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Hilltop Holdings Inc (HTH) Q3 2020 Earnings Call Transcript

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Hilltop Holdings Inc (NYSE: HTH)
Q3 2020 Earnings Call
Oct 23, 2020, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Hilltop Holdings' Third Quarter 2020 Earnings Conference Call and Webcast. [Operator Instructions]

I'll now turn the conference over to Erik Yohe. Please go ahead.

Erik Yohe -- Executive Vice President of Corporate Development

Thank you, operator.

Before we get started, please note that certain statements during today's presentation that are not statements of historical facts, including statements concerning such items as our outlook, business strategy, future plans, financial condition, allowance for credit losses and the impact, and potential impacts of COVID-19 are forward-looking statements. These statements are based on management's current expectations, concerning future events that by their nature are subject to risks and uncertainties. Our actual results, capital liquidity, and financial condition may differ materially from these statements due to a variety of factors, including the precautionary statements referenced in our presentation and those included in our most recent annual report and quarterly report filed with the SEC. Except to the extent required by law, we expressly disclaim any obligation to update earlier statements as a result of new information.

Additionally, this presentation includes certain non-GAAP measures, including tangible common equity and tangible book value per share. A reconciliation of these measures to the nearest GAAP measure may be found in the appendix to this presentation, which is posted on our website at ir.hilltop-holdings.com.

I will now turn the presentation over to Jeremy Ford, President and CEO.

Jeremy Ford -- President & Chief Executive Officer

Thank you, Erik, and good morning.

Before I get into the results for the quarter, I would like to applaud our teams across all three businesses and at the holding company for their unwavering commitment to serve our customers in a safe and highly effective manner. I believe this year has made us a stronger company and will provide the foundation for prudent future growth.

In the third quarter, Hilltop delivered a $153 million in net income and earnings per share of $1.70. This was an increase from the third quarter 2019 of $74 million or $0.84 [Phonetic] per diluted share. Of note, Q3 2020 results include a final true-up of $736,000 related to the sale of National Lloyds. Importantly, Hilltop's Q3 2020 exceptional results reflect outsized mortgage-related earnings at PrimeLending and Hilltop Securities as well as no provision for loan losses at the Bank. However, we remain cautious as the COVID-19 pandemic may continue to adversely affect our businesses, including reduced mortgage volumes and further credit deterioration in our loan portfolio.

Our net revenue for the quarter of $604 million was higher on a year-over-year and linked-quarter basis, as both the mortgage purchase and refinance market remained strong in this low rate environment. PrimeLending originated $6.5 billion dollars in loans during this period, an increase of $1.7 billion from the third quarter 2019. Additionally, the gain on sale margin during this period expanded by 105 basis points year-over-year and by 72 basis points linked quarter.

Total deposits increased by $2.5 billion or 29% compared to the third quarter 2019, but declined slightly on a linked quarter basis as we returned approximately $400 million in broker-dealer sweep deposits due to the Bank's fortified liquidity position. During the quarter, the broker-dealer grew net revenues by 23% from the third quarter 2019 to a $149 million and reported a pre-tax margin of 23.7%. The firm's robust financial results in the quarter were driven by strong performance in the structured finance and fixed income services businesses as well as improvement in the public finance services business.

We continually aim to optimize our capital position. As of quarter end, Hilltop had approximately $1 billion in excess capital. On September 23, we announced the commencement of a modified Dutch auction tender offer to purchase shares of our common stock for an aggregate cash purchase price of up to $350 million and at a per share price not less than $18.25 and not more than $21. The tender offer is scheduled to expire on October 30, 2020. Additionally, we continue to maintain our dividend at a prudent level, and the Board of Directors recently declared a quarterly cash dividend of $0.09 per common share payable on November 30, 2020.

From a risk perspective, we continue to support our bank clients, while maintaining a healthy allowance on our loan portfolio as we monitor credit and the effects of the COVID-19 pandemic on our customers and the economy. As an update on the COVID-19 related loan deferrals, our balance as of September 30 was $291 million, down from $968 million at the end of the second. quarter. I will go into more detail on Slide 5, where we break down the deferments and allowances by category.

Our allowance for credit losses as of September 30 totaled $155 million or 2.08% of the bank's loan portfolio. Our allowance is based on both quantitative and qualitative factors and reflect our best estimate given the expected pace of the economic recovery, the position of our customers, and the value of their underlying assets.

