Cadence Bancorporation (CADE) Q4 2020 Earnings Call Transcript

Cadence Bancorporation (NYSE: CADE) Q4 2020 earnings call dated Jan. 25, 2021

Corporate Participants:

Paul B. Murphy — Chairman and Chief Executive Officer

Edward H. Braddock — Executive Vice President and Chief Credit Officer

Valerie C. Toalson — Chief Financial Officer

Analysts:

Jennifer Demba — Truist Securities — Analyst

Brady Gailey — Keefe, Bruyette & Woods — Analyst

Ken Zerbe — Morgan Stanley — Analyst

Steven Alexopoulos — J.P. Morgan — Analyst

Brad Milsaps — Piper Sandler & Co. — Analyst

Michael Rose — Raymond James — Analyst

Jon Arfstrom — RBC Capital Markets — Analyst

Matt Olney — Stephens Inc. — Analyst

Presentation:

Operator

Welcome to the Cadence Bancorporation Fourth Quarter and Full Year 2020 Earnings Call. Comments are subject to the forward-looking statements disclaimer, which can be found in the press release and on Page 2 of the financial results presentation. Both of those documents can be located in the Investor Relations section at cadencebancorporation.com. [Operator Instructions]

I would now like to turn the conference over to Paul Murphy, Chairman and CEO. Please go ahead.

Paul B. Murphy — Chairman and Chief Executive Officer

Good morning, and thank you all for joining us. Joining me today on the call are Valerie, Sam, Hank and Billy Braddock, the least familiar to many of you, but not all of you. He is now serving as our Chief Credit Officer. When we started Cadence 11 years ago, Billy was one of the first people I asked to join me. Billy is a 26-year veteran of banking and business in Houston. He is very disciplined in his approach to credit. He’s thorough, has a great eye for details. Billy has a confidence of the senior management team and our board, and it’s a perfect fit to see him step into this important role. Billy is a real team player.

As we look back on 2020, certainly it was challenging in many ways. But on the other hand, we feel pretty good about many aspects of our performance and have a real positive outlook towards the future. We continue to report an attractive PPNR and core NIM. Our deposit franchise improved significantly in 2020. We materially increased our reserves and we enjoy very strong capital and liquidity position. So Cadence today is really well positioned to move forward in 2021. I’m extremely grateful to our hardworking dedicated team of bankers, feel good about the markets we operate in and Cadence balance sheet is really in great shape.

So as a result of the many positive developments in 2020, we plan to resume our share buyback, increase the dividend to $0.15, payable February 12 and we plan to reduce maturing and callable debt. Fourth quarter was pretty solid from an operating perspective and showed encouraging improvement in credit as well.

Personal and operating highlights. Fourth quarter PPNR was $260 million, which includes $169 million in accelerated hedge revenues. So normalizing for that, we get to PPNR of $91 million. And for the full year, PPNR of $373 million, which would be a 2.06% PPNR ROA. In normal times, we’d be pretty pleased with that number, but I would say it’s a bit more noteworthy given the pandemic.

NIM continues to be a good story. We increased five basis points to 354 linked-quarter. Most of that is driven by a tightening of our deposit cost. I’m pleased with NIM. As I mentioned, credit metrics improved broadly. Fourth quarter is our second consecutive quarter in which NPAs, criticized and classified loans declined this quarter, down roughly 20%. So that’s a good progress. Billy is going to share some of his perspective on credit later in the call.

For the year, net charge-offs were 79 basis points and our ending reserve excluding PPP loans was 3.12%. So we saw improved credit metrics in Restaurant, Energy and in the C&I portfolios, while only Hospitality saw some modest deterioration linked-quarter. Excluding Hospitality, our CRE credit metrics were outstanding, and as is true with our mortgage credit metrics. Really good numbers there.

So as we think about future growth with the headwinds that we’ve experienced the last few periods here, meaning the decline in Restaurant and Energy portfolios are fading as those portfolios are pretty close to being appropriately sized. Also, the headwinds from just the softer economic backdrop are moderating and many borrowers remained conservative. And as vaccines spreads, there seems to be some reasonably optimistic — some reason to be optimistic about 2021. And I guess a question many bankers get these days about when the loan growth resume, of course, is still hard to answer with certainty. But it does feel like the second half of 2021 we should see some improvement in growth — outlook for growth.

So today, our capital position is very good shape. I’m really proud of the decisions that we made prior to and during the pandemic to ensure the strength of our bank. If you look at our four primary capital ratios, each of them were up meaningfully over the prior year. And a highlight would be CE Tier 1 and Tier 1, both ending the year at 14%, up 250 basis points. So last for tangible book value to end at $15.83, up 8% in a extremely challenging year is a noteworthy accomplishment. So to summarize, all things considered, we’re pleased with our execution, proud of our employees rising to the challenge.

