SouthState - Q2 2023
July 28, 2023
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the SouthState Corporation second quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, simply press Star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press Star one. Thank you. It is now my pleasure to turn today's call over to the Chief Financial Officer, Mr. Will Mathews. Sir, please go ahead.
Will Mathews (CFO)
Good morning, and welcome to SouthState's second quarter 2023 earnings call. This is Will Mathews, and I'm here with John Corbett, Steve Young, and Jeremy Lucas. John and I will provide some brief prepared remarks, and then we'll open it up for questions. As always, a copy of our earnings release and presentation slides are on our investor relations website. Before we begin our remarks, I want to remind you that comments we make may include forward-looking statements within the meaning of the federal securities laws and regulations. Any such forward-looking statements we may make are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in the press release and presentation for more information about our forward-looking statements and risks and uncertainties which may affect us. Now I'll turn the call over to John Corbett, our CEO.
John Corbett (CEO)
Thank you, Will. Good morning, everyone. Thanks for joining us. When we had our last earnings call in April, the banking industry was still in the fog of war. Three months later, the fog is starting to clear. Liquidity is stabilizing, the new regulatory framework is coming into focus, and SouthState is in a position of relative strength for the next phase of the cycle. We're pleased to report that for the first half of 2023, PPNR per share grew by 34% compared to the first half of last year. So far this year, loan and deposit growth has been slightly better than our guidance. You'll recall that for 2023, we plan to keep deposits flat and for loans to grow at a mid-single-digit pace.
We projected that loan growth would be faster in the first half of the year and a little slower in the back half of the year. We're now at the halfway point for 2023, deposits are up 2%, and loans have grown at a 9% annualized pace. Balance sheet growth is on track. Our geographic business model has proven to be a competitive advantage for deposit pricing. Our regional presidents have done a superb job of efficiently using exception authority to protect our core relationships while effectively managing deposit costs. It helps that SouthState has the lowest average deposit size of our peer group at $25,000 per account, and that granularity translates to stability.
The long-term value of a bank is on the right side of the balance sheet, and our granular and relationship-based deposit funding has resulted in a cumulative deposit beta of just 22% this cycle. We're pleased to have had 6% growth in customer deposits in the second quarter. Credit metrics are starting to normalize, but charge-offs remain very low. In the last year, we conservatively set aside $142 million in loan loss reserves to cover only $4 million in charge-offs. The result is that we bolstered our reserve, including unfunded loans, by 30 basis points from 1.26% a year ago, to a current allowance for credit losses over 1.5% at 1.56%.
We believe the strength of our reserves and our capital base will give us an extra level of optionality as we enter the next phase of the cycle. The Southeast has proven to be the winner, it should continue to be the winner in a post-pandemic economy. Population growth and job growth are remarkably strong, that's driving real estate values and new home construction. SouthState operates in four of the six fastest growing states in the country, with the recent announcements of several new multi-billion dollar electric vehicle plants and battery plants, with tourism fully recovered, we see the momentum in the Southeast extending well beyond this decade. We don't have a crystal ball, we don't know the ramifications of the Fed's policies as hard as we try.
We are firm believers that granular and relationship-based deposit funding, discipline underwriting in high growth markets, and an entrepreneurial team of bankers is the recipe for success, regardless of the Fed's interest rate policies. With that, I'll flip it back to Will to walk you through the details of the quarter.
Will Mathews (CFO)
Thank you, John. I'll go through a few details, but I think a high-level summary of the quarter is that we put up a solid PPNR, though our NIM compressed a bit to 3.62%. Our deposit costs were in line with where we expected them to fall. We had forecasted an an increase of 45-50 basis points, and they moved up 48 basis points from Q1 to 111. We had solid growth in both loans and deposits, though we expect our loan growth to slow down in the back half of the year. Our non-interest income performed well, exceeding our expectations, and conversely, expenses were a little higher than expected, largely due to some items that are not expected to recur. On the balance sheet, our 11% annualized loan growth brings our first half growth rate to 9%.
