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Edited Transcript of CHFC earnings conference call or presentation 28-Apr-20 2:00pm GMT

Q1 2020 TCF Financial Corp Earnings Call

Midland May 22, 2020 (Thomson StreetEvents) -- Edited Transcript of TCF Financial Corp earnings conference call or presentation Tuesday, April 28, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian W. Maass

TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer

* Craig R. Dahl

TCF Financial Corporation - CEO, President & Director

* Dennis L. Klaeser

TCF Financial Corporation - Executive VP & CFO

* James M. Costa

TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer

* Thomas C. Shafer

TCF National Bank - President, COO & Director

* Timothy R. Sedabres

TCF Financial Corporation - Head of IR & Director of Corporate Strategy

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Conference Call Participants

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* Christopher Edward McGratty

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* David Joseph Long

Raymond James & Associates, Inc., Research Division - Senior Analyst

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Jared David Wesley Shaw

Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst

* Jon Glenn Arfstrom

RBC Capital Markets, Research Division - MD of Financial Services Equity Research

* Kenneth Allen Zerbe

Morgan Stanley, Research Division - Executive Director

* Nathan James Race

Piper Sandler & Co., Research Division - Director & Senior Research Analyst

* Steven A. Alexopoulos

JPMorgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks

* Terence James McEvoy

Stephens Inc., Research Division - MD and Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to TCF's 2020 First Quarter Earnings Call. My name is Jamie, and I will be your conference operator today. (Operator Instructions) Please also note today's event is being recorded. At this time, I would like to introduce Tim Sedabres, Head of Investor Relations, to begin the conference call.

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Timothy R. Sedabres, TCF Financial Corporation - Head of IR & Director of Corporate Strategy [2]

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Good morning, and thanks for joining us for TCF's First Quarter 2020 Earnings Call. Joining me on today's call will be Craig Dahl, President and Chief Executive Officer; Tom Shafer, Chief Operating Officer; Dennis Klaeser, Chief Financial Officer; Jim Costa, Chief Risk Officer; and Brian Maass, Deputy Chief Financial Officer and Treasurer. In just a few moments, Craig, Brian, Dennis and Jim will provide an overview of our first quarter results. We'll be referencing a slide presentation that is available on the Investor Relations section of TCF's website, ir.tcfbank.com. Following their remarks, we'll open up for questions.

During today's presentation, we may make projections and other forward-looking statements regarding future events or the future financial performance of the company. We caution that such statements are projections and that actual events or results may differ materially. Please see the forward-looking statement disclosure in our 2020 1st quarter earnings release for more information about risks and uncertainties, which may affect us. The information we'll provide today is accurate as of March 31, 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.

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Craig R. Dahl, TCF Financial Corporation - CEO, President & Director [3]

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Good morning, and thank you for joining us today. These certainly are unprecedented times. And as you know, the environment remains fluid with numerous headlines changing daily or sometimes hourly. I want you all to know that we are doing exactly what you would expect and have rallied as a leadership team and as an organization to guide TCF through these volatile times. Before I give more detail about the actions we are taking to address the challenge of the COVID pandemic, I will mention that we reported earnings per share of $0.32 in the first quarter with adjusted EPS of $0.57, excluding $37 million of merger-related expenses, $8 million from the impairment on the MSR asset and $3 million of expenses related to the sale of the legacy TCF Auto Finance portfolio. In addition, we added $74 million of additional provision related to COVID that impacted EPS by $0.38 per share. Dennis and Brian will provide details on our financial performance in a few minutes.

I want to share what we are doing to combat the effects of the COVID pandemic, which are outlined on Slide 4. We are actively managing the business and not letting the business manage us. That is not an easy task and requires the collaboration and dedication of our entire leadership team and all of our managers and employees throughout the company. Culture has been a key focus of ours, as we brought together the 2 banks. And early in the first quarter, we published a new purpose and belief statement to align the organization around a common set of principles. One of our beliefs at TCF is to care like a neighbor, and this statement has never been truer than today, as we seek to demonstrate the care for our customers, employees and communities in each decision and interaction.

This environment has enhanced our culture as an organization and accelerated our team's focus as coming together as one TCF. A couple of our priorities we've been working diligently on include protecting the health and safety of our employees, supporting our customers, maintaining business as usual operations and continuing to execute on the MOE Integration road map.

First, we are working to protect the health and safety of our team. We are a safety business -- service business, and our team is at the center of our customer interactions, and they serve as the face of TCF each and every day. I am proud of our team's nimble and timely response. We ensure that our employees' well-being remained top of mind as we acted to reduce branch service to drive-through only, closed select in-store grocery locations where another drive-through location was nearby. And for those in-store branches which remain open, we have installed protective shields and have provided mask, gloves and necessary supplies for cleaning and sanitation.

After starting with a trial plan to support work from home, we quickly pivoted and transitioned over 4,000 employees to work from home in a matter of days with no disruption to our operations. And with the advent of technology today, we were able to move critical functions to a work-from-home model, including areas such as the call center, credit underwriting, loan processors and other middle and back-office functions. We have been encouraged at how productive our teams can remain while working remotely across the company.

For those employees that have had their branch office closed, are working reduced hours or caring for family members who are sick as a result of COVID, we have committed to pay them for their full regular hours. For employees who have critical roles that require them to continue working in the office, primarily in our branch network, we have committed to taking care of them and ensuring no one feels the financial impact of closed location or reduced hours. In addition, starting April 1, we enacted a premium pay program to recognize the exceptional work of these employees, as they continue working on the front lines to serve our customers.

Second, we continue to stand by our customers who count on TCF to help support their financial well-being. For our retail customers who have been impacted by COVID, we are offering payment deferrals up to 90 days and have suspended any new foreclosure actions. For business customers, from small business to commercial clients, we are offering loan modifications to help them manage through COVID impacts to their business. In addition, we utilized the Paycheck Protection Program to help support their continued employment of staff. We recognize these are not just numbers and loans, but these loans represent wages for employees and families in our communities. To date, we have approved over $1.2 billion of PPP loans. Our project team did exceptional work to get the program up and running in a short time and has remained nimble throughout the process.

Times like these are when the greatest companies show their colors. And here at TCF, we look forward to stepping up as a premier bank in our communities and to support our customers and neighbors. Our bankers are ready to help assist consumers with payment deferrals, businesses with customized solutions, whether deferrals of existing loans or new lending needs. In addition, we've made commitments to lead a matching donation program for 2 of our local hospital groups in Michigan and Minnesota and have made numerous other financial commitments to groups in our communities. Our IT team even utilized a 3D printer to help manufacture protective face shields and donated them to local health systems. We are also thankful and appreciative of the many hard-working health care professionals in our communities.