Moving to Slide 4. PlainsCapital Bank delivered pre-tax income of $50 million as no provision was recorded during the quarter. Net interest margin was 3.03% during the course of the period, a decline linked quarter of 8 basis points as loan yields remained under pressure. PrimeLending had a record quarter and generated pre-tax income of $146 million, an increase of $114 million from Q3 2019 that was driven by a 35% increase in origination volume and again on sale margin of 440 basis points. I would like to commend PrimeLending's leadership, loan originators, and secondary marketing team for originating $16 billion in mortgage loans year-to-date and doing a fantastic job managing pricing during this record year.

Hilltop Securities experienced another great quarter with pre-tax income of $35 million, an increase of $8 million or 31% from the third quarter 2019. In the structured finance business, the TBA group took advantage of the strong purchase mortgage market, which led to a surge in lock volumes that were 71% greater than Q3 2019. In the fixed income services business, credit and municipal products continued to be relatively strong compared to last year. And also of note, the public finance services business showed considerable improvement from a favorable issuance environment. As I referenced last quarter, I believe Hilltop Securities is well under way in building the best municipal focused investment bank by raising the profile of the firm.

Moving to Slide 5. As I touched on earlier, the Bank's leadership bankers and credit team has done a great job serving the needs of their clients while protecting the Bank's capital, and we saw a reduction in COVID-19-related deferral loans of 70% from the second quarter. This positive trend was expected with the request for further deferments coming from the most severely impacted industry, namely hotels and restaurants. While this is a good sign, we do anticipate further deferments and challenges in these highlighted areas and potentially in other areas such as office space, where we believe shifting trends in a gradual economic recovery can have a longer term impact.

The current allowance on the deferred portfolio is $49 million or 17% compared to $69 million or 7% in the second quarter. We believe this to be our best estimate of the reserve needed for the portfolio, given our analysis of the underlying credit and current economic environment.

With that, I now turn the presentation over to Will to talk further about the financing.

William Furr -- Chief Financial Officer

Thank you, Jeremy.

I will start on Page 6. As Jeremy discussed, for the third quarter of 2020, Hilltop reported consolidated net income attributable to common stockholders of $153.3 million, equating to $1.70 per diluted share. Income from continuing operations attributable to common stockholders equated to $152.5 million or $1.69 per diluted share. Hilltop's continuing operations generated $205 million of pre-provision net revenue or PPNR during the third quarter, which brings year-to-date PPNR of $508 million, up from $223 million earned in the prior-year period to date. Growth versus the prior-year period was driven by diversified revenue streams and led by strong mortgage origination.

In the third quarter, provision for credit losses reflected a net recovery of approximately $600,000. The Bank recorded no provision for credit losses during the third quarter as net charge-offs declined to $567,000 and the allowance for credit losses remained relatively stable during the period. During the quarter, a number of items impacted our assessment of the allowance for credit losses, including that approximately $660 million of the loans that were on an active deferrals plan at June 30 are no longer on an active deferrals and has made a payment pursuant to their contractual terms.

In addition, there was improvement in the base case economic scenario that was used to evaluate the loss content across our portfolios at September 30. Further, both the C&I and CRE loan portfolios, excluding mortgage warehouse lending declined versus the second quarter, as payoffs accelerated and overall loan demand remains tepid. Offsetting some of these favorable items, was the impact of negative credit migration during the quarter.

During the third quarter, the Bank migrated approximately $257 million of loans to classified and criticized status to reflect the deterioration related to the pandemic and the softening economy. It is important to note that we continue to monitor all segments of our portfolio very closely and are taking proactive steps to manage risk and protect the capital of the Bank, while supporting our clients through these challenging times. As we have noted in prior periods, the allowance for credit losses and the provision for credit losses could be volatile from period to period, as economic assumptions and portfolio actions will change over time.

During the third quarter, revenue related to purchase accounting was $3.5 million and expenses were $1.5 million, resulting in a net purchase accounting pre-tax impact of $2 million for the quarter. In the current period, the purchase accounting expenses largely represent amortization of deposit and other intangible assets related to prior acquisitions. We expect that revenue from purchase loan accretion will continue to decline as the previously purchased portfolio continues to run off. Further, we expect the revenue from purchase loan accretion will average to $4 million per quarter over the coming quarters.