With that, I’ll pause and turn it over to Billy.

Edward H. Braddock — Executive Vice President and Chief Credit Officer

Thank you, Paul, and happy to join the call. As Paul noted, and you all know, 2020 was a challenging year. And while there is still much uncertainty, we’re happy to report that credit continued to improve over the fourth quarter. From a broad perspective, our charge-offs for the year were elevated, but at a manageable level given the COVID impact. Our criticized levels have shown improvement and our most stressed categories are in generally a better position, but we still got a really watchful eye on those.

Let me start with net charge-offs for 2020, which totaled $106 million or 79 basis points of average loans. Reserves ended the year at a total of $367 million or 3.12% net of PPP. Non-performing loans were 1.17% net of PPP. The vast majority of the charge-offs were either fully or partially due to the COVID impact. COVID-related deferrals, on a related note, have continued to fall to $135 million as of January 15, ’21, down from $376 million at September 30 of ’20.

As we look at credit migration over the fourth quarter, as trends are improving, specifically, non-performing loans declined by over 27% on a linked basis and by 39% when compared to second half of 2020 to first half of 2020. If we turn to our pool of criticized loans, the trend is similar with the pool shrinking about 20% to $872 million, which was driven primarily by upgrades in pay downs. In fact, just 10% of the sequential decline in criticized pool was driven by charge-offs.

By category, Restaurant, Energy and General C&I made up the lion’s share of the positive migration and a pretty even distribution between the three portfolios. The only category that saw an uptick in criticized was Hospitality, which I’ll speak to in more detail shortly.

As we’ve done in previous quarters, let me quickly give an update on a few of the portfolios. First, our Restaurant book include — excluding PPP declined by $161 million or 16% year-over-year. The $837 million portfolio remains 75% quick serve and fast casual, which continues to perform well through the pandemic. The $156 million full service dining segments remained the most stressed segments of the portfolio. Charge-offs for the year were $33 million or 3.5% of average loans excluding PPP. Reserve for the portfolio is $53 million or 6.3% for the total portfolio. While not specifically allocated, this reserve would cover 34% of the full service stressed — more stressful service dining segment. Non-performing loans stood at 6.4%.

On Energy, the overall portfolio declined 13.5% or $193 million from last year to $1.23 billion net of PPP. The more stressed E&P sector had the largest drop at 25% for the year and now makes up 20% of the Energy portfolio, while Midstream makes up 65%. Energy charge-offs for the year were $16.7 million or 1.25% of average loans. Our reserves against the Energy portfolio stand at 2.6% excluding PPP and non-performing loans are at 1.6%.

For the broader C&I portfolio, charge-offs for the year were $46 million or 1.2% of average loans. Our reserve against the C&I portfolio stands at 2.5% excluding PPP and non-performing loans are at 90 basis points.

Now on the CRE Hospitality segment. This is the portfolio that’s under the most stress at Cadence. The portfolio now stands at $257 million. These Hospitality charge-offs for the year were $2.9 million or 1.1% of average loans. Here too, we believe the bank is in a good reserve position with $50 million or 20% against the portfolio of $257 million. Non-performing loans stood at 90 basis points.

A couple of higher points are on the CRE excluding Hospitality and on residential mortgage, as Paul mentioned. Some of the stats behind it are the CRE portfolio excluding Hospitality ended the year at $2.65 billion with only 46 basis points of non-performing loans. Outside of the Hospitality described earlier, credit performance is hard to complain about today in this sector. Comparable stats can be set for our $2.5 billion residential mortgage book of business. These teams of bankers have really navigated 2020 quite well.

So overall, as Paul mentioned, the bank has come a long way in the past year from a credit perspective, and there’s a lot to be cautiously optimistic about with cautiously being the operative word. As we look into ’21, we remain vigilant on credit. We’re encouraged by the trends. And we look forward to a return to a more normalized credit environment.

With that, let me turn the call over to Valerie.

Valerie C. Toalson — Chief Financial Officer

Thanks, Billy. Good morning. For the fourth quarter, our adjusted net income was $200 million or $1.57 per share, elevated over the prior quarter adjusted net income of $51 million and $0.40 per share due to lower loan provisions and accelerated hedge revenue recognized in the fourth quarter due to a partial hedge ineffectiveness determination. I will come back to the hedge revenue in a moment.

The fourth quarter loan provisions of $2.8 million was down $30 million from the prior quarter and reflected improved credit migration and the meaningful declines in criticized and non-performing loans. While the loan provision was materially less this quarter, given the continued uncertainty in the environment, our allowance for credit losses remains robust at 2.89% or 3.12% excluding PPP loans, representing an ACL to non-performing loan coverage ratio of 266%.