Third, maintaining operations during a fluid and changing situation. We started off 2020 with momentum across the business and a solid outlook for organic growth. In January and February, we saw strong business performance that reflected the opportunity we see in our markets as a result of our merger of equals, including robust loan and deposit growth that was even a bit ahead of our expectations, along with stable credit quality and on-time execution of our integration initiatives. With this strong start to the year through February, the COVID situation began to evolve. As of today, we have approximately 80% of our branch locations open and operating. We see a reduction in branch transactions of approximately 40% to 50% compared to a month or 2 ago and an increase in digital banking log-ins.

The benefits of having a strong mobile application and digital banking platform are evident in this environment. Additionally, as part of our integration activities, we are launching digital upgrades for Chemical customers to enhance features and functionality, and that is in-flight as we speak. The digital platform is also supporting increased new online account openings with digital new account openings running at 50% above recent trends in the last couple of weeks. We have an experienced leadership team, including the executive group as well as the senior leaders across the organization.

One benefit of the MOE is the deep bench strength we have across the company with experienced bankers who are continuing to help our customers. Our team took immediate action to form a COVID task force to coordinate our response efforts, and we have been meeting daily as an executive team to ensure timely and open communication across the bank. We have consistent 2-way communication with our employees with regular updates from the task force as well as weekly all manager calls. In addition, as you would expect, we are closely monitoring our credit portfolios and maintaining open dialogue with borrowers to understand evolving trends in their business.

Fourth, continuing to execute on the MOE integration. Slide 5 highlights the key integration updates for the first quarter. Despite some of the challenges resulting from COVID and work-from-home, we remain on track and confident in completing our integration activities on time in the third quarter. In addition to the launch of our purpose and beliefs, we expanded our CRM capabilities for legacy Chemical branches and now maintain a constant CRM toolkit across the footprint. Digital banking upgrades for Chemical customers are being piloted, and we will begin the first wave of customer upgrades in the coming weeks. Adding functionality is the most tangible aspect customers will see from the conversion and upgrading the customer-facing digital platform to what will become future end state will help to de-risk the final system conversion as the customer interface will already be in place.

We continue to make progress on contract negotiations with vendors in order to drive the planned cost synergies. Although there is a large set of work remaining to complete our integration road map, we can see the end in sight between now and the end of the third quarter. Remaining items include completion of the digital banking upgrade, the conversion of the human capital management system, and finally, the conversion of TCF's legacy core system into the FIS IBS platform that we operate today on the Chemical side.

All along the way, we will continue to finalize our cost synergy initiatives to achieve the fourth quarter run rate we laid out, and we will continue to leverage the best of both banks to implement business synergy opportunities. The new TCF is in a stronger position than each bank was on a stand-alone basis prior to the merger. While it is hard to predict which of the many scenarios will play out over the coming months, we have strong capital, liquidity, a diversified loan portfolio, both geographic and by product, and a deep set of experienced leaders throughout the organization to guide us through.

Turning to Slide 6. I wanted to remind you of some of the balance sheet actions we completed since closing the MOE, all of which lowered our risk profile going into the environment we are in today. In the fourth quarter of 2019, we reduced our credit risk by completing the sale of $1.1 billion legacy TCF auto finance portfolio as well as selling $80 million of consumer nonaccrual and TDR loans. In addition, in the third quarter of 2019, we repositioned our securities portfolio by selling $1.6 billion of securities and reinvesting over the last few quarters, which we completed in the first quarter. This reduced our asset sensitivity and enhanced capital efficiency and liquidity. Today, the securities portfolio is high quality and liquid with 96% of securities rated AA or AAA. We also further reduced our asset sensitivity by terminating $1.1 billion of interest rate swaps.

Lastly, our MOE provides additional credit support as we completed comprehensive credit due diligence on both loan portfolios in late 2018. Keep in mind that the acquired loan balances from the merger retain an additional total fair value discount of approximately $167 million in addition to the CECL on balance sheet reserves. Overall, we are in a much better risk position today than we were even just 6 months ago as a result of these actions.

With that, I'll turn it over to Brian.

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [4]

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Thank you, Craig. Slide 7 highlights the strong loan growth trends we saw in the first quarter with total loan balances up nearly 9% compared to a year ago, excluding the legacy TCF auto finance portfolio and was near the top end of our expectations. Our commercial portfolios drove the growth and increased by $1.2 billion in the first quarter. This was led by nearly $900 million of C&I followed by $400 million of growth in commercial real estate and $200 million of growth in the consumer portfolios. The C&I growth, which was led by higher inventory finance balances of $578 million, which generally reaches its seasonal peak late in the first quarter, we could see higher inventory finance balances remain elevated and above normal levels in the second and third quarters given slower sales cycles in the current environment.

In the consumer portfolios, growth continues to be driven by residential mortgage with declining balances in home equity and consumer installment. Drawdowns of revolving commercial lines of credit did not have a material impact on our loan growth for the quarter. As our mix of commercial business does not include the largest upper-middle market corporate borrowers who materially drew on lines during the first quarter.

The strong growth we saw in the first quarter provides a solid starting point for balances as we enter the second quarter. However, given the current environment, we expect our loan growth to be driven by demand from commercial borrowers, which we do not expect to be as strong for the remainder of year given the uncertainty and economic outlook. Our outlook for loan growth this year is unlikely to come in at the level we shared previously, and it is more likely we will see something closer to low single-digit loan growth on a year-over-year basis, excluding the legacy TCF auto portfolio, as we move throughout 2020 with a good portion of our loan growth already being booked in the first quarter. This outlook could change if borrower sentiment improves, but with expected weaker loan demand in our markets, we will be prudent on where we deploy our capital, and we will not be chasing growth for growth's sake.

Turning to Slide 8. We generated strong deposit growth during the quarter, which totaled $1.3 billion and nearly matched our corresponding loan growth in the quarter. This deposit growth continued into April as we saw stimulus checks deposited and deposit balances are up month-to-date over $1 billion. Non-CD balances were up 7.9% year-over-year and increased by $1.3 billion from the fourth quarter with the quarter-over-quarter change driven by money market and checking balances with CDs remaining relatively flat. Going forward, we expect to see deposit growth opportunities across all of our channels, especially as customers continue to hold higher balances in the current environment due to less spending. Total deposit costs declined 10 basis points during the quarter with non-CD cost of deposits down 7 basis points. We expect our cost of deposits to continue to decline over time, as we have reduced deposit rates across our products and have 57% of our CD portfolio maturing in the next 6 months at an average rate of 1.84% compared to the current promotional rates, which are closer to 1%.