Given the significant growth in earnings in 2020, Hilltop's capital position continues to improve as we address both the ongoing impact of the pandemic and position the company to take advantage of opportunities that may be presented over time. Hilltop's period in common equity Tier 1 ratio equated to 19.85% and the Tier 1 leverage ratio equated to 13.03%.

Please note the tender offer that was launched on September 23, 2020 remains open, and therefore, any actions that may result from this transaction did not impact Hilltop's capital ratios as of September 30, 2020. For reference, if the tender offer were fully subscribed to $350 million, the impact to Hilltop's common equity Tier 1 ratio would be approximately 325 basis points, assuming constant risk-weighted assets.

Turning to Page 7. Third quarter net interest margin from continuing operations equated to 256 basis points and declined by 24 basis points versus the prior quarter. Additionally, net interest income from continuing operations for the third quarter equated to $102 million and declined by $11 million versus the third quarter of 2019. The decline in net interest income was driven by lower purchase loan accretion of $4.3 million, which were somewhat offset by interest income from PPP loans, which equated to approximately $1.2 million in the quarter.

Further, net interest income reflected the impact of the second quarter's sub-debt rates, substantially lower yields on investment securities at both the Bank and Hilltop Securities, as well as lower yields on loans held for sale. Over the coming quarters, we expect that net interest income will continue to be pressured as short-term interest rates are projected to remain low for the foreseeable future and we believe that loan growth will remain challenging.

In our bank portfolios, we expect to continue to return broker deposits as they mature, manage down deposit costs and invest excess cash judiciously. In deploying excess cash into the securities portfolio, we do expect to take on additional duration but remain committed to ensuring that our securities portfolio remains very liquid and will not look to take on additional credit risk with these investments.

During the third quarter, Hilltop's consolidated average earning assets increased by approximately $800 million as the business experienced significant inflows of customer deposits across most product types, resulting in higher cash balance. Further, we continue to make measured investments in the securities portfolio at the Bank while mortgage warehouse lending and loans held for sale grew modestly during the quarter.

The consistent growth in customer deposits has resulted in higher cash and investment securities levels and continues to favorably impact Hilltop's already robust liquidity position. Over the coming quarters, we expect to manage on and off balance sheet liquidity levels, which remain in excess of $6 billion to between $5 billion and $6 billion, which should provide some improvement to net interest income and NIM over time. As we continue to manage liquidity in a prudent manner, we will continue to monitor the capital markets, all broader market movements, and Hilltop's mortgage volumes to balance our excess liquidity against risk over time.

Moving to Page 8. Non-interest income from continuing operations for the third quarter equated to $503 million. During the period, mortgage applications and locks remained very robust as PrimeLending locked approximately $8.5 billion of new mortgages in the third quarter. This was a record interest rate lock quarter for the business and reflected the impact of lower rates and better-than-expected demand for purchase mortgages across our market.

The combination of strong lock and origination volume as well as improving gain on sale spreads, resulted in mortgage production and fee income increasing by $161 million versus the same period in the prior year. During the third quarter, gain on sale margins in our mortgage business expanded by 72 basis points versus the second quarter of 2020. We expect the gain on sale margins will remain elevated during the fourth quarter, likely remaining within the 430 basis point and 450 basis point range through year end.

During the third quarter, the securities business continued to show solid progress as fixed income services delivered revenue growth of approximately $5 million and structured finance revenue, which is included in other income, increased by $28 million as both volumes and spreads improved with market conditions. At period end, valuation mark on the structured finance loan pipeline was approximately $12 million, a net reduction of $4 million versus the prior quarter. It remains important to note that results from our fixed income and structured finance businesses can be volatile, as market rates, spreads, and volumes can change significantly from period to period.

Turning to Page 9. Non-interest expenses from continuing operations increased from the same period in the prior year by $78 million to $399 million. The growth and expenses versus the prior-year were driven by an increase in variable compensation of approximately $51 million, variable production-related costs specifically related to mortgage production, and a set of specific items at both the Bank and Hilltop Securities that were recorded in this quarter. As in prior quarters, increases in variable compensation are linked to strong fee revenue growth in the third quarter compared to the same period in the prior year.

