Valley National Bancorp - Q2 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Valley National Bank Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone, and you will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Travis Lan. Please go ahead.

Travis Lan (Senior EVP and CFO)

Good morning, welcome to Valley's Second Quarter 2023 Earnings Conference Call. Presenting on behalf of Valley today are CEO, Ira Robbins, President, Tom Iadanza, and Chief Financial Officer, Mike Hagedorn. Before we begin, I would like to make everyone aware that our quarterly earnings release and supporting documents can be found on our company website at valley.com. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. I would like to highlight slide 2 of our earnings presentation and remind you that comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry.

Valley encourages all participants to refer to our SEC filings, including those found on Forms 8-K, 10-Q, and 10-K, for a complete discussion of forward-looking statements and the factors that could cause actual results to differ from those statements. With that, I'll turn the call over to Ira Robbins.

Ira Robbins (CEO)

Thank you, Travis. In the second quarter of 2023, Valley reported net income of $139 million and earnings per share of $0.27. Exclusive of non-core items, adjusted net income and EPS were $147 million and $0.28, respectively. The quarterly results were highlighted by strong and stable asset quality metrics, consistent loan activity, improved deposit generation, and solid non-interest income growth. The interest rate environment continues to create cyclical pressures for traditional spread banks like Valley. We have conservatively positioned our balance sheet in a neutral manner, which is both prudent and generates largely stable net interest income in varying interest rate environments. The current inverted curve pressures this approach, yet over the long run, we believe it is appropriate.

We firmly believe franchise value is not created by taking interest rate positions, but rather by increasing clients and diversifying the balance sheet. The current cyclical pressure with the inverted curve will ultimately normalize, and the recent client growth realized by Valley will generate significant value. Outside of the cyclical variables impacting profitability, the banking environment has recently undergone structural changes related to the movement of money. These changing trends will have long-term implications to the banking environment. Our investment in technology over the last few years, both from a client and internal operating perspective, coupled with the diversity of our balance sheet, will mitigate some of these structural changes and ultimately position Valley to capitalize on the evolutionary changes in which clients interact with their financial institutions. During my tenure, we have focused on consistent tangible book value growth as a key driver of long-term shareholder value.

While recent market disruption has overshadowed these efforts, I am extremely proud of the near 50% increase in tangible book value over the last 5 years. In fact, when adjusting for the common cash dividend paid, we have generated over 90% growth in tangible book value since March of 2018. As the market returns to valuing banks on fundamentals, our consistent tangible book value growth will continue to be differentiating as we move forward. In an effort to offset certain cyclical revenue headwinds, we began to implement a cost-saving exercise in late June. We remain focused on sustainable long-term growth but acknowledge that we need to flexibly respond to near-term pressures. Our identified saves will primarily come from lower headcount, more efficient third-party consulting and service usage, and specific technology saves.

These opportunities are expected to generate more than $40 million of annual pre-tax savings and will be realized over the next 4 quarters. Culturally, we are reinvigorating the attention to detail, which drove our efficiency improvement from the high 60% range in the beginning of my tenure to the low 50% range in late 2022. Consistent with our history, we will continue to position ourselves to capitalize on the dislocation around us. We anticipate that there will be significant growth opportunities as the environment stabilizes and the yield curve ultimately normalizes. Valley are strong and vibrant institution operating in great markets. I remain extremely confident in our ability to execute, and I'm incredibly excited for what the future holds for our company. With that, I will turn the call over to Tom and Mike to discuss the quarter's growth and financial results.

Tom Iadanza (President)

Thank you, Ira. Slide 4 illustrates the $2 billion growth in our total deposits during the quarter, which reflects the ongoing shift to higher-cost products. The overwhelming majority of non-interest-bearing deposit runoff occurred by mid-May. Since then, both non-interest-bearing and interest-bearing transaction balances have been materially unchanged. The quarter's growth reflects accelerated CD generation, which pressured our deposit beta and weighed on our net interest margin. Slide 5 provides more detail on the continued diversity of our deposit portfolio. Many of our specialty verticals continued to perform well as we saw solid growth within our online channel and our National Deposits of Private Banking areas. Through greater utilization of insurance products like ICS, we have continued to reduce our adjusted uninsured deposit exposure.

