Archives April 2020

Stocks fall in Japan, Australia; most Asian markets closed for holiday


Stocks in Japan and Australia fell in early trading Friday following losses on Wall Street, as most Asian markets were closed for holidays.

Japan’s Nikkei
JP:NIK
slid 2.3% and Australia’s S&P/ASX 200
AU:XJO
tumbled 3.6%, while New Zealand’s NSX-50
NZ:NZ50GR
declined 0.5%. Markets in Hong Kong, mainland China, South Korea, Taiwan, Singapore and Indonesia were closed for Labor Day.

In Tokyo, Toyota
JP:7203
and Honda
JP:7267
fell, as did Sony
JP:6758
and Fast Retailing
JP:9983
. Commonwealth Bank
AU:CBA
and Westpac
AU:WBC
declined in Sydney.

South Korea reported exports fell in April at their steepest rate since the financial crisis in 2009, as coronavirus-related shutdowns continued to weigh on the global economy.

U.S stock futures fell late Thursday after Apple
US:AAPL
and Amazon
US:AMZN
posted earnings but warned of uncertainty in the coming quarter amid the COVID-10 pandemic. U.S. stocks ended lower Thursday as investors weighed mixed corporate earnings. Later in the day, President Donald Trump threatened to impose tariffs against China as retaliation over its handling of the coronavirus outbreak.

The Dow Jones Industrial Average
US:DJIA
finished 288.14 points, or 1.2%, lower at 24,345.72, while the S&P 500 index
US:SPX
lost 27.08 points, or 0.9%, to close at 2,912.43. The Nasdaq Composite
US:COMP
shed 25.16 points, off 0.3%, to end at 8,889.55.

Still, for the month, the Dow gained 11.1%, while the S&P 500 ended up 12.7%, representing their best monthly gains since 1987 and their best April performances since 1938, according to Dow Jones Market Data. The Nasdaq booked a monthly return of 15.5%, its best month since 2000 and the best April for the technology-laden index on record.

West Texas Intermediate crude for June delivery
US:CLM20
, the U.S. benchmark, was up 84 cents, or 4.4%, at $19.68 per barrel in electronic trading on the New York Mercantile Exchange, while Brent crude
UK:BRNM20
, the international standard, gained 52 cents to $27.00 per barrel.

In currency trading, the dollar
US:USDJPY
fetched 107.16 Japanese yen, down from 107.13 yen on Thursday.



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Atlassian Corporation’s (TEAM) Management on Q3 2020 Results – Earnings Call Transcript


Atlassian Corporation Plc (NASDAQ:TEAM) Q3 2020 Earnings Conference Call April 30, 2020 5:00 PM ET

Company Participants

Matt Sonefeldt – Head-Investor Relations

Mike Cannon-Brookes – Co-Founder and Co-Chief Executive Officer

Scott Farquhar – Co-Founder and Co-Chief Executive Officer

James Beer – Chief Financial Officer

Jay Simons – President

Conference Call Participants

Rishi Jaluria – D.A. Davidson

Michael Turrin – Wells Fargo

Ittai Kidron – Oppenheimer

Nikolay Beliov – Bank of America

Keith Weiss – Morgan Stanley

Heather Bellini – Goldman Sachs

Gregg Moskowitz – Mizuho

Luv Sodha – Jefferies

Keith Bachman – Bank of Montreal

Ari Terjanian – Cleveland Research

Steve Enders – KeyBanc

Derrick Wood – Cowen

Operator

Good afternoon. Thank you for joining Atlassian’s Earnings Conference call for the Third Quarter of Fiscal 2020. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Atlassian’s website following this call.

I will now hand the conference over to Matt Sonefeldt, Atlassian’s Head of Investor Relations.

Matt Sonefeldt

Thank you. Good afternoon, and welcome to Atlassian’s third quarter of fiscal 2020 earnings conference call. Thank you for joining and supporting us. On the call today, we have Atlassian’s Co-Founders and Co-CEOs, Scott Farquhar and Mike Cannon-Brookes; our Chief Financial Officer, James Beer; and our President, Jay Simons.

Earlier today, we issued a press release and a shareholder letter with our financial results and commentary for our third quarter of fiscal 2020. These items were also posted on the Investor Relations section of Atlassian’s website. On our IR site, we also posted a supplemental presentation and data sheet. During the call, we’ll make brief opening remarks and then spend the remainder of time on Q&A.

Statements made on this call include forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Forward-looking statements represent our management’s beliefs and assumptions only as of the date such statements are made. We disclaim any obligation to update or revise them should they change or cease to be updated. Further information on these and other factors that could affect the company’s financial results are included in filings we make with the Securities and Exchange Commission from time to time, including the section titled Risk Factors in our most recent 20-F and quarterly report on Form 6-K.

In addition, during today’s call, we will discuss non-IFRS financial measures. These non-IFRS financial measures are in addition to, not as substitute for or superior to measures of financial performance prepared in accordance with IFRS. There are a number of limitations related to the use of these non-IFRS financial measures versus their nearest IFRS equivalents, and they may be different from non-IFRS and non-GAAP measures used by other companies. A reconciliation between IFRS and non-IFRS financial measures is available in our earnings release, our shareholder letter and in our updated investor data sheet on our IR website. During Q&A, please ask your full question upfront so that we can more easily move through to the next speaker. Also, please be patient if we encounter any disruptions or challenges and logistics, given we are individually dialing in from our homes across the world.

With that I’ll turn the call over to Mike for opening remarks.

Mike Cannon-Brookes

Thanks everyone for joining today and for your continued support. We want to start by saying we hope you and your loved ones are safe and healthy. We are in unprecedented times. It’s more important than ever that we embraced our mission to unleash the potential of every team and support our staffs, customers and communities. As you’ve hopefully read in our shareholder letter, we are confronting this crisis head on. Rapid economic change shapes up industry leader boards, and we will continue to position Atlassian to drive long-term growth in the coming quarters and years.

We will leverage our resilient culture and the strength of our business model to take share in the massive markets that we serve. Over nearly two decades, we’ve learned to navigate and adapt to macro change. While we plan to play offerings in this cycle, we also acknowledge that the macro economy presents some serious headwinds. During Q3, our performance was unscathed. We posted strong results with 33% year-over-year revenue growth, 6,200 net new customer additions and solid profitability. At the same time, the reality of serving over 170,000 customers means we have exposure to the small business economy and COVID-impacted industries. We have provided much more detail and many other updates in our shareholder letter that was issued earlier today. We are committed to emerging stronger from this storm, and our culture will help us set our direction.

Before we move to questions, we want to thank our employees for demonstrating incredible resilience and adaptability in becoming a fully remote TEAM under pressure. It has been difficult, and our hard work has never been more important as we support millions of teams across the world.

With that, I’ll pass the call to the operator for Q&A.

Question-and-Answer Session

Operator

Your first question – thank you for calling. [Operator Instructions] Your first question from the line of Michael Turrin with Wells Fargo. Michael, your line is open.

Mike Cannon-Brookes

Everyone’s speechless with the results we have delivered this quarter. Great. Maybe we’ll come back for Michael.

Operator

Your next question from the line of Arjun Bhatia with William Blair. Mr. Bhatia, your line is open. Mr. Bhatia? And your next question from the line of Arjun Bhatia. And your next question from the line of Jack Andrews.

