As expected, we have seen a steady decline in the level of loan and lease balances on deferral status. As of September 30, we had just $400 million on deferral or 1.2% of non-PPP loans, down nearly 80% from June 30. The trend of declining deferral balances is continuing as we are seeing very few new deferral requests. Moving forward, we are likely to see a return to paying for many of these credits coming off deferral and where we believe there are additional accommodations needed for a medium-term period, we are working with our borrowers, such as motor coach, shuttle bus and hotel.
Turning to Slide 14. Overall, we are feeling better now compared to on June 30. However, we continue to see the largest COVID impacts in these portfolios we previously identified, with our top focus on motor coach, shuttle bus and hotel. Motor coach and shuttle bus are the areas we are seeing the most stress. We have separated these 2 portfolios as they have distinct underlying use cases and may perform differently. We have $166 million of motor coach balances, which are more heavily dependent on travel as they are typically the over 50 passenger coaches. Just over 1/3 were on deferral status as of September 30. In many cases, another 90-day deferral does not match the extended recovery time these borrowers are seeing.
As a result, we are taking a proactive approach to portfolio management and are working with our borrowers on these structures. Where we have moved into a longer-term deferral, which will extend into 2021, we have generally moved those balances into nonaccrual. The shuttle bus book is $245 million and generally has a wider variety of uses. Over half of these are not tied to travel and include areas such as day care, retirement and assisted living and education-related services, where there is a higher level of utilization today. Around 13% of the portfolio was on deferral at September 30. Similar to motor coach, we are taking a proactive approach to portfolio management and working on selected medium-term deferrals into 2021.
In hotels, we have $787 million of balances, with the majority having strong guarantors with liquidity and the ability to weather a medium-term recovery of occupancy levels. As a reminder, the book is primarily made up of flagged, limited-service properties in Midwest markets that are generally drive-to, not fly-to locations. We saw deferral balances decline throughout the third quarter with $39 million or 5% still on deferral at quarter end, down from 53% at June 30. We continue to work with these borrowers to provide various deferral structures into 2021. We downgraded $193 million in the third quarter, which we believe represents the subset of borrowers or sponsors who may either be seeing a longer-term return to breakeven occupancy levels or may represent those with lower levels of overall liquidity. Other portfolios, we are keeping a close eye on our retail CRE, franchise and fitness and retail trade. However, we feel incrementally better about these portfolios today than we did 90 days ago.
With that, I will turn it back to Tom.
Thank you, Brian. To wrap up, we are excited to have the merger integration behind us. Our team members did a wonderful job in tough circumstances to ensure we completed the integration successfully and on time. As we work toward executing on the final cost synergies, we can now turn our singular focus to managing the business, driving toward the various revenue synergy opportunities we have in front of us. We’re also continuing to do our part to have a positive impact on our team members, customers and communities as the many challenges of the COVID pandemic continue to impact the markets we serve.
As I mentioned earlier, we are starting to see a rebound in customer activity across our markets. There is still a long way to go to get back to normal, but this is an encouraging first step. In addition, just like other banks, we have a few loan portfolios there going to be more affected than others by COVID. We believe we have isolated these portfolios and are closely monitoring them. Overall, we are well reserved and have a robust capital position. Finally, we remain focused on achieving our financial targets for top quartile adjusted ROATCE, along with a below peer median adjusted efficiency ratio. Lastly, after closely working with Craig for nearly 2 years, including the time we began mapping the integration strategy, I’m excited and appreciative for the opportunity to lead TCF and work with a great team to achieve the potential of our MOE.
With that, we will open up for questions. Chad, can you help us with that?
[Operator Instructions]. And the first question today will be from Jon Arfstrom with RBC Capital.
I think, congratulations to everyone in the room for the most part, everybody has a different role. But the question that keeps coming up, the obvious one, it seems like the fundamentals are fine, but Craig, your decision to retire, it seems a little bit abrupt. Maybe you don’t view it in your mind that way, but that’s the feedback I continue to get from investors. So maybe, Craig, just talk about the timing of the decision. And Dave, if you have anything to add to that would be helpful.
Sure. Sure, Jon. I mean, basically, I’ve been involved in this nearly 7 days a week for two years. And kind of going through the succession planning and just trying to understand what would be the right time. There really isn’t any time that would necessarily be better than the others. I don’t think work from home, although I thought we have been very effective in managing the business in the work-from-home environment, it doesn’t necessarily play to my strengths, which is more in the markets, in the businesses and running town halls and things like that. And then I’ve had some significant family considerations during this time as well. So as we got through, what I would call that, Phase 1 of the MOE, and those items are – we’ve been very clear on what they were.