In addition, while overall expenses have increased over the prior two quarters, we continue to make substantial progress against our growth and efficiency initiatives. Over the last 12 months, headcount has declined by approximately 200 or 4%. Additionally, non-mortgage production-related consulting and other professional service-related expenses have declined substantially, while marketing and business development expenses have continued to move lower. While our progress on efficiency has been broad-based, we're now well positioned to move into the final deployment phases of our core system improvements, which are already delivering value to our franchise and we expect that value will continue to grow upon their completion.

Turning to Page 10. Total average held for investment loans grew by 8% versus the third quarter of 2019. Average growth continues to be driven by the $671 million of net PPP loans on the balance sheet, coupled with growth in the mortgage warehouse lending business, which grew by approximately $156 million versus the same period in the prior year. Other business loans declined versus the second quarter of 2020, as customer demand has remained soft. Loan yields continued to decline during the third quarter as both lower market rates, including the prime and LIBOR rates coupled with lower purchase loan accretion contributed to lower yields. We do expect that loan yields will continue to be pressured as the yields on new loan production averaged approximately 4% to 4.25% during the third quarter.

Turning to Page 11. During the quarter, net charge-offs equated to $567,000 or 3 basis points of total bank held for investment loans on an annualized basis. During the quarter and pursuant to our normal credit management processes, the bank migrated approximately $240 million of loans to a criticized and classified accruing loan status. While many of these loans remain active on contractual payment deferral programs and are currently performing under their existing agreements, the deterioration in our client cash flows is apparent, and in many cases, substantial. As it relates to our credit processes, we remain focused on preserving the capital of the Bank while continuing to work with our customers to support them through these challenging times. During the third quarter, nonperforming assets increased by approximately $13 million, which was the result of deterioration in a diverse set of credits across the portfolio, including single-family residential and these credits are not generally related to the COVID-impacted portfolio.

The chart on the bottom right of Page 11 highlights the current ACL to bank loans held for investment ratio, which equated to 208 basis points at September 30, 2020. As Jeremy noted earlier, the ACL coverage related to the $291 million of loans that are currently active and on deferral is 16.7% as of September 30.

Turning to Page 12. During the third quarter, Hilltop continued to build excess liquidity as client deposits grew by approximately $600 million across most product categories. Notably, non-interest-bearing deposits have continued to grow throughout this cycle as the Bank has been able to take advantage of the overall liquidity trends in the market, while they continue to deepen wallet share and expand our treasury service sales efforts with client.

Interest-bearing deposits declined in the period due to actions taken actively to manage liquidity at the Bank. Some of the most pronounced actions included: the Bank swept back $400 million of broker-dealer sweep deposits of Hilltop Securities. In addition, the Bank allowed $400 million of broker deposits to mature and be returned during the quarter. These actions were somewhat offset by customer deposit growth of approximately $450 million. As previously noted, we have expect to allow most of the broker deposits, which currently represent $1 billion of interest-bearing deposits to mature and be returned over the next nine months to 12 months.

Moving to Page 13. During the third quarter of 2020, PlainsCapital Bank earned $50 million of pre-tax income, which represents a return to profitability from the second quarter. The quarter's results reflect stable revenues and expenses, noting that the Bank incurred $2.4 million of expenses during the third quarter related to certain FHLB pre-payment penalties and a writedown of certain lease obligations related to our ongoing space consolidation efforts. As we noted earlier, the Bank did not incur any provision expense during the third quarter, as improvements in the economic variables offset much of the previously referenced credit migration and the net impact yielded only a modest change to the ACL in the quarter.

The Bank's efficiency ratio during the quarter improved to 52.7% and reflects the ongoing efforts to reduce deposit costs, lower operating costs, and drive prudent revenue growth over time. As we move forward and assuming markets continue to function in an orderly fashion and consumer credit remains stable, we expect to begin retaining PrimeLending originated mortgages on the Bank's balance sheet. We expect to retain approximately $30 million to $50 million of loans per month, as this effort will serve as an alternative for cash investments in the investment portfolio and help mitigate lower [Phonetic] C&I and CRE loan demand over the medium term.