Turning to the balance sheet. Loans of $12.7 billion declined $747 million during the quarter or $629 million excluding PPP loans as over $1 billion in fundings in originations in the quarter were more than offset by pay downs and pay-offs. At a high level, the pay downs were the result of a number of factors; borrowers’ sales of assets, excess borrower liquidity, refinances to other markets and strategic exits of certain credits. Strategic reductions included pay-offs and pay downs of $113 million in criticized loans, $94 million in leveraged loans without modifiers, $120 million in Restaurants and $80 million in Energy. Note that there are some overlap between these categories.

Deposits of $16.1 billion continued to grow during the quarter, up $266 million from the linked-quarter, while at the same time, our cost of deposits continue to fall down to 25 basis points in the quarter compared to 32 basis points last quarter. Our non-interest-bearing deposits ended the year strong at $5 million or over 31% of total deposits, up from 26% a year ago. All in all, it has been a great year for deposit composition, up $1.3 billion with cost of deposits down 89 basis points year-over-year and an improved mix.

Given the quarterly growth in deposits and declines in loans, our balance sheet liquidity continued to grow with loans to deposits ending the year at 79%. We did add modestly to our $3.3 billion [Technical Issue] with the remainder of liquidity adding to our cash balances of $2.1 billion. The securities portfolio now represents just shy of 18% of total assets. We may continue to increase it modestly, but we don’t plan for it to become much more than 20% of the balance sheet. Accordingly, until net loan growth rebounds, we do expect to continue to hold excess liquidity on the balance sheet.

Net interest income increased by $2.8 million in the quarter to $157 million, driven by a $3.3 million increase in loan fees due to loan pay-offs, while lower funding costs offset the impact of lower average loans during the quarter. The fourth quarter loan fees included $4.7 million in PPP loan fees, up $1.3 million from the prior quarter related to the $118 million of forgiven or paid-off PPP loans in the fourth quarter. Remaining unamortized PPP loan fees were $8.8 million at year end with the vast majority of that to be recognized in 2021.

Net interest margin for the quarter improved by five basis points to 3.54%. Yield on interest-earning assets remained stable at 3.85% as loan fees serve to offset lower average loan balances, partially offset by lower securities yields due to fourth quarter purchases and the impact of increased short-term investments, earning 18 basis points.

Cost of interest-bearing deposits declined to 51 basis points from 59 basis points in the quarter as we continued to make progress on lowering our deposit costs, ending the quarter at a record low of 25 basis points, a decline of seven basis points linked-quarter. Excluding the impact of the PPP program, our NIM remained flat from the prior quarter.

Now to clarify our collar income and the accelerated revenue being reflected in the fourth quarter. As you recall, we have been amortizing from OCI into interest income the $261 million collar gain we captured in the first quarter of this year. As we reported in an 8-K earlier this month, declines in forecast hedge eligible loans resulted in a determination under hedge accounting called partial ineffectiveness that resulted in $169.2 million of that gain being brought forward into fourth quarter 2020 earnings. This $169 million accelerated hedge revenue was reflected in non-interest income, while the effective amortization of the hedge gain has and will continue to be reflected in interest income.

Specifically, of the $261 million total gain, we have recognized $226 million during 2020 with the $169 million in non-interest income and $57 million in interest income. And we expect $34 million of the remaining gain to flow into interest income during 2021 and the final $2 million in 2022. I realize this is a bit complicated, but the bottom line, if at all, is that drove the meaningful increase in our capital during the year.

Adjusted non-interest income in the fourth quarter was also impacted by this accelerated hedge revenue at $208.4 million, up from $33.1 million in the prior year. The increases in all other non-interest income categories was $6.1 million, up 19% compared to the third quarter. This growth included quarter-over-quarter increases of $3.6 million in earnings from limited partnership, $0.7 million in investment advisory revenue impacted by market performance and $0.6 million in credit-related fees.

Adjusted non-interest expenses were $105 million in the fourth quarter, up $12.6 million compared to the linked-quarter. The fourth quarter expenses were elevated due primarily to an increase of $8.1 million in personnel expense, driven by year end adjustments to incentive accruals as the result of improved credit and corporate performance in the quarter.

Looking to 2021, compared to our full year 2020 adjusted non-interest expenses of $378 million, we are expecting a low-to-mid single-digit annual expense growth factoring in a return to a normalized level of business development-related expenses, while continuing our long standing expense discipline. The reported full year and fourth quarter 2020 efficiency ratios were both positively impacted by the large accelerated hedge revenue, but before that positive impact, both periods reflected slight increases with the full year at 50.3% and fourth quarter at 53.7%. The full year increase reflects lower revenues in 2020 and the linked-quarter reflects the increases in the fourth quarter expenses.