Turning to Slide 9. Last quarter, we guided towards net interest margin, excluding accretion, between 3.5% and 3.6%. Despite the Fed rate cuts and lower LIBOR rates in the last month of the quarter, we were pleased with the 3.53% margin for the first quarter. As we move into the second quarter, it is likely we will see incremental margin pressure given a full quarter impact of the Fed fund rate cuts and lower LIBOR rates. That being said, we are hopeful the margin, excluding accretion, can stabilize towards the end of second quarter or into the third quarter, as earning asset yields will likely be fully repriced in Q2, but we expect to see some continued deposit and funding cost reductions in 3Q and 4Q. We saw $25 million of accretion during the quarter, which had a 23 basis point positive impact on the margin. We would expect accretion in the second quarter to be in the high teens before any substantial prepayments, and then continue to come down by a couple of million dollars each quarter as we move throughout 2020.

Given the resilient margin in the quarter and strong loan growth, net interest income, excluding accretion, remained relatively stable at $376 million. Similar to the margin, we expect a decline in net interest income in the second quarter, although the strong period end balances at March 31 should be a benefit. It is possible that net interest income could stabilize by the third or fourth quarter. However, it will be dependent on the pace of loan growth and the rate environment.

With that, I'll turn it over to Dennis.

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Dennis L. Klaeser, TCF Financial Corporation - Executive VP & CFO [5]

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Thank you, Brian. Turning to Slide 10. Noninterest income totaled $137 million for the quarter and included an $8.2 million loan servicing rights impairment. Excluding this, adjusted noninterest income was $145 million. This reflects the typical seasonal decline in fee revenue that we mentioned last quarter as fees and service charges, card and ATM revenue and leasing fees all generally contribute lower revenues in the first quarter. The first quarter also included a favorable $6 million interest rate swap mark-to-market adjustment. Adjusted noninterest income would have been $139 million, excluding this adjustment. Gain on sale revenues totaled $21 million for the quarter, driven by strong mortgage banking performance with mortgage gain on sale revenue of $14 million in the first quarter compared to $10 million in the prior quarter. While mortgage banking revenue is generally seasonally strong in the second quarter, it is more difficult to predict this year's trend given the uncertainty. In addition, it is difficult to predict trends for many fee revenue line items given activity and volume levels drive many of the noninterest income categories.

Fees and service charges as well as card and ATM revenues will likely be driven by activity levels, which will depend on how long stay-at-home orders remain in place. We have seen generally higher balances and less activity in retail accounts since these stay-at-home orders have been put in place. Additionally, customer demand will impact the levels of both leasing activity and commercial customer swap transactions, which will drive the outlook for related fee revenues for these items.

Wealth management fees are tied to assets under management. And we also have trust business, so AUM mix contains both equity and fixed income as well as cash and liquid products.

In addition, the quarter was -- the final quarter that will reflect servicing fee income from legacy TCF auto finance portfolio, we have completed the transfer of servicing operations from this business. And we'll see total servicing revenue decline in the second quarter around $2 million or $3 million. Partially offsetting this revenue reduction is lower expected expenses related to loan servicing as well as near-term final wind down of the TCF auto business.

Turning to Slide 11. We continue to execute on our integration cost synergies and remain on track to achieve the $321 million or lower of expenses in the fourth quarter. We made good progress in the first quarter, as adjusted noninterest expense declined to $335 million. This excluded $37 million of merger-related expenses and $3 million of expenses related to the sale of the legacy TCF auto finance portfolio. First quarter expenses included higher payroll taxes of $5 million compared to the fourth quarter, and we saw lower commission expenses in the first quarter, driven by lower quarter-over-quarter activity and origination volumes. COVID-related expenses for the first quarter were modest, as our task force activities only covered a couple of weeks during the latter part of the quarter. As we move into the second quarter, we will see the impact of incremental expenses related to COVID, such as premium pay for certain employees, extra cleaning and sanitation activities and supplies.

In addition, merit increases took effect starting in April. However, we expect to benefit from lower travel expenses due to work-from-home environment and the continuation of our execution against merger cost synergies from vendor contracts and other cost synergy activities. Federal historic tax credit impairment expense for the quarter was $1.5 million compared to $4 million in the prior quarter. We expect this to be volatile depending on timing and completion of a variety of projects with higher impairment expenses in the second half of the year compared to the prior quarter -- prior couple of quarters. But as a reminder, these projects generate associated tax credits, which come in through the income tax line item and that more than offset the related impairment expenses. Excluding any discrete tax items, we expect our effective tax rate to be between 21% and 23% for 2020. Our adjusted efficiency ratio for the quarter was 58.2%. We continue to expect to produce an efficiency ratio below peer median upon completion of our integration activities and cost synergies and once we return to a more normalized operating environment. While all banks are likely to be under some level of revenue pressure, our built-in cost synergies from the MOE should serve as a unique catalyst for TCF.

Turning to Slide 12. We are entering this adverse economic environment with a strong capital position as our common equity Tier 1 ratio was 10.4% at the end of the first quarter, which we expect to put us in the top quartile of our peers. This strong capital level remains even after our $1 billion-plus of loan growth during the quarter. Our regulatory capital levels reflect our election of the 5-year CECL transition for regulatory capital purposes. Tangible book value per share of $26.16 is largely unchanged from the third quarter. The adoption of CECL and the move of equity into allowance negatively impacted tangible book value; however, positive fair value adjustments in our securities portfolio offset a substantial portion of that in the first quarter.

Given the economic uncertainty, our primary focus from a capital perspective will be on maintaining robust capital levels while continuing to serve our customers. Yesterday, we announced our quarterly $0.35 common stock dividend that will be payable in June. As I sit here today, I believe we are in a strong position to continue our dividend. However, this will depend on economic conditions as we move throughout the year. We also want to ensure that we are in a position to take advantage of any platform or portfolio opportunities that may become available and generate attractive risk-adjusted returns. We did repurchase 873,000 shares during the earlier part of the quarter at a cost of $33.1 million. However, in response to COVID, like many other banks, we have temporarily suspended buybacks under our share repurchase program, but we will retain the ability to resume repurchases as the circumstances warrant. We currently have $89 million remaining under the existing authorization, and there is no preset program expiration.

Overall, we have a strong capital and liquidity position. We remain focused on doing everything we can to support our employees, customers and communities.

With that, I will turn it over to Jim to provide an update on credit.