Jack Andrews

Hi, good afternoon. Can you hear me okay?

Mike Cannon-Brookes

Just, fine.

Jack Andrews

Great, thank you. Thank you for taking the question and glad to hear everyone is doing well in this environment. I want to ask something about the – something in your shareholder letter. You mentioned that I think 23% of your attendees from your recent Remote Summit came from business teams, which was essentially double from 2019. I was wondering if you could just talk about what is really accounting for that increase there, whether there’s something that’s happening organically or whether you’ve pivoted your marketing message. And then the second question would just be any early feedback on the new cloud enterprise product. Thank you.

Matt Sonefeldt

Hi, I’ll take the first one. I think it’s just an indication of the continued interest and how broad our products can be deployed and a diverse set of audiences they serve. I mean, Remote Summit lowered the barrier to entry to Summit. So it could be that there’s a lot of interest from a line of business participants in our product and users of our product that may not want to travel all the way to San Francisco for an event, but we made it far easier for them to join an event, meet – and I think that’s something that we’ll continue to explore going forward. And I think Mike will take the enterprise cloud question.

Mike Cannon-Brookes

Sure, Matt. Look, cloud enterprise to those who don’t know was our latest addition of our cloud products that was launched at Summit a few weeks ago. It’s certainly been one of our most important and challenging initiatives in R&D over the last few years. It does give us a full ladder now of cloud additions to meet any customer size. If you count three standard premium in our enterprise with, of course, access for identity and content management across the set, that enterprise addition helps us meet the needs of the, obviously, the largest and most complex enterprises that want unlimited scalability, data residency, the complex security needs to come with that, et cetera.

Those are obviously extremely hard to build to meet those requirements. And those requirements are incredibly prudent for the largest enterprises in the world as they move to the cloud. We obviously had a very good reception to that announcement of the early access program at Summit. We don’t expect it to be a material contributor in FY 2020 or even in FY 2021 as we get those larger customers ramp up. But obviously, in the long-term, it’s an incredibly important initiative. In terms of existing feedback from those large enterprises that have joined the early access program, it’s been very good. Obviously, we spent a lot of time with them before that, making sure that we were building what it was that they wanted, and it was just a validation that we’re on the right track with that addition.

Operator

And your next question comes from the line of Michael Turits with Raymond James.

Michael Turits

Hi, good afternoon everybody. You guided slightly below the street for next quarter and commented that COVID would impact fourth quarter more than the current quarter, if this is a good quarter. I was wondering if you could speak a little bit more specifically about where COVID and the emerging recession will specifically impact the business.

You mentioned SMB, for example, you mentioned COVID-impacted industry. So I was wondering if you could talk a little bit more about that calculation. And my follow-up question would be what you think the impact of all of this will be on the pace of software development projects being rolled out, and of developer hiring and how that might impact you guys in the next 12 months?

Scott Farquhar

Michael, it’s Scott here. I’ll talk to the broader theme, and James can talk about the fiscal impact. As you well know, we have 171,000 customers around the world, everything from Fortune 10 to most of the Fortune 500 and tens of thousands, we talk about the Fortune 500,000 being our market that we do. We have no strategic customer concentration. No one customer makes up more than 1% of our revenue. So there’s not sort of a specific area there. But of course, as you expect from such a broad market that we’re exposed in the same way that you would be kind of across all the different geographies and industries that we’re in.

I do think there is a sort of short-term benefit of people using our products in terms of the work from home aspect they’re using collaboration tools more in the short term. I think the long term, the aspect is that people are going to work remotely more than they have to date. That’s going to require more collaboration tools, whether that is collaborating on work product in Confluence, whether that is managing more workflow in Jira versus talking to the person next term at a desk.

So we see that there’s some benefits of that over the long term. In terms of pace of software development and hiring, I think we’re 6 weeks into this, it would be too hard to talk about that as a broad industry trend. We haven’t seen anything that makes us significantly change what we believe internally about that. James, do you want to talk through any test specific financial impacts there?

James Beer

Sure, thanks, Scott. Yes, as we said, pleased that really a negligible impact from COVID-related factors in Q3. We have seen some impact in April. And in terms of the fact that we serve such a highly diverse set of customers really across all business sizes, geographies and industries, is really one of our major business model advantages. And the reality of that is that when you’re serving that mainly customers, we are going to have exposure to the small business economy and to those particular sectors that have been particularly impacted by COVID.

Now of course, this is reflected in the guide. And yes I would particularly emphasize that, that guide underpins some very beneficial aspects of our revenue model. Recall that over 90% of our revenue comes from existing customers. And indeed, over 85% of our revenue is recurring in nature. So overall, we’re pleased with how the business performed in Q3. We feel like the guide reflects the impact of the coming quarter.

Michael Turits

Okay, thanks guys.

Operator

And your next question from the line of Arjun Bhatia with William Blair.

Arjun Bhatia

Hey, guys. Thanks for taking my question. You mentioned in the shareholder letter that cloud migrations were up 60% this year. How do you think the pace of this migration plays out over the rest of the year, given we’re in a bit more of an uncertain and maybe IT departments are a little busier just trying to keep the lights on. And sort of related to that, we’d just like to hear some early feedback that you’re hearing from the cloud enterprise program that you launched.

Mike Cannon-Brookes

Sure, Matt [ph] I can certainly crack that. Look, in terms of migrations, let me start there. We continue to monitor, obviously, how that will be affected. I wouldn’t say we’ve seen much of an effect other than the normal growth in migration so far. It’s probably worth noting – the larger you are as a company, it’s obviously a large IT transformation project. But once you’ve moved to the cloud, you have reduced impact in terms of the operational load on your own team.

Effectively, Atlassian takes care of a lot of things and you would have taken care of yourself. So depending on your increased workload in a COVID environment, it can actually reduce your workload quite significantly as an IT department to let us handle a lot of the bits and pieces. And that, obviously, as you get smaller down the chain, that can be more pronounced if you are a 500 user customer, or a 100 user customer. So we remain vigilant as to how that will affect the growth we’ve seen in migrations, which has been really good so far.

It’s worth noting that’s been increased by the release of the Jira Cloud Migration Assistant, which is a tool we shipped during the last quarter that allows Jira users, predominantly Jira Software, Jira Service Desk to pick up and move their data to the cloud much more easily. And so it helps you through a lot of the more complex transition work. And that’s obviously increased both the pace and the accuracy of those migrations which has been really good.

From a cloud enterprise perspective, I don’t have a lot to add to what I said before, obviously the early reaction to the ERP from customers who have joined it has been very good. Largely along the lines of that this is the addition we’re looking for. This checks a lot of the boxes that we made, from the highest and most demanding customers with good scale, performance and security requirements. We’ll move into assessment mode and have a look at this. And we are working together with those early access program customers to make sure that cloud enterprise continues to evolve to meet their needs.

Arjun Bhatia

Perfect, thank you. And James as a quick follow-up if I may…

Jay Simons

Sorry, I lost you there.

Arjun Bhatia

Can you hear me now?

Jay Simons

Yes.

Arjun Bhatia

Okay. Sorry about that. Yes, I was just asking about how you’re thinking about price increases this year relative to what you’ve planned and whether those plans have changed at all given the increased uncertainty.