Turning to capital, all of our capital ratios increased meaningfully this quarter due to the increased earnings and lower risk-weighted assets. At December 31, our Common Equity Tier 1 and Tier 1 ratios were up to 14% and total capital was up to 16.7%. The leverage ratio ended the quarter at 10.9% and our tangible common equity to tangible assets increased further to 10.7%. These robust levels of capital along with improved credit metrics allowed the flexibility to be more proactive on the capital front with the capital plans Paul spoke to previously.

Looking back to the uncertainty that we all had in March of this year, I don’t think we could have anticipated wrapping up the year arguably stronger than we started it. We ended the year at $18.7 billion with a very strong balance sheet, including a loan portfolio, reflecting lower risk and improved credit characteristics, a robust allowance for credit losses excluding PPP of 3.1%, earning assets at stable organic yields funded by a record low cost core deposit base and substantial regulatory capital void by our successful hedging activities during the year. And importantly, our tangible book value increased 8% during what was undoubtedly an unprecedented and volatile period. As we look forward to 2021, we are encouraged by the opportunities we have to build on this foundation, return to a more normalized credit and business environment and grow shareholder value.

With that, let me turn it back to the operator for questions.

Questions and Answers:

Operator

[Operator Instructions] The first question today comes from Jennifer Demba of Truist. Please go ahead.

Jennifer Demba — Truist Securities — Analyst

Thank you. Good morning.

Paul B. Murphy — Chairman and Chief Executive Officer

Good morning.

Jennifer Demba — Truist Securities — Analyst

Valerie said you’re looking forward to a more normal credit and business environment. Can you talk about what kind of charge-off levels you think could happen in this year? I know it’s really still difficult to predict given the pace of recovery [Technical Issue]. And then my second question is, you said you had about $1 billion in loan originations during the quarter. Can you just talk about what that consisted of and what kind of opportunities you’re seeing right now for lending? Thanks.

Paul B. Murphy — Chairman and Chief Executive Officer

Sure. Thanks, Jennifer. I would say first of all that I would expect charge-offs to be less than last year. Yeah, still elevated and a lot of the risk in these credits — excuse me, we feel have been identified and reserved for, for the most part. But as we work our way through the year, it should be a better year from a charge-off standpoint that would be my expectation.

The $1 billion in growth was pretty diverse, pretty broad-based. As you know, we have 190 lenders in a great region of the country that is doing well, relatively speaking, coping with COVID better than some other areas. And so real estate, in particular, had a nice year last year, really great growth there. It’s a portfolio that’s been — one of the hallmarks of that portfolio has been great credit metrics as was mentioned in the prepared remarks. So we feel good about that.

We’re starting a call blitz here in the first quarter. We’re going to have bankers all over. And we were a bit on defense last year. And so we just weren’t out hitting as hard. We were focused on credit, it was appropriate. And so we’re turning back to a more offensive mindset. And we’ll have a program where bankers get point for making calls. Take your boss on the call, you get more points. Take your boss’ boss. And so we’re just — we’re at our post. We’re doing what we do. We’re knocking on doors, putting good proposals in front of good companies, and I think it will pay dividends. Hard to pinpoint exactly the inflection point, but we’ve said for some time now the outlook for the second half of the year, we’re encouraged.

Jennifer Demba — Truist Securities — Analyst

Thanks so much. The next question comes from Brady Gailey of KBW. Please go ahead.

Brady Gailey — Keefe, Bruyette & Woods — Analyst

Hey, thanks. Good morning, guys.

Paul B. Murphy — Chairman and Chief Executive Officer

Good morning, Brady.

Brady Gailey — Keefe, Bruyette & Woods — Analyst

I wanted to hit on loan growth, it’s great to hear your optimism about loan growth in the back half of this year. But in between now and then, do you think we should expect to see the same shrinkage in loans that we saw in the fourth quarter?

Paul B. Murphy — Chairman and Chief Executive Officer

Brady, my answer would be probably not. I mean, fourth quarter had some unique things. We had the Main Street program that paid off some deals. We had this intentional reductions in Energy and Restaurant that are substantially complete now. We had really a combination of variety of things, I mean, still the whole COVID impact. And it seems like all of those things are fading a bit. So I would expect it not to be a sharp linked-quarter.

Valerie C. Toalson — Chief Financial Officer

Brady, I would just add that, keep in mind, that we do have the PPP loans. We’ve still got over $900 million of those that are going to be forgiven at some point.