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [6]

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Thank you, Dennis. Turning to Slide 13. As Craig mentioned earlier, our credit results to start the year were strong, and we saw that reflected in our first quarter results as net charge-offs came in at 6 basis points, down 1 basis point from last quarter. Over 90-day delinquencies also remained very low at just 2 basis points. Nonaccrual loans and leases increased $80 million from the fourth quarter; however, that reported increase is primarily attributable to a reclassification due to the adoption of CECL. There were $73 million of loans previously accounted for as purchased credit impaired, or PCI at December 31, 2019. Those loans are reclassified to nonaccrual on January 1, 2020, as a result of CECL. These $73 million of PCI nonaccrual balances have declined from $85 million at the end of the third quarter of 2019, and they are carried at a discount.

If you turn to Slide 14, I'll walk you through our allowance for credit losses for the quarter, where there were changes driven by both the adoption of CECL as well as COVID-19 impacts. We ended 2019 with an allowance of $113 million or 33 basis points of loans. For CECL day 1, we added $206 million to the allowance due to the adoption of CECL on January 1. And this was primarily related to the acquired loan portfolios, which although they carried an off-balance sheet discount, prior to CECL, there was no allowance related to these loans. Recall, this CECL day 1 allowance of $206 million was in line with the outlook we provided last quarter for $200 million to $225 million of higher reserves due to CECL. That increase of $206 million brought our overall CECL day 1 allowance to $319 million or 92 basis points of total loans and leases.

Total provision expense for the quarter totaled $97 million, of which $74 million was related to COVID. Excluding the impact of COVID, provision would have been $23 million and within the range we have seen over the prior quarters. In sum, we ended the quarter with an allowance of $406 million or 113 basis points of loss coverage. And that is before you account for the additional $167 million of coverage, attributable to the fair value discount applied to the acquired loans. As far as our process, we, like most of the banks, draft from a multitude of sources [to decide] potential impacts of the COVID-19 pandemic. Those include macro forecasts, core underlying asset quality trends, payment deferral activity, loan concentrations and sectors of the portfolio identified to be more likely impacted by the pandemic.

Before I close, I would also like to echo Craig's earlier comments and expand on the level of payment deferral activity we are providing to support our customers during these difficult times. Across the consumer portfolios, including mortgage, home equity and installment loans, we have received approximately 7,300 requests for our customers -- from our customers for payment deferrals, representing $825 million of balances. Within the commercial portfolios, we have seen approximately 8,500 customer payment deferral requests, with the majority coming from Capital Solutions, and the remainder from C&I and CRE.

Specifically related to inventory finance, we have partnered with the various manufacturers to review any potential impact to the dealer network and the associated financing of inventories within those programs. TCF, along with our manufacturer partners have extended manufacturer paid interest periods from 90 days up to 180 days and continue to retain the support of the manufacturers for collateral support. We believe it is important to support the dealers during this time as sales cycle times slow. However, we have been pleased by the level of dealer activity we are seeing in certain segments through April. We continue to monitor the portfolios daily, and as you can see, are closely engaged with our customers to offer support. As the duration and intensity of the COVID pandemic becomes more clear, over time, we will adjust our views on forward performance accordingly.

Having said that, our first quarter credit results speak to the benefit of exercising a disciplined credit model with solid underwriting criteria and following a well-diversified portfolio strategy. With that, I'll turn it back to Craig.

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Craig R. Dahl, TCF Financial Corporation - CEO, President & Director [7]

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Thank you, Jim. Now turning to Slide 15, you can see the diversification of the loan portfolio, Jim mentioned. This was one of the most important aspects of the merger of equals to both me and our partners at Chemical. By bringing together both banks, we have one of the most granular and diverse lending portfolios of our peers with no single business representing a substantial overweight position and with no single concentration over 5% of the total loan portfolio. The CRE portfolio is diversified with no components greater than 5% of total loans. All of these asset classes are areas where community banks lend in their markets, and both banks have followed strong sponsor and relationship focus on originations.

More importantly, there are many areas of lending TCF does not participate in that have gathered attention recently. We have no material oil and gas lending exposure. We do not have any aviation lending to commercial airlines or cargo operators. We do not participate in railcar lending or leasing, and we do not have a credit card portfolio. Hotel lending at TCF totaled $764 million and represents only 2% of total loans. This is a modest component of our total commercial real estate mix, and we have reviewed our portfolio and are monitoring occupancy levels. We have had some requests for payment deferrals, and we are working with our borrowers accordingly. Our focus in this sector has been on sponsors with expertise and liquidity, operating flagged limited service properties, generally in the Midwest.

Turning to Slide 16. We have provided additional breakouts of our C&I and leasing portfolios by industry. C&I and leasing together totaled $15 billion, and these include business banking, middle market capital solutions and inventory finance. Total C&I and leases, excluding inventory finance, shown in that first red column are $11 billion. Again, here, you can see the benefits of diversification in the portfolio with no sector greater than 5% of total loans. Manufacturing represents the largest sector and is split nearly 60-40 between traditional C&I businesses and the Capital Solutions business, which adds further diversification of assets.

Secondly, transportation and warehousing is #2, also just under 5% of total loans and is primarily contributed by Capital Solutions. Within the $1.6 billion is further diversified with focused business sectors within this category, including tow trucks, tire trucks, shuttle buses and motor coaches. Importantly, in Capital Solutions, these credits are very granular with an average ticket size just over 100,000, are asset secured and are largely business essential equipment required to operate the company. Arts, entertainment and recreation of $780 million includes $500 million of golf exposure split -- through Capital Solutions, excuse me, split between golf carts and golf turf. We have deep expertise here with manufacturer relationship, courses are starting to open as of last week, and the grass is continuing to grow.

On the right side, inventory finance is centered on 5 industries, and first quarter balances totaled $4 billion, up from $3.4 billion at year-end due to normal seasonal spring shipments of inventory, primarily lawn and garden and powersports. Each of these industries individually represent less than 5% of total TCF loans with powersports at 4.5%, lawn and garden at 3% and marine at 1.6%. Within these sectors, there are numerous manufacturers and programs represented. For example, within lawn and garden includes Toro, Ariens and MTD. Specialty vehicles includes programs with Blue Bird school buses, BraunAbility mobility and wheelchair vans and E-Z-Go golf carts. Powersports includes ATV and off-road vehicles and personal watercraft and some snowmobiles.

Important to note that 84% of the portfolio is tied to exclusive manufacturer programs where we retain support, including repurchase agreements, and we financed the assets in dealer inventory at the lower wholesale costs versus the retail cost. Additionally, we are financing the secured inventory across the dealer base, and we do not provide consumer end-user financing for the purchase of these products.