As I said, we expect this to moderate for the final two quarters of the year.... Deposits grew at a solid 3.6% annualized rate, or 6% if you exclude the approximately $210 million in brokered CD maturities we didn't replace. Like others, we continue to see a mixed shift in our deposits from DDA into money market accounts and CDs. DDA has represented 31% of our total deposits at quarter end, down from 34% last quarter. Pre-pandemic, this figure was 28%-29%, so we appear to be moving toward pre-pandemic levels of DDA as a percentage of deposits. Turning to the income statement, our 3.62 NIM was down 31 basis points from Q1. Loan yields were up 15 basis points, but deposits were up 48 basis points, bringing our cycle-to-date deposit beta to 22%.
Our net interest income of $362 million was approximately equal to what we reported for the 2022 third quarter. Non-interest income was up $6 million to $77 million, the best quarter we've had since last year's second quarter. It was led by correspondent, which had $19 million in revenue after $8 million in interest expense on swap collateral for $27 million in gross revenue. This continues to be a difficult environment for fixed income, but our interest rate swap business had a very good quarter. Mortgage and wealth had solid quarters similar to Q1 levels, deposit fees recovered to levels we saw in Q4. As I said, expenses came in higher than expected this quarter. A few factors impacting the quarter's NIE. Compensation expense was up $3 million, around half of which was higher commission expense.
We recorded a $1.5 million expense accrual for litigation. We recorded an adjustment for our FDIC assessment during the quarter to reflect the new assessment rate effective this year. Our quarterly run rate going forward for FDIC insurance expense should be approximately $7 million, excluding any special assessment and excluding other regulatory charges. Those two non-recurring items, the litigation accrual and the FDIC adjustment, along with the higher commission expense, total around $5 million. Looking ahead, our team's annual merit increases are effective July first. Subject to some variations in expense categories impacted by non-interest income and performance, we expect operating NIE in the next couple of quarters to be in the low to mid 240s.
With respect to credit, we continue to build loan loss reserves in the face of a possible recession, with $38 million in provision expense against only $3 million in net charge-offs. Over the last four quarters, we've averaged one basis point in net charge-offs, or a total of $4 million, while recording $142 million in provision expense for a $138 million build in total reserves in one year. This brings our total reserve to just shy of $500 million and 156 basis points of loans, up 30 basis points from a year ago. We knew the historically low levels of NPAs and criticized and classified loans we've enjoyed the last few quarters were not sustainable. We saw those metrics tick up a bit in Q2, though they remain at very moderate levels.
I'll note that almost 60% of our non-performing loans are current on payments. Like last quarter, we included in the presentation some additional credit information on areas of interest. We continue to have very strong capital ratios with CE Tier One above 11%, or 9.4% if AOCI were included in the calculation. Our TCE ratio improved slightly to 7.6%, with capital retention slightly offset by a higher AOCI impact versus Q1 due to increases in interest rates. As I noted, we expect to see slower loan growth in the next couple of quarters, so risk-weighted asset growth should be lower than what we experienced in the second quarter. With our solid capital position and our capital formation rate, we expect to continue to build and retain capital, though we may potentially utilize our buyback authorization to repurchase shares should conditions warrant.
Operator, we'll now take questions.
Operator (participant)
At this time, I would like to remind everyone to ask a question, press star, followed by the one on your telephone keypad. We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Catherine Mealor with KBW. Your line is open.
Catherine Mealor (Managing Director of Equity Research)
Thanks. Good morning.
Will Mathews (CFO)
Morning, Catherine.
Catherine Mealor (Managing Director of Equity Research)
I thought I'd start with the margin and just see if we could get an updated thoughts on how you, how you're thinking about the margin in the back half of the year. The deposit beta has just been so good, and just curious if you think that's, you know, sustainable in the back half of the year or if we still have a little bit more of a catch-up coming. Thanks.
Steve Young (CSO)
Yeah, Catherine, this is Steve. Thanks for the question, and just to back up for a second, last quarter our guidance was really kind of three things. One was interest-earning assets around $40 billion. Our deposit costs were to increase 45-50 basis points. They increased 48, so that was kind of right in line. The third piece of guidance we said was that our full year NIM expectation for 2023 would be between 3.60% and 3.70%, and then, of course, second quarter came right in line with that. As we think about going forward, the rest of the year and then 2024, just a couple, there's three really big assumptions around it. Interest-earning assets being the first.