I'm moving to Page 14. PrimeLending generated a pre-tax profit of $146 million during the third quarter of 2020, driven by strong origination volumes that increased from the same period in the prior year by $1.7 billion or 35%. As noted earlier, gain on sale margins expanded during the third quarter versus the same period in the prior year, as market volumes and pricing actions provided for higher spreads. During the period, refinance activity represents 35% of total originations. Further, we expect that during the fourth quarter, the portion of originations that are refinanced transactions will remain elevated from historical levels, which should be lower than third quarter given normal seasonality.

During the third quarter, Hilltop retained 89% of the mortgage servicing rights related to loans sold during the period, which resulted in an increase of the MSR asset to a $128 million. We do expect that we will continue retaining a significant portion of the servicing rights for loans sold, likely between 50% and 75% over the coming quarters and that the asset could grow to between $175 million and $200 million by year end.

Moving to Page 15. Hilltop Securities delivered a pre-tax profit of $35 million resulting in a pre-tax margin of 24% in the third quarter of 2020. In the quarter, fixed income services generated solid revenue growth, as volumes increased in the market and we continue to manage our risk positions in a very prudent manner. Structured finance business delivered revenue growth versus the same period in the prior year of $28 million as volumes increased by 71% to $2.7 billion and the secondary markets for mortgage-related bonds has continued to improve. It remains important to note that results from our fixed income and structured finance businesses can be volatile as market rates, spreads, and volumes can change significantly from period to period.

The public finance business revenues increased by $4 million versus the prior year period, as offerings grew and the market remained strong for municipal activity. During the third quarter, the wealth management businesses were impacted by lower market interest rates, which negatively impacted interest income versus the prior year. For these businesses, lower interest rates will provide an ongoing headwind that we're focused on mitigating through client acquisition and improved efficiency.

Turning to Page 16. Given the uncertainty surrounding the economy, specifically related to the pandemic, we are updating our 2020 commentary, but are not providing updated guidance or outlook. While it is not clear exactly how the economy will rebound or the timeline of that rebound, which we believe will be directly linked to the success in managing the pandemic, we remain focused on delivering against those items that we can control. We are committed to the ongoing safety of our associates and our clients, as well as helping our clients work through the unprecedented challenges this pandemic has presented us all. We remain committed to executing our platform growth and efficiency initiatives and delivering against our 2021 commitments. Lastly and most important, we are focused on delivering prudent growth across our business lines while maintaining a moderate risk profile and delivering long-term shareholder value.

Operator, that concludes our prepared comments, and we'll turn the call over to you for the question-and-answer section of the call.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Michael Young with Truist Securities. Please go ahead.

Michael Young -- Truist Securities -- Analyst

Hey, good morning. Thanks for taking the question and congrats on the good quarter. Just wanted to start maybe on the capital side of the equation. I don't know if you guys can provide any update on the modified Dutch auction and either progress there or what the plan would be in and out of the stock's above -- kind of the high end of the targeted range there? Just any comments there would be helpful.

Jeremy Ford -- President & Chief Executive Officer

Sure. On the shortage, we don't have a lot to comment on there. We do have the tender open and outstanding, and it expires on October 30.

Michael Young -- Truist Securities -- Analyst

Okay. And I don't know, again, if you can comment on this either, but after that process is over depending on the amount that's actually filled, would there be, if -- I guess, if it wasn't fully filled, would you guys look to still deploy that amount of excess capital and to maybe accelerated share repurchase or just open market purchases?

Jeremy Ford -- President & Chief Executive Officer

I think we're focused on the tender offer today and thereafter, we'll continue to manage our capital as we've done so in the past.

Michael Young -- Truist Securities -- Analyst

Okay. Fair enough. And then, I guess maybe moving to the mortgage business. Will, appreciate the comments on kind of volume expectations, etc. Just looking at the gain on sale margin though, was there a benefit from maybe having the pricing of the 50 basis point expected increase from the GSEs in there, but not actually having to pay that this quarter that we should sort of normalize out going forward or any other impacts we should think about on gain on sale margin?

William Furr -- Chief Financial Officer

I don't think so. I think we were pleased to see that that kind of pricing change was pushed into the fourth quarter and that certainly I think has benefited the customers and benefited business. From our perspective, what you've seen is volumes have been sufficiently large to allow for spreads to remain reasonably wide. I would note, we've continued to retain a substantial portion of the MSR, which we believe certainly through the second quarter, third quarter were beneficial to us and we believe the asset and the return on that -- of that asset are good at the prices that we are able to get at this point.