Jay Simons

Well as you know we have a very thoughtful and rigorous process to considering pricing moves, and we’ve been doing that for some years now. When you think about what we’ve done in years past, it’s in a balance between lowering prices and in some instances raising prices. And to layer on top of that as well, it’s important to think about the additions, the strategy that we’ve been pursuing in recent times. So now with the roll-outs fully of the free additions of Jira Software, confluence and Jira Service Desk, that compliments the standard additions, the premium additions and as Mike was speaking of earlier now, beginning to roll out the enterprise additions as well.

So, the additions represent another way in which we can be paid for the incremental value that we are offering our particular customer. And our customers are able to align their needs with the right addition. And so that will be an ongoing part of our strategy in years ahead.

And then in terms of a specific price, we’ll always obviously be thinking through all of the different relevant factors, both competitively and relevant to our customers. So we’ll always be looking to find the right balance between being compensated for value that we offer to our customers while being cognizant of doing the right thing for our customer set as well. So we’ll keep having that perspective around pricing, and we’ll update you in the months ahead.

Arjun Bhatia

Perfect, thank you.

Operator

Your next question is from the line of Rishi Jaluria with D.A. Davidson.

Rishi Jaluria

Alright, thanks for that. That’s a new way to pronounce my name. This is Rishi Jaluria from Davidson. Thanks for taking my questions guys. So two, first I wanted to appreciate the commentary that more resilient model because 90% of our revenue comes from existing customers. I just want to drill down a little bit more into that. If we were to kind of take a snapshot of any given year how do we think directionally of new business with a new year, how much comes from existing versus new. And following up on that, if you were to think about your penetration within your existing customer base, I’m sure you’re pretty under penetrated right now. But directionally, what do you think that opportunity just within the existing customer set looks like? And then I’ve got a follow-up.

Mike Cannon-Brookes

Well certainly, we’ve noted that 90% of our activity of our revenue each quarter comes from our current customers. So, we tend to add a lot of new customers each quarter, Q3 was another example of a very nice number, additional customers. But those tend to represent a relatively small proportion of the dollars that we generate each quarter. So it’s very much the bulk of the dollars coming from our Expand Motion. And of course, we have a variety of ways in which to expand across products, across additions that I was just referring to in the earlier question, in terms of expanding across a broader part of that customer, serving more of the groups at that customer, and so forth.

And so we routinely talk about the fact that we believe we’re early in our work to address these very large markets that we serve. So we continue to be very focused on the long term opportunity and very confident about our ability to address that real opportunity.

Rishi Jaluria

Okay, great. That’s helpful. And then just as a follow-up, you did talk a little bit about with the guidance, the SMB side of the equation. But I wanted to think about industry exposure, right? Obviously you’re very well diversified across industries, but if you were to think about just your exposure again directionally to some of the more impacted industries like travel, hospitality, retail, energy. Just wondering if you can give us a sense for how big that exposure looks. Thanks.

James Beer

Sure. Again, we really cover all industries, all sizes of companies and all geographies. That’s one of our terrific business model strengths. And so, yes, we obviously serve some of the companies, but like in the travel sector that would be particularly hard hit in the last several weeks. But really the focus of where we’ve seen an impact is on the smaller sized company end of the spectrum. In fact, it was notable to me how one of the larger FRS deals of March, it was with an important travel services company. The deal took a few more days to close and actually rolled into the early part of April. But at the end of the day I was very comfortable with the terms that we settled upon. And the customer was very appreciative of the fact that we have worked with them to help them through that particularly difficult time.

On the smaller end of the spectrum, obviously that’s where we have more of our cloud customers, recall, that we’ve spoken now or a couple of quarters ago about the fact that we have more than 125,000 cloud customers out of our total of, most recent figure today reported 171,000. So we do skew in our cloud business to a full size of organization.

Taking a step back from that more broadly, I’d say we’re holding steady across the enterprise and large enterprise portions of our business. And on the cloud side, going back there for one last thought I’ve been pleased that while they say there are some customers that who are seeing an impact. I’ve been very pleased by the number of new cloud customers who have been coming to us both in the month of March and thus far in April. In fact, March was the strongest month for Q3 for the addition of new cloud customers. And of course that’s lining up with a month in which we had fully rolled out our three offerings as well. So, really we’re quite encouraged by the developments there in terms of continuing to attract new cloud customers.

Rishi Jaluria

Okay. That’s really helpful. Thank you.

Operator

Next question is from the line of Michael Turrin with Wells Fargo.

Michael Turrin

Hey there. Thanks, good afternoon. I was hoping to hear more around the decision to play offense here in this backdrop. It sounded pretty clear in the letter that you are planning to keep pace in terms of hiring and play offence here in the coming months. Can you just spend a little more time in terms of what that means from your perspective? Are there any specific areas you see yourself maybe pushing even a bit faster behind? And are any of those impacts showing up here in the free cash flow guide, we saw somewhat of a reduction here as well? Thank you.

Mike Cannon-Brookes

Sure let me take that from my side and Scott or James can jump in. As I think we felt it was really important in line with our values. So one of our company values is open company, no [indiscernible]. We wanted to be very clear with investors and partners about how we were approaching the current environment, which is obviously, unusual, it’s not business as usual at the moment. And I think as a company, you have to choose a long-term strategic path with very clear thought as to why one is choosing that path because this is going to play out over many, many quarters.

When we sit down and think about it like – strengths, beside the fact that we are in very large markets. We have a capability to actually gain share through these quarters with turbulence. However, they come at us, and we remain very adaptable and thoughtful about them. Our culture is extremely strong and adaptable. Obviously our go-to-market models, you’re presumably well familiar with, suits the flexibility of these type of environments as we don’t have to get on a lot of plains to sell stuff. We have product innovation and we have an extremely strong, obviously, financial position in terms of generating free cash flow as well as obviously, the cash we have on the balance sheet in the business and the stability of our revenue streams.

So I think when you put all that together, it’s – hopefully shows some of the background why we feel confident to take that strategy as we sell into the coming quarters and years about how we are planning to approach that and why we are choosing to communicate that. Scott, maybe you want to go into a little bit about the actual effects of what that means? We listed a couple in the letter.

Scott Farquhar

Yes, I will touch on them again. The types of things that we’ve done in the past. And Mike and I would hopefully consider ourselves still fairly young in the business and we we’ve been running last year and since I started in the dot-com crash in 2001. And we remember the global financial crisis in 2008 and 2009, pretty clearly. And some of the things we did back then and what we’re doing again now is picking up great key hires and talent that’s available and that we could – maybe wouldn’t be on the market otherwise. So that’s doing well.

Customer acquisition, we’ve – 12 years ago now, we released starter licenses and reduced our price from $1,000 down to $10 for many of our products. A few months ago, we launched free and those in free effectively to that $10 down to zero to aggressively try to acquire customers. And also, I think that increased product innovation, continuing the R&D investments that we are known for and yield great value for our customers. And if there’s any opportunistic M&A that turns up we’re not necessarily going hunting for it, but like there’s often opportunities in this particular market environment where you can pick up things that are very attractive that otherwise, again wouldn’t be available.

So, all those things that we’re considering and we’re discussing in a weekly basis in terms of how to be more, I guess, opportunistic in these times. James can talk to how that flows into free cash flow guidance.