Legal day one, where we effectively closed the merger ahead of schedule. Our system day one, which we never wavered from on what day that was. The integration of the management teams, the installation and rollout of our purpose and belief statements and the opportunity to really live those in almost all of our markets, almost every single day was incredible, delivering on the cost saves that we had identified as part of one of the financials. And then really rolling out the new brand, what’s in it for we. And I think all of those things being completed on time, it just seemed like the right time to step down. And so that’s kind of what drove it. And really, from a transition time frame, as Tom has already indicated in his comments, we’ve been working together every day for 2 years. Mike has been running a significant portion of the business for 2 years. And there really isn’t – it really isn’t necessary, we didn’t think as an organization to put a long runway out there for us. So that’s really the story there, Jon.
Jon, Dave Provost. I want to kind of reiterate that no one works harder than Craig. And when he says 7 days a week, if he could say 8 days a week, that would be more accurate. So it’s been a great run, and we give him a lot of credit to get us to this point.
Yes, absolutely. And a lot of other places we could go. But maybe just for Tom or Richard or Brian, how are you feeling big picture about credit? Is it better? Do you have new concerns? Is it the same? And how do you want us to think about that fourth quarter provision, given that you look at your reserves and marks and you’re well over 2%, and it feels like things are better, but just curious to big picture on how you want us to think about fourth quarter provisioning?
Thanks, Jon. This is Tom. Let me give a little intro and then Rich will probably follow-up. But as it relates to the reserves, I think as we’re going into CECL and the models that we use, we’re closely monitoring indices. So I think that being well reserved is very thoughtful for protecting future earnings as we kind of wander through this. I don’t think it signals anything except our understanding and deep understanding of the economy and the portfolios. We’ve highlighted the higher risk portfolios and the monitoring we have there. On those portfolios, specifically, we have – because of the 20 years of experience our Capital Solutions teams have, we know those markets. We know the collateral; we know the alternative sport. And I think we’re being very proactive and thoughtful on that.
Generally speaking, everyone sees the consensus on the economic forecast. And we are seeing economic activity come back, and that’s good for all of our portfolios. Some stabilization and unemployment right now. And so I think that we’re really well positioned as we march through the next couple of quarters. Rich?
Yes, sure, Tom. Yes, just to follow-up on Tom’s comments. Looking at our capital, our liquidity and our reserve levels. I feel good about where we are in position for the portfolio. We’ve got a very diverse and granular portfolio. There’s not – if you look at our motor coach and shuttle bus and some of our high-impact COVID portfolios, the average loan sizes are very manageable. And when you look at the $549 million or $550 million of reserves versus the credit stats, we’re feeling good about where we are.
It is provision drivers – is growth really it in charge offs? Or is there anything else to think about for the relatively near term?
Yes. I’ll take that. So for provision drivers for Q3, we had a $70 million – $69 million provision expense, about $25 million for charge-offs and a modest reserve build of 45%. As we look forward, we’re going to continue to look at all the impacts that we normally monitor including our CECL model and our deep dive reviews. Of course, our – where we are today with the reserve factors in those portfolios and the forward look on those. So I would expect that if conditions remain stable as they seem to be stabilizing that we would see a more favorable provision expense into Q4.
The next question will be from Steven Alexopoulos with JPMorgan.
Craig, back to Jon’s comments, best of luck in retirement, sad to leave you – see you go. And David, welcome back. I wanted to start on – for you, David. So in your comments, you said on revenue, the message to us was it’s a near-term headwind, not a permanent loss, which really begs the question, how deep of a cost-cutting plan are you guys considering here?
Well, I don’t want to put any specific numbers on it, but we – and it depends on how fast these revenues come back. So there we have to rightsize the organization to match the revenues. We need to get our efficiency targets there. So we’ll have more details in the next 60 days.
Okay. Are you guys using an outside consultant for that or is it internal?
No, it’s internal.
Internal. Okay. And then on credit, so if we look at the most challenged segments of motor coach and shuttle buses, can you walk us through how you guys are approaching these credits? Are you working with borrowers to get them to the point where the economy and their business is a bit more normal? Or are you looking to take ownership of some of these assets here, which could require more severe write-downs?