So, from our perspective, really, market dynamics as well as prudence around our overall pricing actions in our business as we noted, when we started to make the investments in our new mortgage loan origination system. We believed that system would allow us to provide greater oversight of overall pricing exceptions and the like. And I would say the prime lending leadership team has taken advantage of both the technology capabilities but also just enhanced rigor of overall pricing exceptions in the market over the last 90 days to 180 days, which has allowed, again, gain on sale margins to increase and again I think for the fourth quarter, we expect them to stay within -- stay range bound here between 430 basis points and 450 basis points.

Michael Young -- Truist Securities -- Analyst

Okay, thanks, and sorry to jump around, but one last one, just on the corporate and other segment, was there anything unique or kind of larger in this quarter that we shouldn't expect on a go-forward basis?

William Furr -- Chief Financial Officer

Yeah, I think what you will see there is incentive-related compensation, variable compensation impacts there in principle.

Michael Young -- Truist Securities -- Analyst

Okay. So, maybe more of a true-up and then we'll return to more normal kind of levels.

William Furr -- Chief Financial Officer

Correct.

Michael Young -- Truist Securities -- Analyst

Okay, thanks. That's all from me.

William Furr -- Chief Financial Officer

Thank you.

Jeremy Ford -- President & Chief Executive Officer

Thanks, Michael.

Operator

Our next question will come from Michael Rose with Raymond James. Please go ahead.

Michael Rose -- Raymond James -- Analyst

Hey, good morning, guys and thanks for taking my questions. May be asking the buyback question a little bit differently. You guys obviously sold the insurance business, generated a lot of proceeds from that capital levels, really, high as I read the proxy for the Dutch tender. I think it does say that you can repurchase shares in the open market about 11 days after that's complete. Jeremy, how should we think about the levels of excess liquidity and capital that you guys would hold as hopefully the pandemic subsides, now that the insurance business is kind of no longer part of the business mix? And where do you guys think that capital levels and liquidity, I guess, basically should run in a more normalized period? Thanks.

Jeremy Ford -- President & Chief Executive Officer

Sure. Well, thanks for the question. I think when we came up with the size range of having a $350 million that was a combination of considering the go-forward capital that we've won during this pandemic and also be able to pursue opportunities afterwards, we also view that in light of kind of our institutional shareholders and where the demand would be. So, that's kind of -- that's what I can tell you on sizing it, and I think that we're focused on this tender offer, and coming out of that, we'll have to really evaluate our plans for what that bogey will be, given the opportunity set in the M&A environment.

Michael Rose -- Raymond James -- Analyst

Okay. So, is M&A something that you guys are looking at here? You have a conversation? It does seem like chatters picking up. And is that part of the capital deployment strategy that we should be thinking about for you guys?

Jeremy Ford -- President & Chief Executive Officer

Well, it hasn't changed since -- this is the same strategy we've always had and that is we are interested in pursuing M&A opportunities, but we're going to be patient given the environment and be aggressive when we find the right one.

Michael Rose -- Raymond James -- Analyst

Okay. Maybe just one more for me. I looked at the quarter's provision, slightly negative. We see NPA migration. We see criticized balances essentially double. How should we think about the pace of future provisioning? Is it more matching charge-offs from here? And I understand the credit metrics are still very benign, but we did see some migration this quarter. So, just trying to gauge how you guys think about provision as we move forward? Thanks.

William Furr -- Chief Financial Officer

Yeah, this is Will. As we think about allowance, it's going to be a quarter-by-quarter assessment. I think a lot of -- as I mentioned, we had a lot of activity in this quarter, whether it be credit migration, deferral activity, as well as the economic assumptions. So, again, those will continue to be the drivers. The economic assumptions will be a significant impact as well as credit migration in the portfolio. We did see, as you noted, and I think we moved aggressively to downgrade assets that we believed were displaying impairment from a cash flow and from an ability to pay perspective.

We expected through both the deferral programs as well as just kind of the normal matriculation of credit that losses likely don't start to substantially materialize into the late first quarter, second quarter, third quarter of next year. So into 2021, at which point obviously as that matriculation occurs or credit migration occurs, whether favorable or unfavorable, we'll evaluate the allowance as it relates to that. It's difficult to say what the allowance would do on a quarterly basis given kind of the seasonal analysis and the amount of impact of economic forward looking, but again, I think it's important to note. Our view is that the charge-offs won't start to materialize until toward the middle of 2021.