... our rate forecast being the second, deposit beta being the third. On the first one, our interest-earning assets is around $40 billion for the full year. We, we haven't changed that guidance. You know, it started out a little lower, it's ending a little higher, but basically pretty steady in 2023. As it relates to the second assumption or our rate forecast, you know, during the April call, we forecasted rates based on the Moody's baseline to peak at 5.25%.
Of course, based on the latest Fed rate hike this week and the Moody's consensus, we're expecting Fed funds rate to stay flat at 5.5% through the rest of the year before decreasing in 1Q 2024, and then going to 4.25 by the end of 2024. That's what's built into our forecast. Then the last assumption is just around deposit beta. As you mentioned, we have a page in the deck on page 19 of our investor deck that shows our cycle-to-date deposit beta is at 22% versus our historical beta from last cycle was 24%. You know, in April, we did give guidance that we expected our deposit beta to finish up in the high 20s due to the March banking turmoil.
You know, we continue to reiterate that expectation based on what we're seeing. As we think about based on our interest rate forecast, we would expect deposit costs to increase 30 to 35 basis points in the third quarter, and for our deposit cost to end the year between 1.50% and 1.60% in the fourth quarter, which is up about 40 to 50 basis points from the current 2Q level. You, you kind of put all that together and, you know, in summary, we, you know, based on these assumptions, we expect NIM to be between 3.50% to 3.60% in the back half of 2023, and we reiterate our full year NIM guide of 3.60% to 3.70% for 2023.
As we think of, you know, going forward, and of course, there's a lot of assumptions going forward into 2024, really, our, our biggest change would be just we expect our interest-earning assets to grow in 2024. We expect it to average around $41 billion for 2024 as we can, you know, grow loans and, and, and continue to grow the balance sheet. That the NIM would be relatively stable in that 3.50%-3.60% range, just based on all those assumptions. That's a long-winded answer to your question, but I think hopefully that encapsulates the margin question.
Catherine Mealor (Managing Director of Equity Research)
That is really great. Perfect. Thank you so much, Steve. Maybe I'm just thinking about the margins into 2024, because I think for the rest of the year, it makes perfect sense. As we think to 2024, I'm assuming loan yields is really the biggest factor there. If we assume the Fed, you know, stays at 5.50 and then even cuts into next year, the big question is: what can loan yields do into next year? This quarter, I noticed loan yield changes fell back a little bit from the pace that we've seen the past couple of quarters. Any commentary on what drove that?
I know every quarter can be kind of different, but just maybe can give us some thoughts on, on loan repricing and, and maybe within that guidance, where you're thinking loan yields in the end of the year and, and, and upside as we move into next?
Steve Young (CSO)
Yeah, Katherine, I think last quarter, we answered this sort of question on the call, and I think what we were talking about that, you know, based on the forecast, we thought loan yield for our total portfolio would end between 5.5% and 5.75% at the, you know, fourth quarter. You know, there's really no change to that, and that's probably why our NIM guidance really hasn't really changed a whole lot. You know, we would expect that the, you know, loan yield would continue to increase, one, based on the Fed rate hike; two, based on new production; and three, the last is just the maturing or repricing adjustable and fixed-rate loans. That represents about $1 billion a quarter.
That is sort of repricing, you know, somewhere in that 4.25%-4.40% range, and of course, over 7%. Those are kind of the, the three things that give us some, some confidence in the loan yield continuing to increase over time.
Catherine Mealor (Managing Director of Equity Research)
Got it. Great. Thanks for the help. Appreciate it. Great quarter.
Operator (participant)
Your next question is from the line of Stephen Scouten with Piper Sandler. Your line is open.
Stephen Scouten (Managing Director and Senior Research Analyst)
Hey, good morning, guys. Appreciate it. I guess, I appreciate the commentary around $142 million in provisions, only $4 million in net charge-offs. We can see the reserve build, but are there any other dynamics at play there that's, that's leading to a little bit more elevated provisions than, than what maybe, I don't know, I would expect from, from my side of things?
Will Mathews (CFO)
Yeah, Stephen, it's, it's Will. You know, the short answer is the biggest driver to the provision this quarter was the change in the Commercial Real Estate price index forecast. Let me maybe back up just a second and sort of talk about our model. You know, our model is built on historical loss data for 60 different bank charters that make up today's SouthState from the period of 2004 to 2019. Obviously, looking at different economic environments, different loss rates that occurred in those different environments and running regression analyses.