Yes, sure. This is Rich. I’ll take that. So we’re working very closely with the motor coach and shuttle bus clients. Many of these clients have been customers of the bank for years. And we know them very, very well. And the idea is to – for those clients that need to work with us in terms of deferrals to bridge to revenue recovery, we’ve got active dialogues going on with them in terms of the normal channels and avenues we would use for those situations. So deferrals and extensions until we see a recovery of revenue for them.
Okay. That’s good color. And then finally, on the leasing income, maybe for Brian, you said you expect a rebound in 4Q. When we look at third quarter, you were below where you were in the first quarter. So I’m not sure what rebound means. Are we north of $40 million, which is where you would normally be in the fourth quarter?
Yes, Steve, it’s Brian. Hard to put a number on it. But as you know, fourth quarter tends to be the strongest quarter for leasing. So we’re confident we’re going to see growth there. Don’t – wouldn’t be expecting kind of the fourth quarter of ’19 type level. But we’re optimistic that we should see improving levels there that we’ve kind of troughed out here and a lot of – it’s kind of my overall message on a lot of these fee lines. It feels like we’re troughing out and we’re optimistic about the next quarter, especially for leasing.
I know, David, when we announced it – when you announced the deal, you talked about potentially selling TCF leasing products across the legacy chemical footprint. Has that started yet? And when should that kick in where we start to see a bigger lift in leasing?
Well, yes, it started. But with the – we did the integration, and then – or through the integration, we got kind of caught in the COVID, which doesn’t allow for a lot of outbound opportunities. So those were started in January with a great kickoff program, but it’s been a little slow, but we expect a lot of gain on that coming up in the next couple of quarters.
The next question will be from David Long with Raymond James.
Again, congratulations to Craig, and welcome back to David. Looking – going back to the reserve level, the economic stimulus, any expected economic stimulus built into your reserve model at this point in time?
Dave, I’ll take that question. I think with everybody, there’s a lot of inputs and assumptions that go into the ACL process, including multiple scenarios. I think when you just look at the overall underlying economic scenario, whether it’s unemployment, GDP, there’s probably some presumption of economic stimulus that’s built into those underlying forecasts. So there’s not something separate per se, but there are components, I think, of that just in the outright projection of different indices and such.
Got it. Okay. And then shifting gears here. You mentioned the Minnesota market and potentially a higher coming there. Is it safe for us to assume it’s the build-out of the C&I side?
This is Tom. Yes, that is – the primary focus of the regional president would be – not only it’s the C&I build-out, but operating in the marketplace as a bank to make sure that all products are represented to the customer base.
Okay. Great. And then just finally, just more of a housekeeping theme. But you mentioned in the release, a charge-off of $9 million that had been repaid this quarter, charged off last quarter, it sounded like. Is that right? Should we expect this to be a $9 million recovery in the fourth quarter?
Yes. That’s correct.
Our next question will be from Ebrahim Poonawala with Bank of America Securities.
Craig, congratulations on really repositioning the bank after you took over as CEO. I think it’s been amazing what you’ve done in the last 5 years, including getting deal integration done. So job well done and congratulations on the retirement.
But I guess, just following up, Brian, on – I think you talked about core NIM stability, given sort of the funding cost leverage, liquidity deployment. Just talk to us around the outlook for NII relative to the $344 million. Should we read into the fact that loan growth is picking up some of the margin stability, all of that implies that core NII should have also troughed in the third quarter? Or is there more to go as the balance sheet is kind of, I guess, rightsized?
Yes. Good question, Ebrahim. What I would say, and there’s kind of 2 components there, right? There’s the net interest margin rate. I think where we’ve got a lot of confidence around that. We will see excess liquidity on the balance sheet come down, which will be supportive to that. Deposits will reprice as well as even mix changes into the balance sheet can kind of be supported into the net interest margin rate. To really get NII to start growing, it really is going to be centered around loan growth. And I think we are seeing some of that kind of green shoots activity as well as just seasonal activity that could be starting to turn. We do expect to start seeing some Inventory Finance growth in fourth quarter and into Q1.
It’s hard to predict the levels that’s going to come back. But we’re – we expect to see that coming back. We expect leasing to be strong as we get into the end of the year as well as, I think Tom made reference, and I made reference to improved activity, seeing our bankers having improved activity as it relates to kind of CRE or kind of C&I pipelines as well as we know, we’ve got revenue synergies in front of us. So all of those things, we think, can help kind of get this thing turned and make sure that we’re growing NII. NII, on its face will go up in fourth quarter and in first quarter because we’re going to have PPP forgiveness. And our real plan is as that’s happening, real focus, now we can be laser-focused that the 2 companies are together on how can we ensure we’re growing loans because that’s really how we’re going to get NII to start growing from here.