Michael Rose -- Raymond James -- Analyst

Okay, so fair to assume that the economic scenario has not really changed, that we probably are at or near peak for the reserve. Is that fair?

William Furr -- Chief Financial Officer

I'd say we feel adequately reserved given the economic outlook we used for our analysis for the third quarter.

Michael Rose -- Raymond James -- Analyst

Okay. Thanks for taking my questions, guys.

William Furr -- Chief Financial Officer

Thank you.

Operator

Our next question will come from Matt Olney with Stephens. Please go ahead.

Matt Olney -- Stephens -- Analyst

Hey, good morning. Thanks, guys. Wanted to go back to the mortgage discussion and just remind me of the strategy around the MSR. You increased the asset a lot in the third quarter, more in the fourth quarter. Just remind me of the strategy behind this and does that mean you were not releasing the servicing with your sales. So, gain on sale margins could have been even stronger?

William Furr -- Chief Financial Officer

No, I think -- well, let me try to unpack that a little bit. So first, as it relates to the strategy, as we noted late in March and certainly into the second quarter, the overall demand by those who service or to buy servicing was pretty muted, if not non-existent. There were some periods where there was a no-bid for servicing. And so, as a result of our liquidity and our capital position, we were able to take advantage of that and decided to retain servicing, understanding that it hasn't historically been an asset, we were overly focused on growing. We thought that the pricing dislocation allow us an opportunity to take advantage of that.

As it relates to the third quarter and going forward, we are continuing to monitor the market based on the values we can receive and the value that we can sell on a flow-originated basis, those spreads -- those overall -- the overall market has improved and the spread that we believe, that is the value that we believe the asset's worth versus what the market is willing to pay has certainly tightened, but we still believe there is value in the asset, in excess of what we would otherwise get paid on a flow basis for at least a large portion of the asset.

In terms of the impact on the overall gain on sale, the way you recognize MSRs is you book the asset, you book the income, so it flows through at the capitalization rate. I would say that that had a favorable impact on gain on sale in the second quarter, just given the fact that there was, as I mentioned, virtually a no-bid for servicing. And then, during the third quarter, again, we're capitalizing at the market rates today -- market sales rate, so limited impact. It was favorable, but a favorable -- a limited favorable impact as it relates to MSR impact on the 440 basis points. The 440 basis points again more impacted by the overall market volumes in the the full pipelines across the mortgage set, in the competitive set, coupled with again, as I mentioned earlier, the strong pricing actions and the focus that our PrimeLending leadership team is taking on pricing, given our new tools, but also the focus on managing pricing exceptions.

Matt Olney -- Stephens -- Analyst

Okay, that's helpful. Well, thank you for that.

William Furr -- Chief Financial Officer

Sure.

Matt Olney -- Stephens -- Analyst

And then, just a comment. You mentioned briefly, Will, in prepared remarks of the various system upgrades throughout the entire company. Can you just give us an update of where we are on this various upgrades? It seems like it was a two-year initiative that was going to run through the end of this year. Is that correct?

William Furr -- Chief Financial Officer

Yeah. So what we had asserted was we were going to improve PPNR by $84 million on a run rate basis through the end of '21. I think as we sit here today, we feel very good about the efforts that have been launched specifically as it relates to your question around the three major programs. We had a mortgage loan origination system implementation, which we would say is virtually complete. There's still some minor rollout for a few very kind of modest products left, but that process and program is effectively fully launched. Our FIS system -- core system enhancement at Hilltop Securities has been -- was kind of launched in May of this year and we continued to work aggressively on kind of day two enhancements with that overall program.

So, still some day two work to be done there, but again, we're looking to bring that in principle to close by the end of the year. And then, we also had a financial ERP, principally, the general ledger and all the accompanying installations around that, and I would say we have one business left to bring on to the general ledger, but we have implemented that general ledger across three of our operating units as we speak. So, we've got one remaining implementation there that will occur in the early second quarter of next year.

So, we're certainly on target in terms of the deployment. We're already seeing some of the cost saves and benefits, whether it be at the mortgage company around some of the pricing rigor we're talking about or some of the controls and productivity that we expected to receive from that system or some of the benefits we're seeing from the general ledger and other. Also in that $84 million growth and efficiency program, we had efforts as it relates to our focus on purchasing, procurement and integration of all of those things, that work is complete and functioning as designed as we sit here today.