Adjusted uninsured deposit balances declined to $12 billion, or 24% of total deposits, and are now covered more than 200% by on-balance sheet cash and available liquidity. Slide six further illustrates the diversity and granularity of our deposit base. No commercial industry accounts for more than 10% of our deposits. Our government portfolio remains diversified across our footprint and is fully collateralized relative to state collateral requirements. Turning to slide seven, you can see an overview of our loan growth and portfolio composition. Annualized loan growth slowed to 10% from 16% in the first quarter, while origination yields continued to climb. We have worked through the majority of the strong pipeline that existed coming into the year and anticipate mid-single-digit annualized growth for the remainder of 2023.

We will continue to be selective on the lending side and generally supportive of compelling projects led by our high quality and tenured customer base. Slide eight further illustrates the diversity of our commercial real estate portfolio by collateral type and geography. As a reminder, we have an extremely granular loan portfolio with an average loan size of roughly $5 million. From a metric perspective, our weighted average LTV and debt service coverage ratio remained at 58% and 1.8 times, respectfully. We believe these metrics compare favorably to peers, as we have consistently and conservatively underwritten to higher cap rates. Our experience with recent refinancing activity has been positive, given the adequacy of our past underwriting discipline. Slide nine provides additional detail on our granular office portfolio.

Loan to values declined during the quarter. Our office portfolio remains well positioned with a low average loan size. With that, I will turn the call over to Mike Hagedorn to provide additional insight on the quarter's financials.

Mike Hagedorn (Senior EVP and CFO)

Thank you, Tom. Slide 10 illustrates Valley's recent quarterly net interest income and margin trends. The sequential $16 million decline in net interest income was approximately half of the reduction experienced in the first quarter of the year. While asset yields continue to improve, deposit mix shift in the first half of the quarter and continued pricing competition drove funding costs higher. Our fully tax-equivalent net interest margin declined 22 basis points versus 41 basis points in the first quarter of 2023. We estimate that our elevated average cash position in the second quarter weighed on the absolute margin by approximately 8 basis points. As you saw on slide 4, our cumulative deposit beta increased to 47% in the quarter. During the quarter, we enhanced our efforts to extend duration on the funding side.

To this end, we added approximately $1 billion of CDs beyond 9 months and put on incremental FHLB funding out 3 years. We will continue to focus on prudent balance sheet management and further enhancing our maturity ladder as opportunities present themselves. While non-interest deposit balances have been stable since mid-May, as total deposits grow, we anticipate that the contribution of non-interest deposits will decline into the low 20% range. Through the cycle, betas now appear likely to peak out at the mid-50% range by year-end. We anticipate that our 2023 full year net interest income growth will be in the low single-digit % range. We are seeing initial signs of stabilization in net interest income and margin, and increasingly expect that we are approaching a trough.

Moving to Slide 11, we generated over $60 million of non-interest income for the quarter, as compared to $54 million in the first quarter. We saw strong growth in a variety of non-interest businesses during the quarter. Capital markets revenue increased $6 million, primarily due to stronger swap activity. We also saw growth in our wealth management and insurance lines and a modest rebound in gain on sale revenue. While we continue to diversify our revenue sources, we are pleased that stronger fee income results helped to slow revenue compression as compared to the first quarter. On Slide 12, you can see that our non-interest expenses were approximately $283 million for the quarter, or approximately $267 million on an adjusted basis. The increase in adjusted expenses from the first quarter was largely related to a higher FDIC assessment and consulting costs.

Expenses in other categories were generally well controlled. As Ira mentioned, we have identified over $40 million of annualized expense opportunities, which we have begun to execute on. During the quarter, we took approximately $11 million of restructuring charges, primarily in the form of severance associated with these efforts. While these saves will take time to materialize, we expect that they will help to offset potential revenue pressure and more regular expense growth over the next few quarters. We expect that just less than half of the annualized saves will be in our run rate by the end of the year, with the rest of the saves to be achieved by the midpoint of 2024. These expense efforts should help to get efficiency back on track, and we will continue to focus on opportunities beyond the $40 million that we have already identified.