To wrap up on Slide 17, our priorities are as follows: first, we will continue to prioritize the health and safety of our team. Next, we are committed to continuing to serve our commercial and consumer customers. We have a full suite of products and services to meet the diverse needs across our customer base, and we remain committed to being here to serve them. In addition to these actions, we cannot lose sight of our integration program. Despite the added challenges brought about by the COVID pandemic and our work-from-home environment, we remain on track to complete our integration in the third quarter.

Given the current environment, we'll be very focused on our risk profile and credit quality and trends within our portfolio. We have already taken many actions to date that put us in a strong position as we stand today.

Lastly, we remain focused on achieving our financial targets. After we complete our merger cost savings and once we return to a more normalized operating environment, we believe we will be well-positioned to generate top quartile adjusted ROATCE, along with a below peer median adjusted efficiency ratio.

With that, I'll open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today comes from Jon Arfstrom from RBC Capital Markets.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [2]

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Jim, maybe a question for you to start. I think we understand what's going on in credit, but the modifications in commercial, you gave us the number of deferrals, and curious if you're willing to size it and then curious what you're seeing in terms of the pace of modification requests are increasing, stable, slowing? And then comment on what you're seeing in Capital Solutions. I'm guessing it's smaller balance, 90-day deferral-type stuff, but just give us an idea of what's typical there.

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [3]

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Sure. We actually are tracking just your line of inquiry there. What we saw as the crisis unfolded, Jon, was a surge, if you will, in payment deferral requests, and that has moderated. It really required us to ship resources around. It really has moderated across all channels. Now we understand that pace may change, but right now, it's really declined. We don't disclose the balances of the commercial deferral payments, but the number that I had disclosed, I think, it was 85 or so, 8,500 is the level of volume. And then as Craig mentioned, the average ticket size in Capital Solutions is quite small. The deferral payments there really have been pretty modest on a transaction basis.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [4]

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Okay. And these are just businesses stopped or asking for a deferral for 90 days and then it's...

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [5]

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That's right.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [6]

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Kind of a gut -- Yes, okay. Got it.

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [7]

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Yes. One of the areas, Jon, that we're paying attention to, you'll find in Capital Solutions is shuttle bus and motor coach. And that largely supports tourism and travel, which obviously has been halted through shelter at home. So the liquidity position of some of those borrowers isn't as strong as we'd like. And so it really is not just inbound, but also proactive outreach to the borrowers to see how we can help them. So a fair bit of the activity in Capital Solutions be driven from that shuttle bus and motor coach segment.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [8]

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Okay. Good. And then, maybe Brian or Dennis, appreciate the thinking on the margin outlook and the potential for stability in Q3, Q4. You know this question is coming. We understand the puts and takes. But any thoughts on the magnitude of the expected pressure in Q2 on the margin before we start to see some potential stability?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [9]

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Yes, Jon. Good question, obviously. This is Brian. What I'd say is rates really only impacted Q1 margin for that last month of the quarter. So going forward, we do expect that there's going to be some pressure on the margin, as I said in the prepared remarks. Really what you have is you've got a full quarter of rate cuts that are going to be factored in there. We are going to have lower LIBOR levels as LIBOR comes down as well as it likely will continue to normalize, but we will have some other mix shifts that takes place in there. So generally speaking, we expect Q2 to be down. It's hard for us to size it. We might have PPP loans in there for a short period of time, which will influence it. So I'd say we expect Q2 to be down, but then we do -- overall, I think that we can see stabilization and maybe even some upside as we get to Q3 and Q4. So overall, we feel really good about the margins. The fact that we were still at 3.53% at the end of Q1, we really feel relative to peers and just overall that we've got a strong net interest margin, and even if it comes down here a little bit in Q2, we're still going to be in a good position.

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Operator [10]

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Our next question comes from David Long from Raymond James.

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David Joseph Long, Raymond James & Associates, Inc., Research Division - Senior Analyst [11]

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Following up on the net interest margin, the net interest income guidance, Brian, safe for me to assume that that excludes the payroll protection program impact, correct?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [12]

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That's true, Dave.

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David Joseph Long, Raymond James & Associates, Inc., Research Division - Senior Analyst [13]

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Okay. And can you disclose what the amount of fees you may be receiving from that? And then your expected timing and how that will hit net interest income?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [14]

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Yes. Good question, Dave. What I would say, based upon the first round of PPP loans, our fees are probably around, I'd say, $30 million is what I'd say are the gross fees. Now how we recognize that that will be amortized in the interest income over time and the recognition of that will depend upon the forgiveness period as well. So obviously, to the extent that loans are forgiven, it will come in a little bit faster, to the extent that the loans stay around for the 2 -- for the full 2-year period, they'll get recognized over that 2-year period. And then in addition, obviously, we're in our second round of PPP loans. There's potential for more activity there. So the comments I gave are really around what we have approved through the first round of PPP loans.

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David Joseph Long, Raymond James & Associates, Inc., Research Division - Senior Analyst [15]

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Got it. Do you have in your mind a level that you think will be forgiven relatively soon, say, within the first maybe 90 to 120 days or maybe after 60 days if the government is quick on that? And then also with the round 2, do you have any expectations on where that could be? Are you looking at a couple hundred million, several hundred million there? How big is your pipeline?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [16]

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Yes. So 2 questions there, Dave. I'll take the first one, and then I'll have maybe Tom Shafer or somebody else answer the second one. I guess, on the first question, which is around the forgiveness, a lot of that is going to be driven around the borrower activity. So it's really hard for us to predict at this point in time. I'm sure as the quarter progresses and as we kind of get to that 8-week period, we'll know a lot more, but it's really too hard to predict at this point.

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Thomas C. Shafer, TCF National Bank - President, COO & Director [17]

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Yes, David, this is Tom Shafer. Yes, on the -- on kind of version 2 of the PPP program, yesterday was, I would say, a very kind of a lot of stutter steps for the SBA. We were able to submit 100% of our pipeline through batch files yesterday where -- and so it will -- if all are approved, something just under $1 billion, I would expect to be approved in the next round.

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Operator [18]

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Our next question comes from Steven Alexopoulos from JPMorgan.

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Steven A. Alexopoulos, JPMorgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [19]

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Start on the CECL reserve and the build you guys took in the quarter, can you just give us some color, how much different is the economic outlook now as compared to what you use for the day 2 adjustment?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [20]

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This is Jim, Steve. I'd like to say that there's more clarity. I mean, on one hand, the economic outlook has been buoyed by the degree to which certain jurisdictions have been able to begin to control the spread of the virus. And that obviously will have a blowback on capital markets and the banking industry. So on one hand, I'm encouraged. On the other hand, it all seems to be driven by the health care issues. I don't think that there is solid progress yet, demonstrated and proven progress on medical treatment. So we may have been able to contain the crisis. I don't know if we can say that it's clearly on its way to be behind us.