So again, as it relates to the overall program, we'll give a more fulsome update on our January call, but we feel very good about the progress we've made here in the fourth.

Matt Olney -- Stephens -- Analyst

Okay. Okay, that's great. And then, just lastly from me. Will, you mentioned in prepared remarks some comments around excess liquidity and how you expect to manage that. I didn't quite get all of that. Can you just kind of go over the highlights of that again? Thanks.

William Furr -- Chief Financial Officer

Yeah. So, I think two primary items. One, I mentioned we will, during the fourth quarter, start to retain PrimeLending originated mortgages on the bank balance sheet. That has been a program that we had in place for years previously. We suspended it as a result of the pandemic in March as we both wanted to monitor the impacts on consumer credit, but also capital liquidity management as we worked our way through the pandemic.

Now that we believe we've got better visibility there, we are expecting to retain $30 million to $50 million of mortgages per month as a means of which to deploy liquidity, but also some capital in a pretty efficient way with the product that we originate in-house. The second piece is we'll likely be expanding the overall investment securities portfolio at the Bank, which currently stands at about $1.6 billion. We are seeing enhanced paydown in overall flows there, but we do expect that $1.6 billion will go higher, given the overall cash position at the organization.

And then lastly, we will continue likely to sweep additional funds back to Hilltop Securities of those kind of contingent liquidity if they can put those deposits to higher and better use at current than we can from an excess cash earnings perspective. So, those are really the three things we're doing in that regard.

Matt Olney -- Stephens -- Analyst

Okay, that's helpful. Congrats on the quarter. Thank you.

William Furr -- Chief Financial Officer

Thank you.

Jeremy Ford -- President & Chief Executive Officer

Thanks, Matt.

Operator

Our next question will come from Michael Young of Truist Securities. Please go ahead.

Michael Young -- Truist Securities -- Analyst

Hey, thanks for the follow-up. Just wanted to touch base on the mortgages you're going to retain. Are those going to be qualified or will those be some that are just outside of qualified? And then also, what would those -- what are your expectations for maybe rate on those?

William Furr -- Chief Financial Officer

Principally qualified. So, we would be able to -- as we did during the second quarter in the event we felt like we needed to sell those, we were able to kind of execute that sale back through the agencies in the second quarter. So, principally qualified. These are going to be high-quality mortgages. I would tell you the target FICO score is going to be 750 plus on an average basis, while there'll be a range there. Historically, we've averaged 750 to 775 on the retained assets. From a yield perspective, it will be 15-year and 30-year products. So, we're expecting that yield to be between 275 basis points and 325 basis points depending on the mix on any given period.

Michael Young -- Truist Securities -- Analyst

Okay. And as a follow-up, I mean it seems like this will be a fairly effective strategy to leverage some of the excess capital and creating more earnings maybe over more of the medium term, because if it's salable product, you could always ratchet that back down with an M&A deal and sell off the mortgage portfolio. So, is that something we should expect to maybe grow even as a part of the strategy going forward?

William Furr -- Chief Financial Officer

I think I'd answer that in the context of kind of some prior comments. One is, we're going to manage in the context of our overall liquidity position and kind of how the pandemic and the economy continue to mature. And then second, we're balancing it against commercial loan growth. Obviously, we'd like to be doing more business with our core commercial business customers, but if that demand remains soft for the foreseeable future, at least it's our expectation it will remain soft, we are using these assets to backfill both kind of a liquidity position, but also offset some of that softer demand.

Michael Young -- Truist Securities -- Analyst

Okay. Makes sense. Thanks for the follow-up.

William Furr -- Chief Financial Officer

Thank you.

Jeremy Ford -- President & Chief Executive Officer

Thanks, Michael.

Operator

[Operator Closing Remarks]

Duration: 47 minutes

Call participants:

Erik Yohe -- Executive Vice President of Corporate Development

Jeremy Ford -- President & Chief Executive Officer

William Furr -- Chief Financial Officer

Michael Young -- Truist Securities -- Analyst

Michael Rose -- Raymond James -- Analyst

Matt Olney -- Stephens -- Analyst

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