Coming into the year, we set a 2023 expense growth guide of between 10.5% and 12.5%. We continue to feel this is a reasonable level and believe these initiatives could bring us toward the lower end of that range. Turning to slide 13, you can see our asset quality trends for the last five quarters. Nonaccrual loans were effectively flat at 0.51% of total loans, and early-stage delinquencies declined by nearly 40% from the linked quarter. Second quarter net charge-offs were normalized as well, with nearly 50% coming from a single fully reserved construction loan charge-off. We have proactively addressed discrete problem credits in the last few quarters, and the data we see continues to indicate asset quality strength in the near term.

On slide 14, you can see that tangible book value increased approximately 1.8% for the quarter. This was the result of our retained earnings, which was partially offset by a modest increase in the OCI impact associated with our available-for-sale securities portfolio. Tangible common equity to tangible assets rebounded to 7.24% during the quarter as we repaid maturing short-term debt with excess cash. We estimate that our remaining excess cash position at June 30th weighed on our TCE to TA ratio by approximately 12 basis points. For the second quarter, our CET1 and Tier 1 ratios were effectively flat. Our total risk-based ratio declined somewhat as a result of a partial disallowance of a legacy subordinated debt instrument. With that, I'll turn the call back to the operator to begin Q&A. Thank you.

Operator (participant)

Thank you. At this time, we will conduct the question-and-answer session. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. One moment while we compile the Q&A roster. Our first question comes from the line of Michael Perito with KBW. Your line is open.

Michael Perito (Managing Director)

Hey, guys, thanks for taking my questions this morning. I wanted to start on just a couple clarification questions around some of the guidance you guys just provided. I guess, first on the OpEx side. Mike, basically, it sounds like, you know, less than 50% contribution of the $40 million is expected to kind of maybe put you at the low end of the 10%-12% range. Can you just remind us that that's off of kind of the adjusted expense number, not the GAAP number, correct? Would you generally agree with that summary?

Travis Lan (Senior EVP and CFO)

Yeah, that's accurate, Mike. This is Travis. The base in 2022 was our reported expenses less merger charges, then that 10.5%-12.5% growth was based on that, again, you know, ex merger charges for 2023 comparison.

Michael Perito (Managing Director)

Perfect. Then are you guys expecting any other noise in the FDIC insurance premium line moving forward here? Just what are your expectations around that at this point?

Travis Lan (Senior EVP and CFO)

Yeah, Mike, it's Travis again. In our initial, you know, analysis of the potential special assessment associated with the first two bank failures, you know, the number looks to be in the $40 million range. Obviously, that's, you know, for us and based on our assessment base, that's our preliminary analysis, still to be confirmed.

Michael Perito (Managing Director)

Right. That's 1Q 2024 until the end of 2025, correct?

Travis Lan (Senior EVP and CFO)

That's correct. It plays out over 8 periods. I think, you know, just going back with the accounting folks this morning, I think you may accrue for it all day 1, but still need to confirm that as well.

Michael Perito (Managing Director)

Okay. All right. Perfect. Thanks. Then just around the NII outlook. I mean, it sounds like there's expected to be, you know, maybe another step lower in the third quarter and then some stabilization. I mean, does that kind of jive also, you know, in terms of that, the NII dollar guide you gave, Mike, but does that jive also maybe with kind of what you're expecting at this point in trajectory of NIM? I mean, is there another step lower here?

You know, based on where the curve is today and the movement yesterday, your hope would be, especially with the growth, taking maybe a few 100 basis points step back, you know, on a net basis to stabilize as well, or are there other factors over the back half of the year we should be thinking about?

Mike Hagedorn (Senior EVP and CFO)

Yeah. Based on our modeling right now and, and the use of the implied forward curve, you know, the forecast implies a flat NII. I think it's, you know, it's gonna be flattish heading into third quarter, you know, give or take a few basis points either way. Also, it's important to remember, as we mentioned, that when you take the excess cash off, you get back to an adjusted NIM of 3.02%. I think as we work that cash down in the third quarter, you'll also see that, help increase the NIM a little bit.