James Beer

Yes on the guide I would just observe obviously we’ve laid out our revenue guide, the free cash flow guides directionally consistent with that. But then also from a working capital perspective, I don’t know if it’s fair to say that we working with a small subset of our customers who requested help in these extremely challenging macroeconomic times. Now this is a relatively small proportion of our total customer base, less than half of the percent, but we feel as though that’s the right thing to do. And it’s an illustration gain of the long-term orientation that Scott and Mike have been talking about on this call already, just another illustration of that mindset that will work out well for those companies and well for us.

Michael Turrin

That’s a great color for me James, much appreciated. Thank you.

Operator

Your next question come the line of Ittai Kidron with Oppenheimer.

Ittai Kidron

Thanks. Good numbers guys. I guess I wanted to follow-up on a couple of things. First of all, with respect to the free cloud additions, great to see that out. Maybe you can tell us on how many downloads you already have. Or any statistics that you can have there that helps us understand uptake, interest, level of interest or conversion rate, anything on that fund. And I know it’s early, but some color would – would be appreciated.

And then for James on the perpetual license revenue decline, clearly, I’m assuming this is demand related, but maybe you can help me think about that in the context of how much of that was perhaps customers shifting to cloud versus true reflection of softer business activity? And should I assume that that also is the main area where with respect to your guidance, that’s where we see most of the weakness near term.

Mike Cannon-Brookes

Yes. Ittai, I’m Mike I can certainly take the top part of that question. It could be something else as a tricky name. So that’s [indiscernible]. Look, it’s still very early, the results are in fact incredibly encouraging. For history, we started rolling out our free editions back in October in a very limited sense as we told you in the shareholder letter. So sort of looking at 5% and 10% of traffic and seeing what the effects were, as we are always very thoughtful with the impact of changes we made to pricing and try to consider the long-term benefit to that. We solely expanded that.

Obviously, with COVID in the current crisis, we decided to accelerate that somewhat and rolled it out fully in March, which is now available for Jira Software, Jira Service Desk and Confluence. Obviously, that’s alongside Trello and Bitbucket and other products that already had three editions, and that’s a large part of their model already in the cloud.

That have been we didn’t include any closing so far. We can say up to March we had 125% uplift in valuations, which is obviously actually a little bit ahead of where we expected, but is looking really positive for that perspective. I would reiterate, it is extremely early. We did that, I think it’s less than four weeks ago now, a little over four weeks ago. So we’d expect a pop-up off of that. And then it settled down to a number, but it’s extremely in a good spot in terms of where we think it should be. And we had seen limited evidence so far, I would say, but certainly some evidence that is helping us get into even more markets and rich users we would not otherwise have been able to get to, which is our goal of heading towards the Fortune 500,000, so it’s a great step on that particular journey.

Just reiterating the long-term rotation, and this is a great step on that journey. James, I don’t know if you want to take any financial impacts of that?

James Beer

Sure. Well I’ll speak to the license part of the question in particular. First of all, recall that in Q2, so 90 days ago we reported quite a significant pull-forward effect that was driven by the price increases that we had announced previously. So, what we saw in part in Q3 was the effect of having activity that otherwise would have occurred in Q3 actually get pulled forward into Q2.

Now, the second point that’s really important though is that – and as we’ve been talking about this theme now for a number of quarters, is that we’re very much orienting our business towards continuing to grow to subscription revenue business, the cloud business and the data center business. So you saw subscription revenue growth of 67% year-over-year, very much substantial, the primary driver of the revenue line for the company now. And I would expect that that will continue.

And commensurately, you’ll continue to see license moderating over time. In fact, recall that the license line now is a relatively small one. It’s a small component of our overall revenue structure. So this past quarter, the absolute dollar figure is $21 million. So I would continue to expect that we’ll see less license activity over time and more subscription revenue growth.

Ittai Kidron

Thank you, guys.

James Beer

Thank you.

Operator

And your next question is from the line of Nikolay Beliov from Bank of America.

Nikolay Beliov

Hi. This is Nikolay Beliov from Bank of America. Thanks for taking my question. I want to double-click on the 60% increase in migrations from server to cloud. Just wondering how do you measure that? Is that based on users, customers, revenue, et cetera? As you saw that uptick this fiscal year, what strength did you see under the covers in terms of customer sizes moving from server to cloud? Did you guys take advantage in more upsell?

And lastly, what have been the partner feedback on migration tools that got launched a couple of months back, as customers move from manual migration to more automated migration, are we talking about significant decrease in the time of migration maybe from months or weeks? Just whatever you’re seeing would love to get to hear from you guys. Thanks so much.

James Beer

So Nikolay, in terms of – I have some of my colleagues will jump in as well. But in terms of your first part of the question, the migration statistics that we mentioned for our service cloud activity, they’re driven off user count. And in terms of our customer size that is migrating, what we are seeing is that, step-by-step, as we continue to add more capability to our cloud products, as we continue to rollout and increase the capability of the different additions that we’ve been talking about on this call, then we’re seeing more larger companies making that move. And I think we’ll continue to see this trend play out that way over the coming years. Mike spoke earlier to the rollout of enterprise additions. So now we’re in a position where we can address the needs of any customer size.

And I was going to refer to the helpfulness of those migration tools before you added it to your question. I think that has been an important aspect of us continuing down this pathway of making it easier for our customers of all sizes to migrate their path. Jay, over to you.

Jay Simons

Yes. I’ll just jump on, Nikolay, with the back part of that question. I mean, the migration tools are built both for customers that can migrate without partner assistance, also for partners to basically enable a better, more reliable migration. And remember, like in the partner case, there’s a bunch of work that we’re going to do around the migration. That doesn’t involve just moving data from server to cloud. In many cases, they want to reconsider their workflow. They want to reconsider how their projects are structured.

So we’ve taken the work out of basically moving data from point A to point B. But in point B, they have an opportunity to rethink what they really want to do or how they want to change the product. In many cases, the server customers have been using the server product for five or six years and so there may be some classification that they want to partner to help them move past. And I think we’re going to measure that just in terms of velocity over time, like constantly, both with the partner and with the customer directly, we want to make sure that moving is ever, ever easier.

Nikolay Beliov

Got it. And just one clarification question, if I might. James, you mentioned, I believe that you saw some COVID impact in the month of April. Can you please give us some color where in the business you saw that exactly? Thanks so much. That’s it from me.

James Beer

Yes, Nikolay, nothing really to add to our previous answers, the April impacts really in the SMB space, with more of an orientation of SMBs to our cloud products. And then obviously, the most heavily impacted industries in terms of the macro impact from COVID, seeing some factor there, but absent that, nothing noticeable to report across industries or across geographies.

Nikolay Beliov

Thanks so much.

Operator

And your next question is from the line of Keith Weiss with Morgan Stanley.

Keith Weiss

Excellent. Thank you guys for taking my question. Congrats on a very nice quarter. I wanted to follow-up on – I think this is a question that Mike Turits was trying to ask, maybe I’d be a little bit more direct about it. One of the things investors are trying to understand is like which solutions do customers find most strategic and most mission-critical and where you’re most likely to sustain demand even through difficult times and which ones are perhaps less – or deemed less mission-critical.

And I think the question we’re trying to ask is like, if we look across the solution portfolio, is there parts of the portfolio that people find to be more mission critical? Do you expect the demand to sustain better in? Like if we think about Jira Software less mission-critical and Jira Service Desk more? Or is there any way you could kind of help us out in terms of how the customers are thinking about the mission criticality of the suite, number one?