We have to also on top of that, though, you know, incorporate a qualitative overlay to account for the different nature of, of some loan portfolios, particularly the construction loan portfolio, which as you might imagine, heading into the Great Financial Crisis in the 2000, 2010 time frame, was much more heavily speculative land acquisition and development. It was, in some cases, you know, definitely well over, over half of the construction portfolio, where today it's a minuscule fraction, almost on an exception-only basis, whereas we're doing more industrial and multifamily-type lending in that construction category. We have a, a, a qualitative overlay to adjust for that factor.
... but, you know, you have to keep in mind that CECL, you know, it's a forward-looking, measure. So the increase that we, we show is not based on what we see in our portfolio, but rather based upon, you know, drivers, the changes in the loss drivers, particularly the CRE price index in this quarter.
Stephen Scouten (Managing Director and Senior Research Analyst)
Okay. The big move from the unfunded reserve to the funded, is that about loan fundings, or is that still kind of more model-driven in, into what you just spoke to, Will?
Will Mathews (CFO)
It, it's a combination of the two. It's the fact, you know, our, our unfunded, portion of the loan, commitments is, is reducing as we're not refilling the pipeline as much with construction, loans, and also just reflects, you know, some of the, the, the loss drivers in the different, segments and, and the qualitative overlays.
Stephen Scouten (Managing Director and Senior Research Analyst)
Okay.
Will Mathews (CFO)
We kind of view, you know, we tend to view, rather than rolling, we tend to view the total reserve, the 156 basis points, versus just the, the reserve on the, on the, the loans themselves. It's all capital set aside to cover loan losses, so.
Stephen Scouten (Managing Director and Senior Research Analyst)
Absolutely. Yep, perfect. Okay, and then on the loan growth guidance, kind of lower in the back half of the year, that's very consistent, which I appreciate. I know, like this quarter, it looked like investor CRE and resi mortgage were the two biggest drivers. Is one or both of those falling off more so than anything else? Is that, is that why loan growth will back off, or what's is it just more conservatism? Can you give me some color on that dynamic?
John Corbett (CEO)
Yeah, it'd be the residential loan growth category, Steven. I mean, that's, that's grown far beyond our forecast for the first half of the year. You know, basically, in the Southeast, with all this population migration, there's more buyers than sellers. There's a lack of inventory, so we've been financing new home construction for end users, not, not for builders, but for the end users. We see that residential production moderating the back half of the years. We just adjust the mortgage rates higher.
Stephen Scouten (Managing Director and Senior Research Analyst)
Got it. Got it.
Steve Young (CSO)
Steven, what I, what I would add is, you know, that we have a slide in the deck, and I think probably this is the last time we put it in there, but page 35, which speaks to kind of residential loan growth over the past, you know, really three years. What you notice is, you know, when rates are low, we typically sell more in the secondary. When rates are higher, we put more in the portfolio. If you looked at that whole three years, and you said, "What's your compounded growth rate over that three-year period for residential?" It's right at 9%. As we think about managing our balance sheet and our capital allocation, you know, we've sort of, you know, got it back to where we think the long-term average is.
You know, growing at 25% a quarter from here doesn't make as much sense. I think we've kind of allocated what we were going to allocate. We've just got to grow it with the rest of the portfolio.
Stephen Scouten (Managing Director and Senior Research Analyst)
Yep, that's great. Then just last thing for me, obviously, the NIM guidance was very detailed. Appreciate that, Steve. No pressure on that basis point change quarter-over-quarter. You, you did so well this quarter, now we're all going to expect it to be right again. I'm wondering, within that guidance, what's the non-interest-bearing deposit percentage look like in, in, in your models and your thinking? Because it's still 35%, which is phenomenal, but, you know, down from 40. Where do you think that's going to trend from here?
Steve Young (CSO)
Yeah, in, in our models, you know, we're at 31% at the end of the quarter, which fell from 34% last quarter. You know, most of that, of course, is just the business DDA side of it. You know, prior to 2020, in the last cycle, we ended up in, I think, in that 28%-29% range. Just based on our forecast, we're getting to that level by the end of the year. We think there's a couple of percent degradation, although, like everything else, stops going, accelerating so much over the next two quarters. That's kind of how we're thinking about it.