Michael Perito (Managing Director)

Perfect. I'll just do one more, and then I'm sure others have questions as well. Just Ira, maybe just would love your thoughts around, you know, you guys were able to do a couple, you know, really productive M&A transactions leading into this current environment over the last handful of years. You know, obviously right now, the M&A outlook is a little challenged, but, you know, I imagine at some point there will be some opportunities. I'm just curious, at your current size, with everything going on in the market, you know, what are your just updated thoughts generally on the M&A opportunity for Valley longer term? Understanding it's not probably something that's on the near-term agenda, but just would love your thoughts there.

Ira Robbins (CEO)

Thanks. You know, it's definitely not something that we're focused on from a prioritization perspective. I think organically, there's a lot of excitement within the organization based on some of the verticals that we've done and just the, the peer capabilities that we've established over the last few years. Definitely inwardly focused at this point in time. You know, that said, I think as we think about M&A, there are definitely going to be opportunities for us to continue to grow from a strategic perspective. Anytime we see something that fits within the financial discipline that we're focused on, that could accelerate some of the strategic objectives that we're looking at, we would definitely be open to it. Right now, I think the interest rate environment creates a bit more challenges when it comes to that, though.

Michael Perito (Managing Director)

Perfect. That makes sense. Thank you guys for all the color this morning. I appreciate it.

Ira Robbins (CEO)

Thank you.

Operator (participant)

One moment for our next question. Our next question comes from the line of Matthew Breese with Stephens. Your line is open.

Matthew Breese (Managing Director)

Good morning, everybody.

Ira Robbins (CEO)

Good morning, Matt. Welcome back.

Matthew Breese (Managing Director)

Hey, Mike, just on the normalized liquidity commentary, you know, what are you kind of defining as normalized liquidity, and how soon do you get there?

Mike Hagedorn (Senior EVP and CFO)

Yeah, I think it's roughly in the range of about a half a billion dollars when we're in a, a normal environment. You know, obviously, when you compare us to peers, you saw in the first quarter a significant build. You saw that retain some of that build throughout the second quarter. I think somewhere in that, you know, mid-ish half a billion dollars is probably normal go forward for us in a, in a, what would be considered a normal economy.

Matthew Breese (Managing Director)

Okay. Can you provide a little bit more color on perhaps when your, your model shows a, a normal economy?

Mike Hagedorn (Senior EVP and CFO)

Yeah, I think we're, we're headed that direction right now. I think, you know, our belief right now as we model forward, especially for NII, around further Fed rate increases, is that this increase that happened yesterday is the last one, and so that normalizes the, the economy going forward. There are some adjustments, obviously, to unemployment and GDP in there, but overall, I think we're starting to get there. It's the beginning of it, is the best way of saying it.

Matthew Breese (Managing Director)

Okay. I appreciate all the commentary on demand deposits remaining stable after mid-May. How did the NIM progress through the quarter, and did you start to see similar signs of stability towards the end of the quarter?

Travis Lan (Senior EVP and CFO)

Matt, this is Travis. On a monthly basis, the margin was generally flat throughout the quarter. We ended June at 2.94%, which was the quarterly number as well. I'd say that there was a little bit more excess liquidity throughout the quarter as opposed to the June margin. you know, cash adjusted, maybe June was down somewhat. There are clearly signs of stabilization, is pretty consistent. As you said, I mean, demand deposits were generally flat over the last two or three months. you know, that's, that's kind of continued. Our model conservatively projects more compression from non-interest deposit outflows, but, you know, that's not really what we've experienced so far.

Matthew Breese (Managing Director)

accretable yield, was that like a similar kind of $9 million number for the quarter?

Travis Lan (Senior EVP and CFO)

Yeah, all in, purchase accounting income declined $2 million from the first quarter.

Matthew Breese (Managing Director)

Okay, $7 million?

Travis Lan (Senior EVP and CFO)

Yep.

Mike Hagedorn (Senior EVP and CFO)

Correct.

Matthew Breese (Managing Director)

The last one for me, fee income, a lot of items went your way this quarter. Maybe just a little bit of help there, what the guidance looks like for the next couple of quarters. I was surprised to see how strong commercial swap fees were. Maybe just some insight as to what happened underneath the hood there.