And number two for James, on the – I know it’s a very small percentage of customers, but the customers that are asking for help, is the form of the help that you guys are willing to give, is that just on payment terms and the like? Or are you guys actually kind of modifying existing contracts?

Scott Farquhar

Keith, Scott here. I’ll answer the first bit about sort of where our products are most mission critical. Now what we’ve found is that our products because they are workflow products that are embedded in our customers’ workflows in almost all the cases of what we do, whether it’s Trello or it’s Confluence or it’s Bitbucket or it’s Confluence for doing collaboration or it’s just service sets of serving your customers, your internal help desk, like all those things are baked into our customers’ workflows. And so we don’t really see them as a discretionary expense that gets turned off when you want to save money, like it’s a key to people being productive. And I think we have an added benefit that we’re relatively compared to our peers or competitors, we will be well cost to provide that outcome.

And so we – in 2008, we saw some benefit to us because people switch to a low-cost provider to provide those things where maybe they had a legacy provider and they wanted to move. Now – so that’s the way I think about it. It’s not an area where I’d say we’re particularly strong or weak there. Obviously, our customer base, the more embedded we are in our customers, the stickier we are, and so to the extent that more – to be able to customize our products more, which we’d say probably a medium or larger-sized customers have customized our products more. And where people use our third-party marketplace so if two companies look alike, I’d say the ones that have customized it more and have used more third parties, we know are stickier in the numbers.

James, do you want to talk to the next part?

James Beer

Yes, sure. The bulk of where we’re working with our customers are really around payment terms. And I’d note that those are changes to our arrangements that are temporary in nature, and that’s quite clear in our dialogue with those customers.

Keith Weiss

Excellent. Super helpful. Thank you, guys.

Operator

And your next question is from the line of Heather Bellini with Goldman Sachs.

Heather Bellini

Great. Thank you so much. Just had a couple of follow-ups. And thank you, I know the shareholder letter was longer this quarter, but it was very helpful. My two questions relate to a little bit what other people have been asking. Just looking at what you said about April, are you assuming that spending levels from those affected companies and industries, stay the same throughout the quarter? Or in your assumptions, are you expecting business to actually get better for those affected companies and industries in May and June?

And then my follow-up is just, again, you also highlighted 90% of your revenue comes from existing customers. From the industries that aren’t impacted, what assumptions are you making about net expansions, if you will, versus prior periods for June? Thank you.

James Beer

Okay. Heather, I’ll take that one. So in terms of the guidance that we’ve offered, a few thoughts. First of all, I’d say that the philosophy that we brought to setting the guidance in terms of setting the range, placing the range is quite consistent with what we have done historically. We have laid out a broader revenue range. Clearly, with this macroeconomic uncertainty, there is a greater potential variability in our results. And it’s certainly challenging to accurately estimate the current environment’s impact across such a large customer base.

So we have looked carefully at our experience in April and considered that and our various leading indicators are top of funnel type indicators and assumed that, that sort of situation plays out across the balance of the quarter. So hopefully, that’s helpful to that part of the question.

In terms of around the 90% or so of our revenue that comes from our existing customers. I wouldn’t add anything other than, obviously, we factor in what we’ve been seeing in the last few weeks. And again, think specifically about the relevant forward-looking indicators for that type of element of the overall revenue structure.

Heather Bellini

Great. Thank you, James.

Operator

And your next question is from the line of Gregg Moskowitz with Mizuho.

Gregg Moskowitz

Okay. Thanks. Gregg Moskowitz from Mizuho. Hi, guys. I guess my first question, in the shareholder letter, you mentioned that you have over 150,000 organizations on starter licenses or subscriptions, and clearly, it’s a very large number. However, there were over 175,000 starter accounts a year ago. And just given your very strong top of funnel, I’m wondering why that has declined. In other words, have you converted a lot of these to paid accounts? Or are there a bunch of them that have just gone away for one reason or another? Hello?

Mike Cannon-Brookes

Hi, Gregg. I think, Jay, can you take that one?

Jay Simons

Yes. Hey, Gregg. So I think the macro trend is just the shift to cloud. Remember, like the starter license largely talks about the server end user license for $10. And increasingly, the more attractive value proposition even at the pre-free price was to move to cloud, and that was like the macro trend, people aren’t going to install a piece of software, if you can get it for effectively the equivalent price run in the cloud. So that’s been some pressure. And then free is a far more attractive place to start on any Atlassian product. And so that’s sort of the – I think the macro effect here on the server starter license.

Gregg Moskowitz

Right. Okay. Thanks, Jay. And then just as a follow-up, curious about what kind of demand you saw in the quarter for data center subscription as well as your cloud premium SKU? Thanks.

Jay Simons

Good. We were pleased with both. I think James mentioned this. But largely the enterprise segment, both just in terms of how we performed in the quarter and then the overall pipeline and traction, we saw both through the quarter and headed into this one with positive, both across data center, both directly and then in with our indirect global channel, and from standard to premium as upgrade pattern in cloud.

Gregg Moskowitz

Perfect. Thanks.

Operator

And your next question is from the line of Brent Thill with Jefferies.

Luv Sodha

Hi, this is Luv Sodha on for Brent Thill. Thank you again for squeezing me in. First of all, congrats to Jay given it’s his last quarter. And I wanted to ask maybe a couple of questions. One was now with the release of the Atlassian Cloud Enterprise, could you maybe talk about the investment in Enterprise Advocates? I know you guys have a viral go-to-market motion. But the Enterprise Advocates have been helping in terms of phishing Atlassian as a solution set. So what about the investment in that team going forward?

And then the second one, on the M&A front, I know you guys mentioned that you would be more offensive there. Sort of anything in your portfolio that’s lacking right now? Or how would you think about the strategy going forward? Thank you.

Jay Simons

Yes, I will take the first one. So we’ll continue to invest in Enterprise Advocates as we have to support the data center upgrade motion in server, both the migration motion from server to enterprise cloud and the upgrade motion from standard cloud to enterprise cloud is really similar. And so I think we’ll continue to expand that team to serve the opportunity that enterprise cloud presents, both for existing server customers and moving in for big enterprise customers that are growing.

Remember that we get a lot of leverage in the Enterprise Advocates group, both from our indirect channel that we – that is pretty large and deeply connected to our products and our customers in the market, and we work hand-in-hand with them on that bigger enterprise upgrade motion and selling motion. So we get leverage there, which is why the Enterprise Advocate group can grow modestly over time.

And we get a lot of leverage just from the flywheel. We’re landing inside of these biggest customers with a high-velocity starting point that I think we’re really well-known for. And then we can use that as a more efficient leverage point to grow customers, both as we have in data center, and it’s certainly up the stack in cloud to enterprise cloud. I’ll hand it over to Mike on the M&A question, or Scott on the M&A question?

Scott Farquhar

Yes. I’ll grab it here. I think the M&A, again, we’ve been really proud of how we’ve done that. You can build products, you can partner, you can have a marketplace, you can acquire. And I think Atlassian as a company has done all those very successfully over almost over 20 years there. And when we look at acquisitions, the things we always look for is, firstly, are they aligned with our mission to unleash the potential of every team to help us get to our big hairy goal of 100 million active users. Do they fit with the values of our company? Do they fit with our business model? And then there’s a lot of long tail a lot of things we really look for. And I think we’ve been very successful with that approach and a measured approach of making sure that we bring on the companies that are really great fit for Atlassian.