Stephen Scouten (Managing Director and Senior Research Analyst)
Okay, perfect. Great. Appreciate all the color, guys.
Steve Young (CSO)
Thanks, Steve.
Operator (participant)
Your next question is from the line of Kevin Fitzsimmons with D.A. Davidson. Your line is open.
Kevin Fitzsimmons (Managing Director and Senior Research Analyst)
Hey, good morning, guys.
Steve Young (CSO)
Good morning.
Kevin Fitzsimmons (Managing Director and Senior Research Analyst)
I was just wondering, on the, you know, deposit cost headwinds, the, the level of competition, the mix shift that we, we just were speaking about one minute ago, we've had a few banks cite that they've, they've observed that easing over the course of the quarter, and specifically here in the last, you know, in the month of June and coming into July. Is that consistent with what you're seeing? That you're seeing some of those headwinds abating, or not necessarily? Is it, is it, is it just as fierce, in terms of the pace that you're dealing with?
Steve Young (CSO)
Yeah, Kevin, this is Steve. Yeah, that, that's consistent with what we're seeing. Now, certainly, that can change, but that's really built into our guidance. You know, last, last quarter, we guided between 45 and 50 for the quarter. This year, we're sort of in the 30-35 range, and, you know, that's consistent with what we're seeing today and probably consistent with the industry. You know, certainly, anything else can happen that would move or change that, but right now, that's sort of, that's sort of where we're seeing it.
Kevin Fitzsimmons (Managing Director and Senior Research Analyst)
Okay. All right. And Steve, if I'd apologize if it was said and I missed it, but it was a very good quarter for correspondent and capital markets and as Will pointed out earlier, on the swap side. Can you, can you update us on what your outlook or how we should be thinking about non-interest income if we're looking at, like, a run rate in the second quarter of $77.2 million, how we should be thinking about that going forward?
Steve Young (CSO)
Sure, Kevin. Yeah, right. The fee income was $77 million, or, you know, the way we think about it, 69 basis points of assets. which was better than our guide of between 55 and 65. You know, the biggest drivers you mentioned was correspondent, and really it, it came down to our interest rate swap revenue. If you think about the environment in the second quarter, one of the things that happened was we had much lower 10-year Treasury, and then we had some, conversions on LIBOR that, that sort of drove some of the revenue.
The way we're thinking about that business for the back half of the year is sort of back at its first quarter levels, because, you know, the 10-year Treasury has now picked up to about 4%, that sort of drives a little bit of that. You know, as we're thinking about, you know, obviously, service charges came up a little bit, too. We think that probably comes down a little bit and then rebounds in the fourth quarter, like it usually does. Even from here, I think our guidance really hasn't changed. I think it's, you know, sort of that 55-65 basis points for the rest of the year.
You know, as we think about the, you know, get clarity on the Fed rate hikes and maybe even potential cuts in 2024, we'd expect in 2024 that the non-interest income to average assets would start moving up from, you know, more in that 60-70 basis points due to these interest-rate- the interest-sensitive businesses like mortgage and correspondent, which, which tend to do a lot better during a period of stable to lower rates. You know, really no change. We had a really good quarter. We're not expecting quite those levels going forward for at least the next couple of quarters, but into 2024, we'd expect the, the, the, the sort of rebound back, just, just due to the fact that, you know, the Fed's a little bit more stable.
Kevin Fitzsimmons (Managing Director and Senior Research Analyst)
Okay, great. I, I think I know the answer to this, but just want to ask. There's been, you know, you guys are cash flowing the available-for-sale securities. I would imagine at one point- you know, at some point, AOCI is going to unwind for you. We've had a few banks pull the trigger on, on, you know, chunkier, bond restructuring transactions. Just wondering if that's something that's on the table or on the, the radar for you guys, given your strong capital, that you could kind of accelerate that process or not? Thanks.