So, therefore, that introduces a degree of uncertainty. Will there be more shelter-at-home on a second wave. And so for that reason, Alex, I hope you understand, I don't want to create a longer-term forecast with some degree of certainty. I'm encouraged by what we're seeing on the health care front. I don't know if it's sustainable. But I would say today versus 3 weeks ago, I'm feeling slightly better. I think you see that reflected in the market as well.

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Steven A. Alexopoulos, JPMorgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [21]

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Yes. Yes. And, Jim, to follow up, as I think about reserve coverage, quite a few of us are looking at DFAST, and it was -- the last was 2017, when you guys released DFAST. And losses in that stress test were around 3.6%. When we think about the new company here and you think about losses through a cycle, do you think that's still a reasonable range? Or is it much higher, much lower, given that you have a new company today?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [22]

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I would say directionally you would see the benefit of the diversified business model by combining the 2 banks. We have a very strong deposit base, driven largely by what's happening in the community banking model inside of Michigan. I think overall performance would be more favorable post-merger than pre. So adding the 2 together, I think there's a net benefit to forecast performance on credit. We haven't actually disclosed a combined stress case -- a stress test with you. We've, of course, done some analytics on that during the merger process, but we are not at this point required to submit a DFAST any longer. But I feel better post-merger than prior.

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Steven A. Alexopoulos, JPMorgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [23]

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Okay. That's helpful. And then final question. You guys obviously had a nice quarter on expenses. What portion of the cost saves are now in the run rate?

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Dennis L. Klaeser, TCF Financial Corporation - Executive VP & CFO [24]

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It's -- Steve, it's about 2/3 or so. So clearly, we're marching it down overall operating expenses. And again, we expect the core operating expenses to be $321 million or lower by the fourth quarter. So we'll make some incremental progress here in the second quarter then significant -- much more significant progress as we end the third quarter and go into the fourth quarter.

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Steven A. Alexopoulos, JPMorgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [25]

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Okay. And Dennis, there's no reason that the system conversion should be delayed because of what's happening with COVID?

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Dennis L. Klaeser, TCF Financial Corporation - Executive VP & CFO [26]

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Clearly, it's more challenging with the work-at-home. But right now, we feel confident that we're going to stick on schedule. And so we're very intensely working on that to make sure that we stay on schedule.

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Operator [27]

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Our next question comes from Ebrahim Poonawala from Bank of America Securities.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [28]

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I just wanted to follow up, Jim, I guess, on your -- on some of your responses on credit and reserve build. So you're right, I think it's -- the environment feels a little bit better today even relative to last week or 2 weeks ago. And I guess with that lens, if I ask this question, if 3 months from now, like when you think about reserve build, what's going to have a bigger impact on that reserve build? Will it be the changes in the macro scenario than what banks look at from a Moody's standpoint? Or will it be more driven by better portfolio insights as you finally start to weed out around actual potential problem loans as opposed to just convenience-driven deferrals at this point?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [29]

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If I had to pick one thing, Ebrahim -- this is Jim, I would pick unemployment. What we really need to understand is the degree to which return to work allows the economy to begin to restart. And that will provide some sustainability to employment. If that is not successful, the payment deferrals are only going to carry liquidity challenges so far. And then you'll see the losses flow through. And that will also impact things like asset valuation, particularly on the residential real estate side. So if I really had to focus on one thing I'm watching it's -- are we able to stave off a high unemployment rate by the return to work in different geographies? If we're successful, and it looks like we might be on that trajectory, then I'm going to feel better going forward. I don't think the portfolio insights necessarily -- it's not as if we study them more we learn more. We really have to see what's impacting the borrower. And to me, that's more of an external issue on things like employment. I don't know if that's helpful. That's the way I'm looking at it.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [30]

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That's actually helpful. And sorry, if I missed this earlier, what's the assumption within your scenarios around unemployment for the rest of the year into 2021, if you could share that?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [31]

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Yes. Sure enough. Sure. So, Ebrahim, we have our process. I'll just provide a little bit more color here. We take a consensus forecast. So we're not wedded to a singular forecast to support and derive our quantitative CECL reserve. And then we overlay that with qualitative. So the qualitative is really where the COVID impact comes in. So that it's not as if we picked a macro scenario, we ran our models through it, and that is how we arrived at the COVID impact of $74 million. It's not the way it worked.

I will tell you, we did look at macro forecasts, and those range from peak unemployments on the 9% with a quick reversion to sustained unemployment over many quarters, 7%, 8% in the longer duration. That was another lens. We also, Ebrahim, look at a number of what we call Q factors, which is asset quality trends, loan review, sort of the core performance of the portfolio, loan review reports, other macro factors, key performance indicators. It's a compilation of things that derive that qualitative forecast. So I would discourage you from focusing on a macro factor and trying to translate that into a reserve level because that's not the way our process works. It's a piece, but it's only a piece of the overall. Is that helpful?

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [32]

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No, that's extremely helpful. And I guess just moving to the Slide 15 CRE disclosure, and sorry if I missed this one, but do you disclose the LTVs on the CRE book, whether a lot of these loans are backed by borrower guarantees. Just any sort of color around. We've seen a fair amount of growth in this book over the last 10 years. What -- I mean, so they're all small individually as exposures. But if you could talk to just the LTVs, borrower guarantees, what's kind of the sponsorship behind these loans?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [33]

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Sure. I'll offer a thought, and then maybe Tom or Craig would like to follow up. It really depends, Ebrahim, on whether you're looking at sort of an owner-occupied transaction or a sort of a national corporate banking, commercial real estate, almost an institutional type of credit. For the latter, I can tell you that we have -- as the credit cycle has elongated, we have taken a moderately and consistently more conservative position over time. So 25% equity in a corporate CRE transaction would have been normal a few years ago. That's probably gravitating more towards 30% times better than that, sometimes 35%. So the CRE asset classes are a little different when you put the 2 banks together, but I think if you're looking for an equity level, it's not uncommon to see 30% on average. I don't know, Tom, if you'd like to add anything to that.

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Thomas C. Shafer, TCF National Bank - President, COO & Director [34]

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Yes. I think that's right, especially as you're talking about the institutional -- the growth that we've had in the institutional real estate segment. For the regional bank, community bank, I would say that 25 -- 20% to 25% equity has been standard as the expansion has continued for the last couple of years. Most of these are in-market sponsors that we know, sponsors that we've had long relationships with. And in some cases, some level of sponsor support. But we've been, I think, careful across all these classes to make sure that there is legitimate owner contributions in each of these classes, especially on what you're looking at on Page 15.