As Mike and I’ve been the biggest shareholders of Atlassian, we’re aligned with all of you on this call and all the shareholders listening in terms of being good stewards of capital and making sure that we invest wisely to get the returns that all of us would want.

Luv Sodha

That’s great. Thank you.

Operator

And your next question is from the line of Keith Bachman with Bank of Montreal.

Keith Bachman

Hi. Thank you very much. I want to ask two questions. The first one is on mix and the second is on COVID. The mix question is probably for James to build on something that was asked before, but perpetual was down year-over-year, and you indicated you had some pull-ins. It actually hasn’t been down previously despite some pricing changes. And so as we look out, you said growth would moderate. Would it still be – you think positive numbers we look out over the next couple of quarters?

And the related part of that is on the maintenance side, maintenance has been steady area, call it, 20%, 21% growth for some time. If perpetual wanes, should we start to think about the maintenance side, also perhaps slowing? I would think that would be a long process. But I just wanted to hear a little bit about that, and then I’ll ask my COVID question as a follow-up.

James Beer

Sure. So in the perpetual license line, yes, we have been seeing those pull forward effects into Q2 from Q3. And I would expect other of upcoming quarters, the next couple of quarters, for example, to see similar types of pull-forward effects when we record those results. So that will drive the dynamic of whether it’s a lower percentage growth or whether it is, in fact, a shrinking of the absolute dollar figure. Again, the dollar figure is a relatively small one at this point in time because so much of the new activity is taken by our customers going straight to one or more of our cloud services.

Now also in terms of the maintenance line, clearly, we have spoken a great deal about our efforts to migrate customers from server over to cloud. And indeed, some of our server customers migrate up to data center as well. So as that continues to happen and continues to build over time, then, yes, there’ll be fewer customers executing their renewal of their server contracts. Instead, they’ll be taking on data center or cloud contracts. And so yes, you would see that affect the maintenance line over time.

But I think you’re right in characterizing that as a more gradual effect the net that you see in the license line because the license line reflects brand-new activity, either a new company coming in to buy our server products or it could reflect a current customer buying additional licenses, more users for their current licenses, that sort of thing. And so I would expect you to see the drawdown most pronounced on the license line but also a similar effect over time on the maintenance line.

Keith Bachman

Okay. Great. That’s very helpful. And then, Jay, maybe in the spirit of this is your last call, direct this one to you. When you think about or talk about COVID and the interactions with the customers, is there any sense about you could give us some dollar exposure to SMB? In other words, is that X percent of your revenues? And B, when you say that you’re having some impact, what’s the behavior there? Is it less upsell? Is it not renewing the monthly? Is there any feedback you can give on what that means in terms of behavior when you say you’re being impacted. And all the best in your future endeavors.

Jay Simons

Thanks, Keith. I’ll start, and James maybe want to tack on. I think we’ve addressed this a bunch over the course of the call, like we’ve seen largely – the impact that we’ve seen has been from the small to medium business segment in cloud, and we saw that in March and continued a little bit in April. And mostly, that is around customers either not expanding at the rate that we wanted them to, or in some cases, reducing their license counts because they reduced the size of their employee population. We’re happy – on the cost side, by the way, we’re also happy with the rate of new customer acquisition has been where we want it to be. And so I think that’s a good positive signal.

And then as I mentioned, the enterprise segment, which is a growing proportion of our business remains healthy, both just in terms of what we did in the quarter and pipeline that we’re building. And James you may want to tack on some color as well.

James Beer

No, I think you covered it, Jay.

Keith Bachman

All right. Thanks, gentlemen.

Jay Simons

Thanks, Keith.

Operator

And your next question is from the line of Ari Terjanian with Cleveland Research.

Ari Terjanian

Thank you so much for having me on the call. Congrats on the results. Two questions. First, you guys just give a little bit more impact. You touched upon it on the shareholder letter, but – and talked about collaboration. But any more examples of how customers may be using your tools and solutions to help address COVID and you think you guys will make more templates, more kind of prepackaged applications to help.

And then second, you talked about take-up of the leaderboard. Are there any areas where you see potential for the greatest share gains over the next 6 to 12 months across your portfolio? Thank you.

Jay Simons

Let me take the first one. Scott mentioned a bunch of these use cases, but I mean, we become a way to coordinate project activity content. In the case of COVID where everybody’s gone remote, I think our products become pretty critical as a way to connect people to what they’re trying to do. And so I think there’s a bunch of great use cases highlighted in the document, even when you think about something as maybe that seems little mundane is how do we get people back into our offices. I mean, that is a fairly – can be a fairly complicated amount of work with a whole bunch of considerations as we emerge from this and maybe people go back into an office and to work, and they’ve got to do things like get on an elevator, you have to consider like how desks get spaced out differently. That involves a ton of human coordination and action. And that’s typically where our products get brought in to help customers and help teams.

And maybe who is taking the second part, maybe Mike?

Mike Cannon-Brookes

Yes. I can certainly take the second part of that. Look, the question is where do we expect share gains, et cetera. Look, all of the markets we operate in, whether you look at Agile and DevOps in the software teams market, whether you look at IT and the broader sort of ITSM, enterprise service management spaces or whether you just look at collaborative work management tools whether teams are remote or not remote, right, people are going to change their work styles as a result of this.

So I would say all sort of three of our major markets, we have very small shares, and all three of the markets are growing by themselves. So we expect there to be a lot of opportunities to look there. Scott mentioned talent, it’s quite likely that this is a period over the next couple of years where there’s a higher availability of talent in different markets that we operate in geographically. That’s very important for us.

And I think what’s important is to see us just constantly optimizing our business. Again, as Scott mentioned a little bit in 2008, 2009 when we introduced the starter program, which is a little bit of an analogy to what we’ve done in free and cloud. That really sets the platform to drive a decade of growth across a lot of different markets that brought in tens of thousands of businesses to the Atlassian experience that over time grow up into different parts of our world. And those are companies you see at the moment moving from server to data center or evaluating cloud premium or cloud enterprise.

So when we talk about playing in the long-term game, that’s exactly what we mean. We believe this can have an opportunity in three very large markets that we serve, and you’ll see us continue to make moves to try to be opportunistic where we see that. You’ve seen that in free already. You’ve seen that in hiring. We’ll continue to evaluate our acquisition opportunities as we look through that. But we’re very positive about what that means to us going forward.

Ari Terjanian

Great. Thank you so much.

Operator

And your next question is from the line of Alex Kurtz with KeyBanc.

Steve Enders

Hi, this is Steve Enders on for Alex. Thanks for taking the question. I just want to get a better sense of how your partners and sales teams are adjusting to work-from-home initiatives and their ability to drive expansion within your largest customers. And secondly, I want to get a better understanding of, I think you mentioned that you’re looking to hire more people and focus more on the R&D side. But where are the biggest opportunities for investment in the product and R&D teams now? Thank you.

Jay Simons

Hey, Steve, I’ll take the first part. I mean, our sales teams – our direct sales teams are all largely inside, and so – inside teams. And so – they’re working largely either from home. They’ve did work from home in the past or they work in offices, engaging with the customers. So I think that rhythm hasn’t really changed.