Tom Iadanza (President)

Sure. Hey, Matt, it's Tom. Yeah, the fees were strong for the quarter. You know, swaps, just a bigger demand, on the swap front, from our customer base. You know, we expect, for the next two quarters to report in the mid-fifties on the fee income. You know, we'll offset some of it through our, our newly, you know, the tax credit business has a seasonal uptick in the fourth quarter, and we've been doing a lot more FX and trade finance, through the, through the products we received from Leumi.

Matthew Breese (Managing Director)

Great. I will leave it there. I appreciate you taking my questions. Thank you.

Mike Hagedorn (Senior EVP and CFO)

Thanks, Matt.

Operator (participant)

One moment for our next question. Our next question comes from the line of Steven Alexopoulos, sorry, from J.P. Morgan. Your line is open.

Steven Alexopoulos (Equity Research Analyst)

Hey, good morning, everyone.

Ira Robbins (CEO)

Good morning, Steve.

Steven Alexopoulos (Equity Research Analyst)

I want to start on the non-interest-bearing deposits. The outflows accelerated a bit this quarter. I think you were calling for mid-25%ish by year-end. You're there already. I think now you're saying down to low 20% range. Could you take us behind the scenes in terms of why that's coming in even lower than you guys expected? Are companies just optimizing to a lower level of operating balance?

Mike Hagedorn (Senior EVP and CFO)

I think there are two main points to consider there, Steve. You know, first, we're starting to see and we're continuing to see consumers utilize their checking accounts for purchases and some of our commercial treasury optimization from a customer's standpoint as they manage their cash balances, you know, more precisely. The other thing that is important to note that over the long-term history of Valley, the average non-interest bearing as a percent of total deposits has only been 24%. We're not that far off of what that, the average is for a longer period of time. Obviously incorporates a lot of different economic environments.

Steven Alexopoulos (Equity Research Analyst)

Got it. Okay. That's helpful. I'm curious, the original guidance on the efficiency ratio is around 50% for the full year. You're clearly running above that, taking the NII guide down now. What's a more reasonable target for the efficiency ratio for this year?

Mike Hagedorn (Senior EVP and CFO)

I think for the full year, you know, in the lower 50s, with the help of the $40 million annualized expense saves that we announced. Again, obviously, not all those are going to be realized on the income statement in 2023, but I think it will help us get to the lower 50% range.

Steven Alexopoulos (Equity Research Analyst)

Got it. Okay. Final question. The loan growth is pretty strong, and you had quite a bit of growth in commercial real estate. It's an area we're not seeing many banks grow. Give some color on what you're seeing there, why you feel comfortable taking on more commercial real estate here. Thanks.

Tom Iadanza (President)

Hey, Steve, it's Tom. Our focus has really been on servicing our long-term existing customers. That commercial real estate growth, 84% came from our customer base. Still very granular, the metrics of debt service coverage over 1.8 times, which is consistent with our historical underwriting and loans to values in the 60% range. We're bringing them on to existing customers, solid projects with the same credit metrics and underwriting standards that we have always used. You will see 11% quarterly annualized growth in CNI, and that's been consistent for the past several quarters. We continue to drive our CNI business, which gives us deposit and additional fee opportunities while servicing those strong long-term real estate customers.

Steven Alexopoulos (Equity Research Analyst)

Got it. Then, this mid-single digit loan growth for the rest of the year, I haven't worked out the math yet. How does that change? The prior outlook was 7-9 for the full year.

Tom Iadanza (President)

We should be at the higher end of that 7-9 range.

Steven Alexopoulos (Equity Research Analyst)

Got it. Okay. Thanks for taking my questions.

Mike Hagedorn (Senior EVP and CFO)

Thanks, Steve.

Operator (participant)

One moment for our next question. Our next question comes from the line of Manan Gosalia with Morgan Stanley. Your line is open.

Manan Gosalia (Equity Research Analyst)

Hey, good morning. I just wanted to follow up on the, the last set of questions on NIB deposits. I think you said that NIB deposits have been stable since mid-May. And yet you're saying that your guidance bakes in further outflows as clients optimize their cash. I'm just trying to square the two. Are you being more conservative, or is that based on, you know, any conversations you're having with clients, you know, maybe where ECR rates are going, or even any flows that you've seen quarter to date in 3Q?