Steve Young (CSO)
Yeah, sure, Kevin. I mean, it's certainly something that we've, we've talked about. You want to always want to keep our options open because, as you know, things change, yield curve levels change, shapes of the yield curves change. I think the way we think about it is we're really balancing kind of three things: capital, earnings, and liquidity. You know, as we, as we think about, you know, NIM potentially stabilizing here, you know, we probably see less of a need to do that. At the same time, if the yield curve changed and moved down and there was an opportunity, we might want to do it. You know, I guess that's really a non-answer, but I, I think we, we always look at it, but there's nothing burning that makes us want to do it.
At the same time, you know, there could be an opportunity at some point if, if, if, if the yield curve allows.
Okay. Thanks very much, guys.
Operator (participant)
Your next question is from the line of Michael Rose with Raymond James. Your line is open.
Michael Rose (Managing Director of Equity Research)
Hey, good morning, everyone. Thanks for taking my questions. Hey, Steve, I just wanted to confirm that the margin guide that you gave includes purchase accounting accretion, or is that on a core basis? Just trying to clarify.
Steve Young (CSO)
Yeah, no, it, it does. It includes, includes all of the above. You know, purchase accounting accretion continues to move down. You saw it move down a few million this quarter, I think, and we'd expect that to kind of continue to move down through 2024. It really becomes less of a, you know, story when you're, when you're, having several, you know, $300 million worth of NIM. I think, yeah, all that includes everything.
Michael Rose (Managing Director of Equity Research)
Great. just wanted to circle back to, to loan growth. You know, one slide that really sticks out to me is slide five, where you have kind of the GDP and the footprint, you know, being in line with Japan and above Germany. Why, why is there not... Why are you guys not given your footprint, why is growth not stronger? I know you said it's going to decelerate, and some of that's just the fund up of some of the construction, you know, stuff that was on the books that, that's waning. Is it more of a measured approach from, from you all, or is it just the market is, is really, you know, your markets are slowing down, and there's just not as many opportunities? Thanks.
Steve Young (CSO)
Yeah, I, I think, Michael, it's a measured approach from, from our bankers, and it's a measured approach from our clients. You know, our C&I clients, there's still good business in the marketplace, but as they think about making large strategic decisions and they're thinking about the implications of an inverted yield curve and the potential recession in 2024, they're just being more cautious. You go back to CRE, and clearly, with the interest rate environment like it is, a lot of these deals don't pencil out for us as underwriters. They don't pencil out for the developers. It requires them to put 45%, 50% cash in the deals, that activity is slowing down. You know, that's what the Fed has designed. I think that's what the Fed wants to happen.
We don't want to fight the Fed here from a growth standpoint. I would tell you, as I think about different regions of the country, about the amount of opportunities for loan growth that we're going to see in the next couple of years, I think will be at a faster pace than other areas of the country. I think when it comes to potential recessionary risk, it's going to be a lot less in the Southeast.
Michael Rose (Managing Director of Equity Research)
Great. That's, that's good color, John. I appreciate it. Maybe just one final one for me. You know, you guys are trading around 1/8 of, of tangible. I know you talked about maybe some, some buybacks, but, you know, we have seen two kind of larger deals this, this week. I mean, what's the outlook for, for M&A here, just given that you have a stronger, you know, currency and, you know, if you were to look at something, I mean, is, you know, is there a preferred size range? Would you consider an MOE? I, I think there's going to be a lot of interesting things that happen, but we'd just love your overall thoughts on, you know, how you view M&A at this point. Thanks.
Steve Young (CSO)
I, I think those two deals kind of caught everybody a little bit by surprise last week. In the short term, there, there are obvious headwinds. The economic uncertainty, the interest rate marks on this deal math, and then the regulatory approval process is just too long. That's, that's the short term. From a long-term standpoint, the, the logic is there. If we've got an inverted yield curve and there's continued revenue pressures, and we're starting to see, Michael, a dispersion of multiples, that could drive a good accretion in M&A. Really, our guidance has- hasn't changed. As we think about good partners for us, ideally, we, we would like to partner with banks that are about 10% to a third of our size.
Our preference geographically would be to double down in the great markets that we're in, and if we ever look to expand into an area outside of our markets, we'd want it to be similar high-growth markets that we're already in.
Michael Rose (Managing Director of Equity Research)
Appreciate the call, John. Thanks, everyone.
Operator (participant)
Your next question comes from the line of Brody Preston with UBS. Your line is open.
Brody Preston (Sell-side Equity Research Analyst)
Hey, good morning, everyone.