Brady Gailey — Keefe, Bruyette & Woods — Analyst

Yeah, yeah. And then, Valerie, just an outlook on the margin. I know you have — you still have some accretable yield that’s flowing through there. And then now you obviously had changes with the acceleration that happened in the fourth quarter. Maybe an outlook on the margin into 2021?

Valerie C. Toalson — Chief Financial Officer

Yeah, sure. No, the margin is definitely impacted by the accelerating collar revenue. And so we’ve laid that out for you pretty clearly on Slide 17 in our slide deck, you haven’t seen that. But then as high level summary, we had about $63 million in income from the collar this year in interest income. It’s going to go down to about $32 million next year. So clearly that’s going to have an impact.

You mentioned the accretion, it’s going to kind of — just kind of gradually decline similar to how it has in the past. But on the rest of the margin, it’s really going to be dependent upon the timing of that loan growth. We’ve had huge success in our deposit cost this year, and there’s still some opportunity for those to come down a little bit further as we go into the year. So we’ll continue to see positive movement there. But we’ve got — we ended the year with $2 billion in cash on the balance sheet. And that’s a whole lot of excess liquidity earning of 18 basis points. So we are ready to leverage that into more earning assets when the time is right. And so that’s really going to be the biggest dynamic in where our margin sits.

Brady Gailey — Keefe, Bruyette & Woods — Analyst

Okay, great. Thanks, guys.

Operator

The next question is from Ken Zerbe of Morgan Stanley. Please go ahead.

Ken Zerbe — Morgan Stanley — Analyst

Hi, great. Thanks. Two questions. So I guess the first one, it’s good to hear you guys talked about buybacks. Obviously, with the 14% of CET1 ratio, it looks like you have a lot of flexibility to do buybacks. Can you just talk about sort of how much you’re thinking? Like, what is an appropriate amount? It does sound like it’s free and starting in first quarter. Is that right? Thanks.

Paul B. Murphy — Chairman and Chief Executive Officer

Yeah, Ken. The expectation would be that we would start as early as the first quarter. What the board has approved thus far is a $200 million total buyback. And the pace and timing of that is something that we will play a buyer. We don’t have a deadline or a fire drill. But you have known us to be conservative with respect to capital, and that will continue. But yeah, we all agree there is somewhere in there.

Ken Zerbe — Morgan Stanley — Analyst

Got it. Okay, great. And just maybe one for Valerie. Specifically on the loan yields, I think that there is some benefit to loan yields from the PPP fee acceleration, but it still look like loan yields kind of were up quarter-over-quarter a little bit. Can you just talk about why that might have been the case? And how you see loan yields specifically trending over the next couple of quarters? Thanks.

Valerie C. Toalson — Chief Financial Officer

Sure. No, we — and you’re exactly right. We did have a nice amount of loan fees come in this quarter, about $10 million in total. Part of that being PPP-driven, but really part of that being related just to our own portfolio. When you strip out all that, when you strip out the PPP impact, the accretion, the collar impact and the fees, you get to really kind of a base portfolio yield of 367 for our loans.

What we saw in the fourth quarter is actually new loans came on higher than that, at 378. And so that certainly bodes well for the overall margin. That compares to 371 that came in, in the third quarter. And this quarter it was 63% C&I, and that’s really one of the big factors that helped support that level as well as the fact that we’re having significant success in putting in loan floors. And so that also was helping support the rates right now.

Paul B. Murphy — Chairman and Chief Executive Officer

Ken, I would just add. I know you tracked this as well you should, and I think the key point that Valerie made there is our mix of C&I. In other words, in comparing us to some others, obviously our mortgage business yields there pulled us down somewhat, but the C&I book is a decent margin business, good margin business and I think one of the reasons why we’re touch higher than some of the others you look at.

Ken Zerbe — Morgan Stanley — Analyst

That’s perfect. All right. Thank you.

Paul B. Murphy — Chairman and Chief Executive Officer

Thank you.

Operator

The next question comes from Steven Alexopoulos of J.P. Morgan. Please go ahead.

Steven Alexopoulos — J.P. Morgan — Analyst

Hey, good morning, everybody.

Paul B. Murphy — Chairman and Chief Executive Officer

Good morning, Steven. To start, first looking at this slide on the roll forward on criticized loans, I’m looking at the quarterly on Slide 12, it’s very helpful. But if I look at the upgrades to pass, the $896 million and then the addition $119 million, maybe for Billy, can you walk through at this stage, what’s driving the upgrades? Is it business conditions improving? Are there other factors, and same for the additions?