Mike Hagedorn (Senior EVP and CFO)

Yeah, it's none of those things. Really what you started out with, that we're being a little more conservative on our estimate right now as we take a look at, have we reached the absolute bottom of customers rotating into interest-bearing products. We don't think we're quite there yet.

Manan Gosalia (Equity Research Analyst)

Got it. I think last quarter you had mentioned that the deposits were coming in around like 250 towards the end of the quarter. Can you tell us what the number is for June?

Tom Iadanza (President)

Yeah. In June, we generated new deposits, new customer deposits at a blended rate of 3.77%.

Manan Gosalia (Equity Research Analyst)

All right, perfect. Just a question for me on loans. Some of your peers have announced loan sales during the quarter, particularly in commercial real estate. Is that an opportunity that you're looking at or you could look at in the future?

Tom Iadanza (President)

Yeah, at this point, we're not looking at that. We're comfortable with our return and risk requirements within our portfolio. That said, if something compelling comes along, that's the right economics and allows us to redeploy into higher value capital opportunities, we would certainly look at it.

Manan Gosalia (Equity Research Analyst)

Great. Thank you.

Operator (participant)

One moment for our next question. Our next question comes from the line of Steve Moss with Raymond James. Your line is open.

Steve Moss (Managing Director)

Good morning.

Mike Hagedorn (Senior EVP and CFO)

Morning, Steve.

Tom Iadanza (President)

Morning, Steve.

Steve Moss (Managing Director)

Maybe just on, on loan yields, just, you know, I'm just curious, where is loan pricing these days in terms of just what is the total add-on yield? I know you guys typically talk in spreads, but just kind of curious as to, you know, are you in the 7s for loan pricing these days, or just how to think about that?

Tom Iadanza (President)

Yeah. Hey, Steve, the loan, yields for the quarter was around 7.35%. For June, it was just about 7.7%. We have been consistently receiving spreads in the mid threes for the past several quarters. The new business, new production we're putting on, it's coming at a higher spread than historical levels.

Steve Moss (Managing Director)

Okay, great. Then in terms of the cumulative deposit beta, I think I heard mid-50s earlier. It kind of sounds like you guys think the margin maybe troughs here, or maybe deposit costs peak in the fourth quarter, I should say, and stabilize for 2024. Is that how you guys are thinking about it right now? Just want to make sure I heard that correctly.

Mike Hagedorn (Senior EVP and CFO)

I think that's a fair assumption. You know, also we're starting to see we've been seeing this, but we started to see in the second quarter, a very nice ramp-up in the generation of new accounts. As an example, new depository accounts were at the highest level they've been in the prior 6 quarters in second quarter of 23. I think you have the migration of non-interest bearing to interest bearing, which is going to impact your beta. You also have the ability to add new deposits as well. Those incremental new deposits probably come on a little higher cost, but the engine that we've created obviously shows, as I mentioned, that we're at the highest level in the last 18 months.

Ira Robbins (CEO)

Steve, one of the other things I think that impacts that is, the decline in some of the projected loan growth. You know, we were growing 17% in the first quarter, 10% this last quarter. As we guide towards the mid-single digits, for the next 2 quarters, the demand for deposits are going to decline within the organization as well. That should have a significant impact on what those forward-looking data look like.

Steve Moss (Managing Director)

Okay, appreciate all that. Maybe just one more thing in terms of the dynamic of slowing loan growth here. You know, how much do you think is, you know, customer conservatism versus, you know, wider spreads here going forward? Just kind of any sense you have for the economy and how customers are?

Mike Hagedorn (Senior EVP and CFO)

Yeah. Hey, Steve, it's really, you know, both are a factor. You know, certainly the widening spreads has had customers relook at the value of the projects, and many are holding off and pausing until they see where the interest rate environment levels out at. From the cautious standpoint, we're not seeing as much. Certainly, C&I companies are managing their inventory tighter than they had been, but we're not seeing the same level of cautiousness.

Steve Moss (Managing Director)

Okay, great. Thank you very much.

Mike Hagedorn (Senior EVP and CFO)

Thanks.