Steve Young (CSO)
Morning.
Brody Preston (Sell-side Equity Research Analyst)
I was hoping to maybe just dig in a little bit more granularly on the margin. I was wondering, Steve, do you guys have any loans? Just because the loan yield, you know, I know that it's still kind of on track to get into the range you outlined, but it came up a little bit less than what I was looking for.
Is there any, I guess, within kind of the, the $9+ billion unfunded commitment that you, that you have, is there anything that's like, you know, funding up that, you know, is maybe coming on at, at yields that, you know, were agreed to, you know, a year ago or something like that, that's, that's a bit below the market right now, that's, that's kind of stopping that loan yield from moving, you know, towards the high end of the 5.75% that you expect?
Steve Young (CSO)
That's a good question. You know, I think, some of this has to do with the number of days in a quarter and all those kinds of things. You think about the first quarter, for instance, one of the things that, that can drive some, you know, distortion maybe is just around, you know, like on February is a 28-day month, and you have 3360 loans that sort of make that yield a little higher. There's things like that. I don't think there's anything, you know, back to what we forecasted last quarter, what we're forecasting this quarter, hasn't changed for kind of the back half of the year.
I don't, I don't think there's anything that we're seeing that, you know, kind of keeps us from being in that 550-575 range by the end of the year based on what we see. You know, some of that is, you know, our models have repricing in them and, and, you know, loans that are adjustable, loans that are maturing, those kinds of things. There's nothing in there that I think is unusual or, you know, anything that... You know, the question you ask, I don't, I don't have right off the top of my head. I don't think there's anything that, that's really driving that.
Brody Preston (Sell-side Equity Research Analyst)
Okay, got it. I, I did also want to ask on the, on the opposite side of the ledger, just the, the transaction and money market cost of deposits. They were up again, they, they held in, you know, I, I think, quite a bit better than, than some of your peers. I was wondering, you know, kind of what the, what the interest rate you're, you're paying on, you know, money market is for, you know, kind of negotiated rates with your business clients or, you know, just a, a broad kind of average rate. Any detail you can give us, give us there would be helpful.
Steve Young (CSO)
Yeah, you know, obviously, so much of that remix this quarter was in the business DDA going into business money market. You know, that's, that's that. As it relates to, you know, the rates that are paid on those particular accounts is really driven by so much of it being relationship pricing, and so it really, the answer is it depends. I think our average money market rate for the quarter was in the high two to maybe 2.70-2.80 kind of range. Of course, you saw a huge remix from business money market or business DDA to business money market. I guess the question really that you're asking is: when does that slow down?
If, if we have another 3% or so that moves in, you know, you could continue to see that money market rate move up. I remember looking back, and this is a long time, and it was a different bank, but 2007, when Fed funds was around 5.25%, you know, our money market, you know, average rate was in the 3% range. It doesn't surprise me a whole lot that we're sort of trending toward that at the end of this rate hiking cycle. Obviously, this, this cycle has been different, and so it's hard to predict, but that's, that's maybe some data points for you.
Brody Preston (Sell-side Equity Research Analyst)
Okay. Could I ask just, just on that remix that's happening, you know, from the, from the, business checking to the business money market? We can, we can see that pretty well on the, on the end of period balance sheet, but those two categories get consolidated for the average balance sheet. Did any of that happen later in the quarter that might have influenced, you know, the, the, the cost of deposit, you know, being, being lower than we should expect going forward?
Steve Young (CSO)
You know, I, I think, you know, the events of March really kicked in some of that remix in April and probably May, and certainly to a lesser extent, June. I think back to our earlier comments on the cost of deposits, what other banks are seeing, and sort of that, a little bit of a deceleration, I would say that probably most of that was maybe a little bit, you know, it was all throughout the quarter, but I'd say more heavily weighted towards April and May, and, yeah, versus June.
Brody Preston (Sell-side Equity Research Analyst)
Got it. Okay. I just had a couple left. Well, the litigation expense, was that for anything specific? You know, I was just kind of wondering what that was. The guidance you gave for expenses, the low $240s to mid $240s, it implies just a, it's small, but it implies a step up in the expense guide just a little bit, off of the full year $950 that you had talked about before. Is there anything specific that's kind of driving that as well?