Edward H. Braddock — Executive Vice President and Chief Credit Officer

Yeah, hey. Thanks, Steven. It’s very granular and widespread. I’d say a lot of it is on the upgrade front. A lot of it’s from our resolution efforts that we’re getting into — in our stress portfolio. So might be new equity coming in or some restructuring effort that would warrant the upgrade. As far as the additions, the bulk of the additions are like we had mentioned in the prepared remarks in the more stressed segments, Hospitality and then a few — and kind of the senior-assisted living. So it would be in the space of that you would expect. So that’s how I think I would address that with you.

Steven Alexopoulos — J.P. Morgan — Analyst

Okay, okay. That’s helpful. And then on the dividend, obviously, positive news again in the quarter. Is the new dividend you’re announcing, is this the new dividend or could this increase a bit further do you think given where capital levels are and you’re not exactly back to where you were prior to the dividend being reduced?

Paul B. Murphy — Chairman and Chief Executive Officer

Yeah, Steven. I think it’s fair to think of that as the most likely run rate for the dividend for the time being. We evaluate it every quarter. So never say never. But yeah, there was more of a kind of a thought about the year than there was a thought about the quarter when we were setting this dividend.

Steven Alexopoulos — J.P. Morgan — Analyst

Okay. That’s helpful. And then, Paul, lastly. So a big picture question. I think about Cadence really from the IPO, you guys were a growth bank. And in the past, we have seen many growth banks that needed to work through a credit challenge end up tightening the credit box, and you have a new chief credit officer, right? With the end result being a higher quality loan portfolio moving forward, but one that didn’t grow as it did in the past, how should we think about this going forward?

Paul B. Murphy — Chairman and Chief Executive Officer

Yeah. I think you really asked the question in a very thoughtful way. So the way I think about it is, take a step back in the old days, smaller base, higher percentage growth, hired a big team, did some impressive percentages, but elected to slow that growth in the fourth quarter of ’18, ’19 and now COVID. And so I think that sort of Cadence core growth capability would be in that 4% to 6% to maybe 7%. And when does that resume? We said, hopefully, second half of the year. But no, we won’t have the double-digit loan growth percentages from kind of the old days going forward.

Steven Alexopoulos — J.P. Morgan — Analyst

Okay. Thanks for all the color.

Paul B. Murphy — Chairman and Chief Executive Officer

Thank you.

Operator

The next question is from Brad Milsaps of Piper Sandler. Please go ahead.

Brad Milsaps — Piper Sandler & Co. — Analyst

Hey, good morning, guys.

Paul B. Murphy — Chairman and Chief Executive Officer

Good morning, Brad.

Brad Milsaps — Piper Sandler & Co. — Analyst

Valerie, I just wanted to follow-up on the size of the balance sheet. I think I heard in your prepared comments that you really didn’t — I think that you would take the investment portfolio much higher than maybe it currently is. You mentioned $2 billion of cash on the balance sheet at the end of the year, you still got roughly $1 billion of PPP loans coming back. Assuming that liquidity sticks around, is it fair to assume you’re just going to sit in Fed funds? I mean, I know you have a small amount of debt out there, but is that the way to think about the balance sheet? Just trying to get my arms around kind of the size of balance sheet and the impact of the liquidity that you’re thinking about?

Valerie C. Toalson — Chief Financial Officer

Yeah. No, you’re exactly right. There is going to be — continue to be excess liquidity on the balance sheet from some time and we were trying to optimize that as best as we can without positioning ourselves negatively as we look going out. Certainly, we don’t want the securities portfolio to get too large, certainly at these rates of putting on new securities.

The real trick is going to be when we see that net loan growth turn and be able to start effectively using that excess liquidity. But you’re right, on that margin, there is a couple. We’ve got some callable debt, we’ve got the maturing debt. Certainly, looking at everything we can do on the margin. And that’s been one of the key things that we had strong start in deposit growth in the year even with bringing down our lower deposit costs. We’ll continue to bring that deposit cost down at the margin, we’ve got the flexibility to do that.

Brad Milsaps — Piper Sandler & Co. — Analyst

Okay, great. And then just as a follow-up. Paul, you guys have always kind of been real conservative in how you treat capital, the income statement, etc. Just kind of curious in terms of the reserve, I mean, do you think that you’ll be in a position that you’d be taking a negative provision at any point or do you think that’s where we sit today, that’s really not in the cards at this point?

Paul B. Murphy — Chairman and Chief Executive Officer

Yeah, Brad, it’s hard to say. I mean, clearly, as we saw in the fourth quarter, we had some credits that were resolved, 100 cents on the dollar, that had some reversal in place. So we’ve got some reserve release there. Net-net, we’re still looking at some downgrades in the portfolio. I mean, every quarter we have upgrades and downgrades. So that will continue. I think the answer led us to be determined. Let’s see how the year unfolds. I mean, we have been proactive with our reserve percentages. Time will tell.