Operator (participant)

One moment for our next question. Our next question comes from the line of Jon Arfstrom with RBC Capital Markets. Your line is open.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Thanks. Good morning, guys.

Ira Robbins (CEO)

Morning, John.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Hey, just a few follow-ups. I think most of my questions have been answered, but just back on the margin. Bigger picture, are you guys optimistic on the margin beyond the third quarter? Is it returning to normal? It feels that way, but I thought I'd ask it.

Ira Robbins (CEO)

Yeah, yeah. I think one of the interesting things is how we look at the margin. You know, you go back over a two-year period, you know, the volatility in our margin has been about a 22% number versus about 30% for the peers. I think, you know, in an inverted curve, which are cyclical, these things happen, you know, for us, there's definitely margin compression. I don't anticipate operating in an inverted curve for the rest of my career, just like I don't think the rest of the management team does either. The margin will ultimately rebound and come back up to a more normalized level. When that happens, I think the franchise value of the organization is going to increase dramatically. We're opening up more accounts today than we've ever opened before.

We're in amazing individual vertical business lines that we weren't in before, and the balance sheet's obviously shifted. You know, three, four, five years ago, 17% of this balance sheet was in residential mortgages. You look at the concentration that we have in C&I today and the diversification, even within the CRE portfolio, it's a very different balance sheet, and we believe that there'll be definitely some benefit coming forward as the interest rate environment normalizes.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yeah. Okay. Control what you can, right?

Ira Robbins (CEO)

Yep.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yep. Okay, Mike, on slide 12, there's a comment about the last bullet, additional variable expense opportunities. What's an example of that, and what's the potential magnitude there?

Mike Hagedorn (Senior EVP and CFO)

Sure. It's some of the usage things, right, that we have discretion over. A good example of that could be consulting costs. It could be the additional usage of contracts, because we're going to go through a core conversion in the fourth quarter that might spill off, and we might have some additional savings there as well. It's also attitudinal. It's, it's having an organization that looks at cost and with a critical eye and tries to eliminate everything that we don't really need to do.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Okay. I guess the last one on the allowance. Did you guys change your qualitative thinking at all in terms of your reserve levels? I'm just curious, you know, a gut check on, do you expect a worsening economy? Do you feel like a worsening economy is already inflected in your reserves? Just give me some thoughts on that. Thanks.

Mike Hagedorn (Senior EVP and CFO)

You know, I'll start off here. This is Mike, and then, our Chief Credit Officer is here as well, so I'll have him fill in where I get this wrong. I think the first thing to note on this is we did migrate the weightings on Moody's. That's the first thing to kind of take into account. We went to a slightly higher percentage, 10% more on the baseline, and we reduced S4, which is that more severe recessionary. Why did we do that? As Moody's refines their estimates each quarter, the baseline started to capture more of the, if you will, negative both GDP and unemployment numbers.

We've always been conservative in our weightings, I think, relative to our peers on this, but as we've taken a look at their numbers, it became pretty apparent that the baseline would capture more of that. So we did make that change, which has some bearing on allowance in the CECL model. I'll turn it over to Mark.

Mark Saeger (CCO)

Right. This is Mark Saeger. Yeah, Mike, that's absolutely accurate. We had been holding at the 50, 30, 20 on the 30 and 20 on the 2 downside scenarios. Based off of a continued migration to a slightly more negative conservative outlook on Moody's baseline, we did back that off. That being said, that was not a material change in the overall weighting because our movement of the 10% was offset by the more negative outlook on the baseline, so we view that as modest. We did not impose any additional qualitative overlays on the ALLL for this quarter, as we did not see any material weaknesses in portfolio that warranted qualitative adjustments upwards.

We are looking at performance of portfolio, in the future to see if that may be necessary, but the performance of portfolio continues to be exceptionally strong and does not warrant any qualitative overlays.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yep. Okay. Interesting comment on the baseline being almost approaching S4. That's a good comment. Thanks, guys. I appreciate it.

Ira Robbins (CEO)

Thanks, John.

Operator (participant)

That concludes the question and answer session. At this time, I would like to turn it back to Ira Robbins for closing remarks.

Ira Robbins (CEO)

Just want to say thank you to everyone for taking the time to listen to the call today.

Operator (participant)

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.