Got it. And just tied to that, is when we look at the Inventory Finance business on Slide 19, it’s down whatever, about 30% to 35% year-over-year. As we think about the fourth quarter, give us – what’s the right way to think about what level of rebound do we see in 4Q and going into 1Q? Should we look at that 30% decline as a decent comp thinking about despite the seasonal uptake? Or is there a better way of how we should think about it?
Yes. Ebrahim, there’s been nothing kind of ordinary as it comes to kind of the balance of Inventory Finance this year with manufacturers closing and inability to kind of produce product was the first headwind. And then the second headwind was just the strong sell-through of inventory from the dealerships. So it’s – again, it’s hard to predict where these balances are going to go. But I think the comments we made at the beginning, we don’t see permanent impairments in this business. A lot of this business, we have exclusive programs. We have relationships with the manufacturers and dealers. As the activity comes back, it’s going to be our business. So we think balances will be higher here in 4Q and into Q1, but it’s really hard with kind of the new dynamics that are in place to predict what that level is going to be. But we know it should be higher from here.
Got it. And if I may, just one question for David and Tom. I mean, I guess it’s not missing on anyone, your history in terms of deal-making with Talmer into Chemical into TCF. Just talk to us in terms of – we’ve talked about being merger-ready since the deal was announced. Now with the integration over, just talk to us in terms of your thoughts around consolidation and what role TCF might play in that as you think about the next year or two?
It’s Tom, when we think about – we’re in a consolidated industry, that’s going to continue. You know that as well as us. We’ve got a tremendous footprint right now and the capacity to add to the franchise is from all directions. But – and Dave can speak more specifically to that. But I think that when we talk about being acquisition-ready, part of it is making sure that we’re on a stable system and can handle the growth of an acquisition. And having the combination of our FIS system and D3, we are really in an enviable position in the industry to have that technology stack and the operational support it will give our company in the really years to – many years to come. And then preparing our team to – for continued change that the industry is going to bring us. It’s not only the industry that brings us, the rate of change for our customer behaviors is going to create opportunity for us. And positioning our team to be ready for that and having the right skills for it, which I think we’ve got a long history of having.
Tom mentioned acquisition-ready. So we’re acquisition-ready. But our history. We want to do deals, but we want to do deals that are accretive to our shareholders. So if those opportunities come up, you never know when they’re going to come up. If they come up, we’ll take advantage of that. We’re in a position to do that.
The next question will be from Terry McEvoy with Stephens.
Craig, I just want to say I have enjoyed working with you over the years. And David, nice to hear your voice on the call and congrats to others. My first question, you talked about the review of the bank over the next 60 days. Could that result in the exit of any lending businesses or any markets? Or is the focus over the next 60 days really on the expense line?
I’ll answer, and Tom can add to it, too. What I’d say is we’re focused on the efficiency ratio of the bank. I think the company has always shown great expense control. And we have to be cognizant of the environment that we’re in. So we’re not looking at holistic changes in the business or in the businesses that we’re in. As part of this, it’s more just trying to, as I mentioned, rationalizing real estate as well as looking at now we put all the systems together, but we just need to look at end-to-end processes in those processes and drive out some incremental efficiency.
And then just a follow-up question on equipment. The equipment financing activity, where was that running in the third quarter maybe versus pre-COVID last year? I know you talked a little bit about your fourth quarter expectations, but just trying to get a sense of where activity was last year – last quarter versus a more “normal” environment?
Yes, Terry. What I’d say there is, like the other businesses that we’ve mentioned, we’re seeing increased activity levels. Even when we talked about kind of internally, some of the revenue synergies and bringing leasing to banking customers, we had pipelines at the beginning of the year as it related to those. And we saw things kind of just slow down into April and May. But with the increases in activity that we’re seeing just kind of, I’d say, all around the economy, we’re seeing activity pick up there as well. Now there are specific events that are related to kind of customer activity levels that can drive revenue opportunities. But generally, we feel optimistic standing here as we get into fourth quarter, as fourth quarter is typically stronger for that business than some of the other quarters. So we think we’ve kind of troughed out there, and we should see things start to lift from here.