Will Mathews (CFO)
Yeah. The litigation accrual was related to the settlement of a case from that's been out, out there for a while. We had it accrued and for mediation, and finally got it settled. That's accrued up for that amount. The, you know, the expense guide, yeah, there's a little bit about that $950 range, which if you, if you put them all together. I'd say the hard things to predict there, as you know, one would be variable compensation expense associated with some of the variable revenue, business lines, commission, et cetera. That's a component that, you know, depends upon those. The other is, you know, loan production volume impacts the FAS 91 loan origination cost deferral as well.
That's one that's hard to predict. If, you know, if loan volume slows down, you'll have less of that as an NIE offset. Those would be two, two of the things. As you go through the year, your costs control, your incentive compensation through the rest of the year, and that's, that's one that, you know, has some variability to it. That's all, those are some of the things that are in there that, you know, lead to that being a range like it is.
Brody Preston (Sell-side Equity Research Analyst)
Got it. Thank you for that detail. Then the last one I had was that I, I did notice that when I was kind of comparing the, the investor CRE slides quarter-over-quarter, I did notice that there was a step up in the substandard, and special mention office portfolio. I wanted to ask if that was the result of any reappraisals that you had done or if it, or if it was something different.
Steve Young (CSO)
Yeah. Brody, it's the 2nd quarter of the year, this is when we get in a lot of the year-end financial statements. And to your point, on page 25, you can kind of see that over the last year, special mention loans have been trending lower, substandard loans have drifted higher. If you put it all together, we're roughly flat from about where we were a year ago, we are seeing a mix, and I think it's predictable. We've been upgrading hotel loans coming out of the pandemic, and we've been putting some of the office deals on watch. If you look at our NPAs, today, nearly 60%, I think Will said this in the prepared remarks, nearly 60% of them are current on payments.
About $19 million have a government guarantee. There were two C&I credits that migrated to non-performers in the second quarter. One we feel pretty good about. We don't think there's a loss. The other one might have a charge in the third quarter, but based on what we know today, we should finish the calendar year with total charge-offs probably at or below 10 basis points.
Brody Preston (Sell-side Equity Research Analyst)
Got it. Thank you very much for that. I appreciate it, guys.
Steve Young (CSO)
Sure.
Operator (participant)
Your next question comes from the line of David Bishop with the Hovde Group. Your line is open.
David Bishop (Director)
Yeah, good morning, gentlemen. Most of my questions have been asked and answered. I guess one final question, maybe on the new loan origination deals. Just curious, where you saw those trending this quarter relative to last. Are you seeing any, any differential or better pricing in some of your markets and others? Just curious what you're seeing overall in terms of new, new loan origination deals.
Steve Young (CSO)
Yeah, David, this is Steve. They, they did improve for the quarter, and, you know, I guess, I don't have the data right in front of me as far as where they, where they, trended up from in the first quarter. Part of it is I do have residential loan yields, which I think was in the 620 range, give or take. As we think about-- you know, the commercial loan yields are much higher than that. As we think about moderating the loan growth in the back half of the quarter, most of that's going to be in residential. We'll start seeing that, you know, new loan yield probably be over seven is probably where we're thinking. I think we're in the high 6s, give or take, in the second quarter.
As we kind of move residential down, which is a lower yielding, what we think a safer asset, it really, it'll move back, back towards that 7%. It's kind of where we're thinking.
David Bishop (Director)
Got it. Then, one final question. The guidance in terms of loan yields expectations, I hear it was 5.50%-5.75%? Thanks.
Steve Young (CSO)
Yeah, that, that would be, just to be clear, that would be, in the fourth quarter, and we would expect, you know, it to move kind of in between here and there, in the third quarter. You know, that's all part of the margin guidance. Yeah, we would expect the loan yield to sort of, yeah, to, to be roughly in that range by the, by the end of the year.
David Bishop (Director)
Great. Thank you.
Operator (participant)
There are no further questions at this time. I will now turn the call back over to Mr. John Corbett.
Steve Young (CSO)
All right. Thanks, everybody, for joining us this morning. We know it was a busy morning with a lot of earnings calls going on. If we can provide any other clarity for you, don't hesitate to give us a ring. Hope you have a great day.
Operator (participant)
Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now disconnect.