Valerie C. Toalson — Chief Financial Officer

Yeah. I would just add that, we are at 2.89% on our reserve level. When you look at kind of a day one CECL reserve level, it was I think about 1.55%. I’m sure that we’ll be higher than that really somewhat on a more normalized basis, but that’s a lot of room between here and there. And so at some point, as it’s warranted by the credit environment, that percent of allowance should migrate down.

Brad Milsaps — Piper Sandler & Co. — Analyst

Great. Thank you, guys.

Operator

The next question is from Michael Rose of Raymond James. Please go ahead.

Michael Rose — Raymond James — Analyst

My questions have actually been asked and answered. Thanks, guys.

Paul B. Murphy — Chairman and Chief Executive Officer

Thanks for joining us, Michael.

Operator

The next question will be from Jon Arfstrom of RBC Capital Markets. Please go ahead.

Jon Arfstrom — RBC Capital Markets — Analyst

Hey, thanks. Good morning.

Paul B. Murphy — Chairman and Chief Executive Officer

Good morning, Jon.

Jon Arfstrom — RBC Capital Markets — Analyst

A few follow-ups, but maybe bigger picture, Paul. Can you touch a little bit on your footprint? You alluded to it earlier that you have some of the better markets, and I guess, I want to get into some more details in a second. But just bigger picture, what — how do you feel about your footprint?

Paul B. Murphy — Chairman and Chief Executive Officer

Jon, yeah, I mean, I really think the regions that we cover are some of the best growth markets in the United States. I love our Atlanta team. We’ve got a great team in Dallas. The Houston core group is always hard working and contributes nicely. Our Tampa team is outstanding. Some of the smaller markets; Birmingham, Huntsville, I mean, really, really good markets and I’m proud of our bankers there. So when I start mentioning certain areas, I mean, our core business back in the Golden Triangle in Mississippi is not as much growth, but really solid markets and in a place where we’re happy to be active and to be doing business. So it’s a good combination for sure, and I like the growth outlook.

Jon Arfstrom — RBC Capital Markets — Analyst

Okay, good. And I guess, Valerie, back to follow-up on Brad’s question. Is it safe to assume the near-term when you think about the loan growth that any decline in reserves is likely through charge-offs and we just have a very minimal, if any, provision requirement? Is that a fair way to look at it? I know, Paul, you mentioned lower charge-offs relative to the prior year. But is that the way we should think about reserves coming down?

Valerie C. Toalson — Chief Financial Officer

Well, I think when you look at this quarter, while the percentage increased, the actual dollar amount came down. And so that is a factor of the various things that you mentioned, obviously the lower balances and the net charge-offs. There are so many factors that factor into the reserve, this whole environment. There is still a lot of uncertainty not just on the credit front, but really just the impact of the virus on the recovery and resurgence. And so all of those will have a play. But if you just kind of assume all of that is fairly stable, then yeah, credit migration, charge-offs and growth in the portfolio, her shrinkage and those are key drivers.

Jon Arfstrom — RBC Capital Markets — Analyst

All right. And then, one more kind of a follow-up on Steve’s question, just on the longer-term thinking. I hope this comes out the right way, Paul, but you know that there are a lot of people where you need to rebuild trust on credit. And maybe it’s you or Billy, can you just talk about what’s different in terms of what you’ve done to the credit department? How you’d go about looking at sectors that you’re in? And I know that a lot of this maybe isn’t fair because it was a pandemic, and it just kind of hit you squarely in a couple of businesses. But just help give us a little bit of comfort, help us understand what’s different as you go forward, I think that would help? Thanks.

Paul B. Murphy — Chairman and Chief Executive Officer

Yeah. Jon, it’s totally fair and it’s, yeah, definitely a question that we’ve spent time on, our board risk committee spent time on, we’ve looked at every line of business, we’ve looked at underwriting guidelines. I mean, the biggest thing we looked at is leverage, what’s the leverage profile. And starting in the fourth quarter of ’18, we felt like that was something that we should adjust and we began pulling our underwriting metrics down. We did have some disappointments in ’19, as you’re well aware and investors are well aware. And so we were showing some really positive trends. And then COVID came along and there are couple of business lines that are hard hit by COVID, restaurant especially, family casual dining and hospitality being two, and I know we’ve reviewed those numbers with you.

So you wouldn’t say there is just a huge sea change, you would say that at the margin, there’s just more and more focus, more and more caution, more and more scrutiny and diligence of each and every credit each and every relationship. I mean, take CRE, for example. There is zero change there. It’s outstanding portfolio, performed beautifully through COVID. So it really would be the C&I portfolio, anything levered without moderators and then the family casual dining and of course hospitality, the stress that industry is dealing with is certainly well documented.