The next question is from Nathan Race with Piper Sandler.
Congrats, again, to everyone in the room. I was hoping to start on credit. Curious if you guys could kind of describe the migration that we saw in the kind of at-risk segments that are outlined in the deck. I mean, what was that kind of starting point heading into the quarter? And what overall criticized migration look like outside of these segments that are outlined in the deck on this slide – maybe on here, let’s see, Slide 14.
Nate, maybe I’ll take kind of first question on that. I think the majority of the migration that you’re seeing is really in these COVID-impacted portfolios. I’d say there probably is some stuff away from this. But I think, by far and away, the things that we’re trying to highlight here are really the areas that we’re focused on. And I think those are the main contributors to it.
Okay. And then just switching gears, on the balance sheet dynamics in the quarter. Obviously, kind of deleveraging, to some extent, helps support the margin here in 3Q. Just curious kind of what the opportunity set looks like to continue to go down that path if Inventory Finance balances and loan growth kind of remains challenging, at least over the next quarter or 2?
So yes, I think that as we take a look into the fourth quarter, first quarter, all of the businesses that we’re in, we’re seeing additional activity. The mortgage business has been a good business for us; equipment finance, we’re seeing more activity. We’ve actually seen – and I want to be careful not to overly predict, but passing the point where the liquidations are greater than sales in the inventory business. That business is now growing again. But we’ve got to be careful because I don’t know that it’s a – it’s a complete trend, but we’re seeing very positive trends for us and holding in – and the dealers holding more inventory as we come out of the summer.
So we’re going to – I think that the pipelines that we’re seeing that have been rebuilding. Typically, those are obviously early signs of activity, and we’re working with our borrowers and prospects closely. We’ve actually received some additional relationships from PPP. We are a strong PPP company in all of our marketplaces. And we’re getting business from that activity and that initiative. So I think we’re, I’d say, optimistic about the green shoots that we’re seeing in the different segments that we’re serving today.
Our next question is from Chris McGratty with KBW.
On prior conference calls, I think it was last quarter, you talked about the ability to go back to expenses if the revenue environment didn’t materialize like you thought, and that’s obviously what you’re talking about today. Is the right way to think about, without going into specific dollars, a slower rate of growth off that $321 million goal or outright declines?
It’s a good question, Chris. And again, we’re doing the review. Part of this is trying to find additional dollars will also be partially how much of that can we reinvest so that we can ensure that we’re accelerating revenue. We see opportunities to invest as well. But trying not to have those incremental expenses to the company is also the goal. So whether it’s an outright decline or whether some of this gets reinvested, that’s what we’re focused on. That’s what the review is going to do. We’ve got to be thoughtful about it. Again, we’ve been very successful at bringing the 2 companies together and finding ways to realize the expense synergies. But in no way should it – should you take a view that we don’t think that we’ve got investment opportunities and ways to grow revenue so that we only can go to expenses. We’re still very excited about our opportunities to grow revenue as well into ’21. Tom, I don’t know if you have anything you want to add?
Having the dollars to invest in growth is critical. We’ve got a number of initiatives that are very important to us. We need to be able to make sure that we have cash flow to support them. I would say that the – that we’re cognizant of some of the shifts in revenue, and we need to make sure that we’re achieving the objectives that we’ve laid out for efficiency and supporting all the constituents we have, including investors.
Great. In terms of capital, obviously, the slower – the smaller balance sheet with the growth headwinds is building your capital levels. What are the thoughts on capital return in terms of buybacks? Is it as simple as you’re going to wait until the bigger banks give you cover? Or would you consider like a few banks have done, repurchasing stock over the next couple of quarters?
Yes. Chris, this is Brian. Obviously, the big banks are prohibited from that. Obviously, we feel we’ve got excess capital levels. We’re not at the point where we would buy back shares today. But as we get into 2021, and we see what this environment is. If we feel we’re on the other side of the corner here, it’s definitely one of the things that will be for us to review and consider.
Okay. One last one, Brian. On the tax rate, can you help us on the fourth quarter? And also, is there any material change in sensitivity if we get a Biden tax increase now that the companies are combined?
Yes. No change as we currently kind of sit on kind of the forward look for our tax rate in this high teens, low 20s area is where we’re at. And overall, with some of the repositioning we’ve done, even if tax rates were to go higher, we think we’re less exposed to that than we would have been even as a stand-alone legacy TCF.
The next question is from Jared Shaw with Wells Fargo Securities.