Partners are in market with customers. And so I think there’s an impact there for our partners that can’t meet with customers. But we’ve been working over the past 10 years to help digitize like our solution partners. And so the way that we market, co-market with them, the way that we help generate demand in market combines both offline, which may have a little bit of a pause until we can get back to a different – the old normal. But we complemented that with a whole bunch of online digital demand capability that we will open to them. Just in terms of building pipeline and letting them serve customers, I don’t anticipate that we’ll have too much of an impact.

James Beer

Yes. And if I could just briefly interject on that, Jay, just to support that, I’ve been pleased with as I said earlier, we’ve been tracking very closely all aspects of our financials in April and partner performance has been tracking well. And one of – I guess I can comment on the second part of that in R&D.

Jay Simons

I’m sorry, I can jump in and take the second part of that in R&D. Look, we still believe we have a massive number of opportunities to invest in R&D. The highlights are certainly things like Trello and Toggl advantage of the change in work style. As more companies are working from home, tools like that are obviously becoming more valuable, Confluence for a synchronous communication, things like this. So obviously, in the product set, there’s a lot of opportunities.

Secondly, we’re in the midst of a decade-long transition to our singular Atlassian platform, the Teamwork Platform. That’s not a simple exercise. It’s going to continue to take us years to build out, even though we’ve done really good progress so far. You’ve seen lots of examples about the new collaborative editor rolling out in Confluence, which is a huge change, involves a lot of changes in identity and other key parts of our platform as they roll through different products.

And then thirdly would be in the enterprise segment, right? We’ve talked about cloud enterprise, the new addition that we put into early access program this year. That’s a massive amount of infrastructural and calculated changes in how we operate our products to meet the demands of our largest customers and scale them in the cloud. That’s not a one-and-done exercise. That’s a continued R&D investment and requires large-scale changes in our infrastructure and how we deploy products, how we work with data residency, how we work with security, how we work with our company’s own networks, et cetera, and still provide the flexible cloud products that we do and scaling for those needs. So you’ll see us continue to invest largely all across the board, but hopefully those are the three useful examples of areas where we are investing.

Steve Enders

Yes, very helpful. Thanks guys.

Operator

Your next question is from the line of Derrick Wood with Cowen.

Derrick Wood

Great. Thanks for squeezing me in. First question, James, with respect to guidance. If I look at the midpoint, it does imply sequentially down revenue for Q4. And I guess I’m just trying to understand the kind of bigger levers in driving that. Does it increase the dollar churn? Or should we think maybe there’s more trade down to pre SKUs or perhaps an acceleration of on-prem to cloud? If you could give some color there, and then I’ve got a follow-up.

James Beer

So it just points to really three different thoughts. First of all, recall my earlier comments about pull forward activity, so I would expect what we benefited from in Q2 in terms of a pull forward effect. That’s drawing from both Q3, Q4 and probably the next two quarters of fiscal 2021. So I think that’s important to bear in mind.

Yes, as Mike talked about earlier. We have fully rolled out free as the default option for our entry-level customers. So I would say that the effect there is quite modest. We guided at the start of this year to the impacts that we thought would occur from free during the year, and it was one of three components of a one-point headwind to revenue growth. And I feel as though we’re tracking well to that. And then obviously, we’ve been talking about the impacts of COVID generating the macroeconomic sort of circumstances that are impacting some of our SMB cloud customers in particular.

Derrick Wood

Okay. I guess a broader question. I mean, I would imagine there’s a lot of people that are looking for cost optimization right now. Maybe that gives you a window to attract more IT people to your platform. You’ve got low cost particularly around Jira Service Desk. So can you talk about maybe some new initiatives you guys are thinking about doing to target the IT buyer more aggressively in this environment.

Jay Simons

Yes. I mean, Derrick, we believe it’s an ongoing focus for us. IT is, as we’ve talked about, is an increasing place that we can land with JSD. And to your point, like we agree, we are, I think, a value choice and a high product quality choice. And that combination, I think, sets us up well in this environment. We’ll continue to talk about the IT service management and IT, kind of broad collaboration, service collaboration areas that we focus on, both across JSD and with Opsgenie, and with Confluence and Trello. I mean, there’s we’ve got, I think, a really rich portfolio that we can talk to IT about both to help serve the problems that they’re trying to solve internally for themselves, but more importantly, for the problems that they’re in charge of for their companies.

Derrick Wood

Thank you.

Operator

And I will now turn the call back over to Scott Farquhar for closing remarks.

Scott Farquhar

Thank you, everyone, for joining our call today. We appreciate your ongoing support, and we hope that you and your loved ones remain safe and healthy. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.





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Bond investors batter bloodied Pemex with no relief in sight By Reuters


© Reuters. FILE PHOTO: The Pemex logo is seen at its headquarters in Mexico City

By Stefanie Eschenbacher and Rodrigo Campos

MEXICO CITY/NEW YORK (Reuters) – Since Petroleos Mexicanos lost its coveted investment grade rating earlier this month, bond investors have punished the Mexican state oil company, with no clear sign of how the government plans to turn its fortunes around.

President Andres Manuel Lopez Obrador has promised to revive the company known as Pemex, but it remains saddled with more than $100 billion in financial debt. In the first quarter, it posted a staggering $23.6 billion loss.

The grim outlook is becoming increasingly costly, with spreads between Pemex bonds and those of its nearest peer, Petroleo Brasileiro (Petrobras) (SA:), widening sharply.

“Bond holders are pricing in a higher probability of default for Pemex than for its high yield peers,” said Patti McConachie, an analyst at Columbia Threadneedle Investments, which invests in Pemex.

“When you compare Pemex to peers that are also exposed to oil price volatility, and owned by sovereigns, their spreads to their sovereign bonds are much tighter relative to Pemex.”

Through March, investors sought some 330 basis points more yield on average to hold a 6.5% Pemex bond due in 2027 than a Petrobras 7.375% bond due the same year .

The gap jumped to 470 bps through April, Eikon Refinitiv data shows. Relative to the U.S. five-year note, the 2027 Pemex bond has a spread of 1,090.8 basis points while Petrobras’ stands at 661.5 – a near 430 bps difference, even though both companies have the same credit rating. A year ago, the gap was 77 bps.

(GRAPHIC: https://tmsnrt.rs/35judkI)

Once Pemex began nearing junk status last year, banks warned that investors whose mandates required them to hold investment grade assets would start dumping billions of bonds.

As many as 75% of active investors, including the majority of pension funds, have done so already, Citi estimated. Passive investors, which track indices, will follow suit once Pemex drops out of indices at the end of April.

Investors said Lopez Obrador needs to give some indication he will either change tack, or find some way of finding breathing space for the company.

But he has so far refused to allow new private sector tie-ups for Pemex or water down his plans for an $8 billion new oil refinery – policy shifts that could cheer the market.

Meanwhile, the price to insure against the risk of a Pemex default has risen sharply. Credit default swaps insuring Pemex five-year bonds rose by 255.1% over the year on Thursday and by 164.7% for the 10-year bond, Refinitiv data shows.

Investors with strong nerves see a buying opportunity, arguing Pemex will be propped up. But the rising risk perception increases borrowing costs for Pemex, making it harder for Lopez Obrador to finance plans to increase crude output, boost refining or contain liabilities.

TOO BIG TO FAIL

Fitch Ratings downgraded Pemex’s bonds to junk in June.