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Operator [35]

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Our next question comes from Chris McGratty from KBW.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [36]

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Brian or Dennis, I had a question on the reserve. I just want to make sure I understand the $167 million discount. If I were to add that to the existing reserve, it would look like, something like a 1.6 reserve coverage. I'm interested in kind of the breakdown in that between rate and credit. And could you speak to how that -- how we should be thinking about absorption between accretion and just traditional credit?

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Dennis L. Klaeser, TCF Financial Corporation - Executive VP & CFO [37]

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It's Dennis. So roughly 2/3 of that mark is related to a credit mark from day 1. That's still remaining. Now I should note really that going forward, it really doesn't -- that distinction between credit mark and interest rate mark is less relevant because both of those marks accrete in over the life of the loan portfolio. Now if at any point in time, there's a loan that's charged off within the Chemical portfolio, if you think of the accounting, it's that $167 million absorbs the first part of the loss. And then if there's loss above that mark, then you begin to eat into the on-balance sheet allowance for credit loss.

So I like to think of it as what's available to absorb loss, you have the off-balance sheet remaining mark as well as you have the on-balance sheet allowance for credit loss. So for that portfolio, we do have -- I think you should think of that entire $167 million currently available for absorbing part of the loss. But note that over time, that cushion that's there does get accreted into income through the -- through net interest income.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [38]

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Okay. That's great color. In terms of the fee income, I understand there's a ton of moving parts. And I know this is a topic last quarter. But if we think about the pieces for leasing and your -- some of your consumer banking fees from the impact of the quarantine, can you just maybe elaborate a little bit more about the potential near-term pressure, although maybe just a couple of quarters for some of those items?

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Dennis L. Klaeser, TCF Financial Corporation - Executive VP & CFO [39]

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Sure. So overall, fee income reported $137 million. A couple of moving parts was the MSR impairment, and then we had a gain from interest rate swaps netted out. If you took those 2 out, we would have had $139 million of fee income. So clearly, in the fees on deposit accounts, the card and ATM revenue are impacted by the COVID situation now. It was only impacting it for part of the quarter. We will have some more impact there going into the second quarter depending on overall activity levels and how quickly we come out of the stay-at-home orders. And I would think that within the leasing revenue as well, we probably had a little bit of headwind there as a result of COVID. So we do have some headwinds from those things.

But when you look at overall fee income and look at the various categories, I think it's important to note that there's a variety of business synergy opportunities that are ahead of us here with the card and ATM revenues with the service charges on deposit accounts, for example, rolling out the digital banking applications that TCF has into the Chemical franchise creates fee income opportunities, not only directly in terms of activity going on with accounts, but also, as you know, TCF has grown account relationships, retail account relationships. So I think as business synergies come -- hold there, there's some upside to fee revenue. We also talked before about selling our leasing services into the legacy Chemical franchise. And so that creates some upside.

I feel pretty optimistic about our mortgage banking business. TCF was really at its infancy in developing the traditional in-market, first mortgage lending within its franchise. And legacy Chemical had developed a really good platform that I think is very leverageable. And so I think over time, we have good upside in terms of mortgage banking fee revenue. Of course, it is going to fluctuate depending on interest rate environment and refinance activity. As that business grows, we should see growth in servicing fee revenue. I did note that we'll see a bit of a dip into the second quarter, as we now give up the auto loan servicing revenue.

And then also in wealth management revenue, first of all, historically, we would see a pick-up in second quarter, a seasonally stronger quarter for fee revenue with wealth management. But then longer-term, we see some business synergies there of rolling out wealth management and trust services across the TCF franchise. So longer term, I see some strong potential for growth overall in fee revenue.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [40]

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That's great. Just one more. You saw one of your Midwest peers raise some subordinated debt, I think, last week, given the drop in rates. You guys have plenty of capital in terms of CET1, but any thoughts on utilizing a similar strategy just how the markets are open?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [41]

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Yes. This is Brian. What I would say is we feel really good about the liquidity and capital position of the bank. It's one of those things where we want to consider bolstering on more capital. It's something that we will consider depending upon market conditions, costs. I wouldn't rule it out, I guess. But we don't necessarily feel that we're in a position where we would really necessarily need it today.

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Operator [42]

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And our next question comes from Nathan Race from Piper Sandler.

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Nathan James Race, Piper Sandler & Co., Research Division - Director & Senior Research Analyst [43]

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I appreciate the disclosures on Slides 15 and 16. And I guess just trying to put this in context with some -- with what some other banks have disclosed so far in earnings season and outside of inventory finance. I guess we kind of get through a number anywhere between kind of l4% to 15% of total loans that are more so exposed to the ongoing pandemic. Just curious if you guys had any thoughts on that number, just kind of how you guys view the portfolio outside of the inventory finance that could be more at risk near term, I suppose?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [44]

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Sure, Nathan. This is Jim. I'll offer a point of view. The part of the reason that we wanted to give you some insight into the composition of the CRE portfolio and C&I portfolio is, as you can see, it's pretty granular. There aren't large concentrations. So I'm not sure if I would say -- I think you maybe said l5% of the portfolio are things that you would expect to be impacted. Anticipating maybe being asked, what are you worried about? I'll answer your question this way. As we indicated before, our hotel portfolio at $764 million is 2% of the portfolio, maybe 2.1%. We have shuttle buses and motor coaches, about $410 million of that, that's 1.1%. And then it starts to drop off pretty significantly. I am watching carefully our restaurant portfolio that's 0.2%. So you can see suddenly the list of things that you really have front and center gets to be very small. I'm not sure I'd say 14%, 15%. As Craig mentioned, we look for the obvious when the crisis began to unfold, oil and gas, aviation. Oil and gas inside of shared national credit, the numbers are very, very small. We're not really worried about those because it wasn't part of our strategy. I would say if the crisis extends and it does impact collateral valuation, a lot of banks will be looking at residential real estate collateral values. I don't have a reason to believe that's where we're going, but that would be a different concern. I'm not worried about it yet, but I'm very watchful of it. So hotel, shuttle bus, motor coach, restaurants are the ones that come top of mind. That might be -- 4% of the portfolio would be the most obvious.

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Nathan James Race, Piper Sandler & Co., Research Division - Director & Senior Research Analyst [45]

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Got it. That's helpful. And if I could just ask, Craig, on the inventory finance portfolio, I appreciate the disclosures there. And I'm just curious in terms of your views in terms -- in that how this portfolio may perform in this downturn. I appreciate the guidance -- I'm sorry, the indication that you guys have had just 12 basis points of charge-off since 2019 on an annual basis. So just curious if you have any thoughts on how this portfolio has performed during previous downturns and just maybe how some of the loss offsets are in place relative to a traditional C&I book? And again, I appreciate the fact that 84% of this portfolio is tied to direct OEMs.