So I don’t know. Billy, we would like to hear your comments.

Edward H. Braddock — Executive Vice President and Chief Credit Officer

Yeah, sure. And our like are the same. But if you really look back from when this trend started for us, I mean, an example is leveraged loans have come down 31% since the third quarter of ’19. We feel like the mix of that, kind of the restaurant book, the energy concentrations we had, is it a better place than it was then, just from a from a mix and a concentration standpoint. So I mean, our daily activity, our weekly activity and loan committee is active. I do bring a slightly different perspective than we’ve had historically. And it’s a balanced approach, I’ve been doing this my whole career. And I think that’s just like Paul said, it’s going to be at the margin and at the margin we’re going to be on the conservative end of things.

Jon Arfstrom — RBC Capital Markets — Analyst

Okay. Thanks a lot.

Operator

[Operator Instructions] The next question comes from Matt Olney of Stephens. Please go ahead.

Matt Olney — Stephens Inc. — Analyst

Hey, good morning, and thanks for taking the question. I want to go back to the hedge ineffectiveness that you guys highlighted a few weeks ago, and obviously we saw the big pull forward here in the fourth quarter. I don’t really appreciate maybe all the accounting you built behind this, but if loan balances continue to contract the first half of the year, could we have see an additional pull forward of the remaining hedge beyond what you’ve laid out today?

Valerie C. Toalson — Chief Financial Officer

So it is based on forecast. So in theory, if our forecast ineffectiveness going forward was high and it came in lower, then you could have an additional level of ineffectiveness. But where we are at is, we’ve got $33 million of this remaining gain that will come in, in ’21 and the remaining $2 million in 2022. So even if it were, it wouldn’t have a material impact in 2021.

Matt Olney — Stephens Inc. — Analyst

Okay. Got it. And then, Valerie, you may have mentioned this in the prepared remarks, any more details you can provide on the callable debt that you expect to retire? And then beyond that, it sounds like you’re also considering maybe some other borrowings or other debt tranches that you’re considering prepaying? Any more details you could discuss?

Valerie C. Toalson — Chief Financial Officer

Yeah, yeah. What we’ve got is, there is $40 million of callable sub-debt. And so that’s available to be called, and then on quarterly call dates. And then another $50 million of senior debt that matures in June of this year. And so obviously given the excess liquidity, we don’t need to be holding on to any of that debt.

Paul B. Murphy — Chairman and Chief Executive Officer

And Matt, I would just add. The combined savings from those are about $4.7 million a year. And this might interest you. $260 million in debt, our annual cost of that debt is about $12.7 million. It will come down by 4.7. If you think about that, that would be the equivalent of $5 billion in deposits at 25 basis points. So it’s — yeah, it’s cheap capital if you need capital, but if you are well capitalized as we are, it’s kind of expensive debt. So we’re not just pleased to see it being reduced.

Matt Olney — Stephens Inc. — Analyst

Yeah, good point. Thank you for that. And then just lastly on the operating expenses. I think I get the guidance for 2021. The press release highlighted the $8.5 million in the fourth quarter from the incentive compensation. It sounds like that was a catch-up for the fourth quarter. Is that correct? And so should we see the salary line decline in the first quarter?

Valerie C. Toalson — Chief Financial Officer

You’re right. There was some catch-up there. Early in the year, we really basically had no bonus accruals put into play just as with the concern about what the year could look like and so forth. But obviously, that transpired differently as we went through the year and we were able to add back some incentive dollars.

Matt Olney — Stephens Inc. — Analyst

Okay. Got it. Okay. That’s all from me. Thank you, guys.

Paul B. Murphy — Chairman and Chief Executive Officer

Thanks, Matt.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Paul Murphy for any closing remarks.

Paul B. Murphy — Chairman and Chief Executive Officer

Great. Well, thank you all for joining us. We’re really hoping that we will be able to meet with many of you in 2021 and resume travel and back to a more normal lifestyle here. Also look forward in the future to explaining more, sharing more with you about our diversity, equity and inclusion initiatives, our ESG program. We’re very focused on being a great place to work and partnering with our communities.

If you just kind of take a step back and say, what’s the core competence at Cadence today? Confidence took a hit back during the shutdown, for sure. We grow bonus accrual and reached for hunt it down preparing for the worst. And the core confidence at Cadence is now fully recovered. We’re back on the field looking for business and building the franchise as we have done in the past. A bit more cautious and conservative than in prior periods, but still active and hard working and we can to do a good job for clients and build our business further, grow revenue, grow earnings and create value for our shareholders.

With that, we stand adjourned. Thank you.

Operator

[Operator Closing Remarks]