I just want to echo everyone else’s congratulations as well. Most of my questions have been asked, but on the PPP balances this quarter, was there any – did you actually have any forgiveness or accelerated payments? Or is that just the impact of the full quarter?
Yes, Jared, this is Brian. No forgiveness at all in third quarter. We had a very small amount of payoffs that occurred, but it’s really just the amortization of the fees over the life. But we do – we have now and the window is open, and we have gotten our first borrowers here in October through the process with the SBA for forgiveness. So we do expect to see acceleration of some of those fees here in the fourth quarter. Again, it’s still hard to tell exactly how much of it lands in fourth quarter versus early next year. But it’s a positive progress that the process has been kind of established, and we’ve actually gotten some through the pipeline already here in the fourth quarter.
Okay. And then just on credit, is the expectation that really all of the negative credit migration has now been dealt with or is there still some further migration as you continue to evaluate portfolios, assuming – let’s assume that a broader economic background backdrop stays stable?
Well, we’ve been through deep dives in all of our portfolios and matter of fact, a number of times now, and Rich can talk to the depth of those, literally portfolio by portfolio in the segments that we’re serving. So we think we’ve been very proactive in identifying stress in our borrowers, and those segments that have more stress, fully reserved form and – but where is the economy in Q1, Q2 and unemployment that will also dictate where the – some of the portfolio scale. But I think we’ve done a great job getting through and understanding what we have. Rich?
Yes. Thanks, Tom. I would just echo that the number of portfolio reviews we’ve done across different vectors. For instance, liquidity analysis and liquidity reserves versus cash burn, loss estimates and ratings analysis are happening constantly. And so we feel pretty comfortable with where we are on the rating of the entire book. And I think Tom is right, it all comes down to the economy and the impact of COVID. But if the assumption is that things are stabilizing, then I think we’re in pretty good shape.
Okay. Great. And then just finally for me, on the Inventory Finance, here, what you’re saying that you’re starting to see some of the balances rebuild at the dealers. When you look at the factories, though, are they still running at pretty significant reductions from full capacity? Or are you starting to see manufacturers actually approach more normal production levels?
So the feedback that we’re getting from the Capital Solutions group is that in Inventory Finance is that factories are really not up to pre-COVID production. There is some supply chain issues in certain areas, but substantially back. There’s – like most manufacturing or retail facilities, they’ve got to be careful with taking care of team members. And then again, the intermittent supply chain issues, but production is substantially back to pre-COVID levels. What was remarkable is just consumer demand in all product lines.
Our next question is from Ken Zerbe with Morgan Stanley.
Great. How much – or what are you assuming that accelerated PPP amortization adds to your NIM and NII during fourth quarter?
Yes, Ken, this is Brian. Again, it’s hard to know. We’ve started the process with the SBA of getting things through the forgiveness window. So to date, of the gross fees that are out there, about $60 million, we’ve recognized about $20 million of that life-to-date here. So that remaining $40 million will come through. It’s really hard to predict how much is going to happen in 4Q versus how much is going to happen in 1Q. Just we started the process, we’ve got some going through there. I don’t know if it will be half or be something less or more than that. It’s just really hard to predict at this point.
You made a comment that NIM is going to be stable to slightly higher in fourth quarter. Would it still be higher if you excluded the PPP amortization?
Yes. Just to be clear, Ken, this is Brian. Those comments are related to the core NIM. If the fees come through, yes, the GAAP NIM will go higher just because that all gets recognized through interest income. So when I was speaking to being able to maintain NIM, again, at this 3.19% level or maybe even see that go up, that’s speaking to the core NIM, not with PPP, so excluding PPP or accretion.
All right. That helps. And then how much of your loan portfolio still needs to reset lower? And I guess on that fixed piece, where are those yields versus new money yields today?
Yes. No, good question, Ken. What I’d say is we are seeing a yield – loan yield still come on lower than where the existing book is. I think that was 6 or 7 basis points from last quarter to this quarter. Again, in the short run here in the fourth quarter, we think that deposit repricing, being able to run excess liquidity off the balance sheet as well as if we have change in mix on the balance sheet, meaning as we have more Inventory Finance balances, those tend to be at higher yields. We think we can offset that kind of loan yield headwind in the short run here in the fourth quarter.
Ladies and gentlemen, we have reached our allotted time for the question-and-answer session. And also, thus concludes today’s call. We thank you very much for joining today’s presentation. You may now disconnect. Take care.