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Craig R. Dahl, TCF Financial Corporation - CEO, President & Director [46]

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Sure, Nate. I remember most of this portfolio was on what we would call pay-as-sold terms. So there aren't required principal payments to be made typically until the asset is sold. In addition, as you've already indicated from our disclosures, over 80% of this portfolio is a manufacturer exclusive program, where we have manufacturer support as far as repurchase and remarketing. And so typically, supporting this dealer. We entered this business, Nate, in '08 at a time when people were wondering if financing the dealers and these community bank cities made a lot of sense, and we've had just tremendous credit performance. And again, partnering with those strong manufacturers has always been key to this program.

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Operator [47]

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Our next question comes from Terry McEvoy from Stephens.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [48]

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Just a question. What is the expense benefit in the third quarter coming out of the core conversion? And so what would that mean to the fourth quarter as those costs come down?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [49]

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Yes. It's really a couple of things. One, it's compensation related to employees around the IT systems. And think of it as really -- we're running 2 systems right now. And we'll convert to a single system going forward. And I don't have the exact breakdown, but you'll see some reduction in equipment expenses as well coming down. But the guidance is that we're going from the $335 million or so of core expenses that we saw in the first quarter down to $321 million or lower in the fourth quarter.

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Craig R. Dahl, TCF Financial Corporation - CEO, President & Director [50]

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Nate -- or I'm sorry, it's not Nate anymore. This is Craig. The other thing to remember. It's going to be a really messy quarter because all of those expenses are going to come out in the quarter, the retirement of the legacy system. So all that activity is going to go flow through. There'll be a lot of merger-related numbers in that third quarter.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [51]

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Understood. And then, Craig, it's Terry, a question for you. I know it's low on the priority list in terms of excess capital, but you have talked about opportunities in environments like this where you could see portfolio purchases and opportunities to buy some portfolios. Are they out there in the marketplace? And what's your interest today in seriously taking a look at them?

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Craig R. Dahl, TCF Financial Corporation - CEO, President & Director [52]

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I mean, I would -- the only thing -- yes, they are out there today. But from our standpoint, the long-term return on capital, these asset moves would be the primary driver. We're not looking to grow just to add portfolio or add net income necessarily. We want to make sure that based on our strategic value analysis that we've got the right -- we're investing in the right thing. So everybody has got their antenna up. But right now, we're just handling our own portfolio.

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Operator [53]

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Our next question comes from Jared Shaw from Wells Fargo Securities.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [54]

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First question, just on the on-balance sheet cash liquidity. Should we assume that you keep levels at this level sort of going forward until we're through sort of this COVID-19 environment? Or should we expect to see some of the $1.3 billion drift down over the next few quarters?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [55]

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Yes. This is Brian. I'd say, in general, most of our asset liquidity is held in the investment securities portfolio. If you did see us kind of finalize that reinvestment, we actually finished that back in January when yields were quite a bit higher. So I wouldn't see overall securities levels as a percentage of assets coming down at all. There might have been a little bit of excess cash on hand at the end of the quarter depending upon how the quarter ended. But in general, the investment securities portfolio will stay its size. We could potentially see some expansion of the investment portfolio. I know in previous quarters we had said we might look to grow that as another percentage of investment assets. I'd say, as of today, kind of where yields are at, we're more kind of in the wait mode to see if that makes sense. But overall, as a company, we have a lot of on-balance sheet liquidity. We've got a lot of contingent borrowing capacity. So we've probably got liquidity both on balance sheet as well as contingent, more than $10 billion, even up to $15 billion. We have access to wholesale markets as well as access to capital markets. So we feel really good about where we sit from a liquidity position.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [56]

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Okay. And then on Slide 13, looking at the $73 million that was added to nonaccrual that was previously PCI. If there's outperformance there in terms of actual credit performance, will that assuming that sort of flows through the provision is an offset to provision for new loan growth? Or I guess, how will that work?

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James M. Costa, TCF Financial Corporation - Executive VP, Chief Risk & Credit Officer [57]

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That provision went off-balance sheet to on-balance sheet. And because it was classified as PCI, it has a substantial reserve against that small portfolio. And you're right, if we outperform, essentially, that provision is released and relieves pressure on future provision expense.

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Operator [58]

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And our next question comes from Ken Zerbe from Morgan Stanley.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [59]

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I just want to clarify, in terms of your low single-digit loan specifications, specifically around the PPP program, I just want to know if they're going to stay or go? And I assume your guidance is not in the period, like what -- is the low single digit, excluding all PPP impact in the year?

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Brian W. Maass, TCF Financial Corporation - Executive VP, Deputy CFO & Treasurer [60]

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Yes, Ken. This is Brian Maass. You're kind of cutting out on the question or my phone was cutting out. But I think your question was with our loan growth guidance, does that include PPP loans along with those come off balance sheet. What I would say is the guidance I gave on loan growth, I'd say, is core loan growth relative to the business. Obviously, as we talked about, we have approved over $1 billion of PPP loans from the first round, and we don't know exactly how much we're going to wind up in the second round, but it could be another $1 billion potentially. So that was really excluding, I'd say, the PPP loan. So that would be separate. And it's hard to predict exactly how long those will stay on balance sheet again. It relates to the forgiveness period, and really that's driven by the customer behavior and what they use the funds for, will drive when that comes off of our balance sheet. So hopefully, that helps.

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Operator [61]

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And ladies and gentlemen, with that, we'll end today's question-and-answer session. I'd like to turn it back over to Mr. Dahl for any closing remarks.

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Craig R. Dahl, TCF Financial Corporation - CEO, President & Director [62]

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Thank you, Jamie. First of all, I wanted to commend my -- the team that's on the phone here today that just did a fantastic job in getting prepared for this call. The amount of detail, the scripting of it is just -- they did a great job working remotely. It's been fantastic. Next, I want to thank all of you for listening this morning. Then next, I want to thank all the health care professionals in our markets for their sacrifices during this time. As you know, several of our markets, including Detroit and Chicago, have been severely impacted, and we owe a debt of gratitude to these health care workers. I want to thank all of our team members for their hard work, as they've experienced new challenges of balancing work and family commitments. But not only are our teams managing through work-from-home challenges, we are staying on track of our integration work streams, which is remarkable, and I'm extremely proud of the team's efforts. We will all get through this together, and I'm confident we'll come out of this stronger than ever before. Thank you.

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Operator [63]

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Ladies and gentlemen, that does conclude today's conference call. We do thank you for joining. You may now disconnect your lines.