The second junk downgrade, by Moody’s (NYSE:) Investors Services, came after months of warnings that Lopez Obrador was not doing enough to put Pemex’s finances on a sustainable footing.

Lopez Obrador has not addressed the descent to junk status and his finance ministry responded only by saying Mexico itself still had favorable access to credit markets. The government has yet to say what new measures it will take to stop the rot.

In a letter to investors, Pemex reiterated it had the “absolute backing” of the government.

Pemex also said ratings agencies had cited the impact from the coronavirus outbreak as a reason for the downgrade. In fact, Moody’s had cited Lopez Obrador’s policies only days earlier, and underlined the pandemic was not the decisive factor.

The president’s single-mindedness and tendency to dismiss orthodox economic arguments he associates with privileged elites have reinforced expectations he will not change course.

“The market is reflecting the fact that (Lopez Obrador’s) flagship policies are key drivers of the company’s need for material sovereign support, and that his economic policies make it more difficult to deliver that support,” said Gorky Urquieta, co-head of the emerging markets debt team at asset manager Neuberger Berman, which invests in Pemex bonds.

Noting that Mexico’s sovereign bonds are almost trading flat to Brazil, whose debt is rated junk, Urieta said the downgrade appears to have had “no impact” on Lopez Obrador.

But having hitched his fortunes to Pemex, investors may take some consolation in knowing the president is highly unlikely to allow the company to go under.

“The bad news is the government has still not gotten the message from rating agencies and markets, which means things will probably get worse before they get better,” said Aaron Gifford, an analyst at asset manager T.Rowe Price, one of the top investors in Pemex bonds.

“Pemex is too big to fail, which means extraordinary support will ultimately be forthcoming,” he added.





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Mortgage rates fall to new record low — here’s why some loan applicants won’t be offered them


Mortgage rates have dipped to a record low for the second time in as many months amid the global coronavirus outbreak.

The 30-year fixed-rate mortgage dropped to an average of 3.23% during the week ending April 30, a decrease of 10 basis points from the previous week, Freddie Mac
FMCC,
-1.21%

reported this week. This represents the lowest level since Freddie Mac began tracking this data starting in 1971. A year ago, the 30-year fixed-rate mortgage averaged 4.14%.

Previously, the 30-year fixed-rate mortgage hit an all-time low back in early March, when it dropped to 3.29%. Before that, the lowest rates recorded were seen back in November 2012 in the wake of the recession, when the average rate for a 30-year fixed-rate home loan fell to 3.31%.

Meanwhile, the 15-year fixed-rate mortgage dropped nine basis points to an average of 2.77%. The 5-year Treasury-indexed hybrid adjustable-rate mortgage averaged 3.14%, down 14 basis points from a week ago.

Read more:Only 50% of Americans believe it’s a good time to buy a home, an all-time low, Gallup poll says

Freddie Mac’s report is based on a survey of lenders, and it reflects the dollar volume of conventional loans, meaning loans eligible for purchase by Freddie Mac or Fannie Mae
FNMA,
-2.82%
.
The survey therefore does not reflect movements in rates for loans backed by other agencies, such as the Federal Housing Administration or the Department of Veterans Affairs. It also doesn’t include rates for jumbo loans.

But whether borrowers get a loan featuring a record-low rate will depend on a number of factors. “While some borrowers could be quoted rates close to the lowest they’ve ever been, others either with less-than-excellent credit scores or seeking an atypical loan type — like jumbo or FHA loans — may be offered a much-higher rate,” said Matthew Speakman, an economist with real-estate firm Zillow
ZG,
-3.20%

.

In recent weeks, some banks have begun tightening the standards prospective borrowers must meet in order to get a home loan. Mortgage companies have become stingier in terms of who they’ll lend to because of the risk posed by the current economic environment.

There’s an increased chance that a borrower could lose their job soon after getting a mortgage, which would make it much more difficult for them to make their monthly payments. Lenders are eager to avoid that at a time when some 3.5 million homeowners have already requested relief from making their monthly mortgage payments.

Also see:More than half of renters say they lost jobs due to coronavirus: ‘They could face housing situations that spiral out of control’

Nevertheless, in spite of the challenges people may face getting a low-interest rate mortgage, Americans continue to apply for new home loans in droves. “These low rates are driving higher refinance activity and have modestly helped improve purchase demand from their extremely low levels in mid-April,” said Sam Khater, Freddie Mac’s chief economist.

Last week, the volume of refinance applications was more than three times larger than it was a year ago — a reflection of the appeal of low rates, according to data from the Mortgage Bankers Association. The number of Americans applying for loans used to purchase homes, while 20% down from last year, had nonetheless improved after hitting a five-year low.

But low rates won’t be enough to change the tides in the housing market, experts said. The number of listings of homes for sale continues to decrease as home buyers and sellers across America have grown wary of making such a large transaction given the state of the economy.

“Many buyers — stuck at home and worried about their jobs — have hit the ‘pause’ button,” George Ratiu, senior economist at Realtor.com, said. “With financing less of an incentive and inventory disappearing, we will see a sharp contraction in sales over the next two months.”



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Valley National Bancorp (VLY) CEO Ira Robbins on Q1 2020 Results – Earnings Call Transcript


Valley National Bancorp (NASDAQ:VLY) Q1 2020 Earnings Conference Call April 30, 2020 11:00 AM ET

Company Participants

Travis Lan – Director of Investor Relations

Ira Robbins – President and Chief Executive Officer

Mike Hagedorn – Chief Financial Officer

Tom Iadanza – Chief Banking Officer

Conference Call Participants

Frank Schiraldi – Piper Sandler

Alex Lau – JPMorgan

Matthew Breese – Stephens Inc.

Collyn Gilbert – Keefe, Bruyette & Woods, Inc.

Steven Duong – RBC Capital Markets

David John Chiaverini – Wedbush Securities

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2020 Valley National Bancorp Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to your speaker, Mr. Travis Lan, Director of Investor Relations. Please go ahead.

Travis Lan

Good morning, and welcome to Valley’s first quarter 2020 earnings conference call. Presenting on behalf of Valley today are President and CEO, Ira Robbins; Chief Financial Officer, Mike Hagedorn; and Chief Banking Officer, Tom Iadanza.

Before we begin, I would like to make everyone aware that you first quarter earnings release and supporting documents can be found in our company website at Valley.com. When discussing our results, we refer to non-GAAP measures, which may exclude certain items from reported results. Please refer to today’s earnings release for reconciliations of these non-GAAP measures.

Additionally, 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 and the impact of the COVID-19 pandemic. Valley encourages all participants to refer to our SEC filings, including those found on Form 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements.

With that, I’ll turn the call over to Ira Robbins.

Ira Robbins

Thank you, Travis. Good morning, and welcome to those of you that have joined the call today. On behalf of the Valley team, we hope that you and your families remain safe and healthy during this challenging time.

This morning, I will update you on efforts that we have taken to support our employees, clients and communities amidst the COVID-19 pandemic. Mike will then offer details on the financial results, CECL implementation and our recent liquidity initiatives before opening the call up to your questions.

The global health crisis brought on by the spread of COVID-19 has quickly changed our world in many ways. For the first time, our management team is hosting this quarterly call remotely. This is consistent with our business continuity plan, as well as the social distancing guidelines and work-from-home procedures that have become the norm.

COVID-19 has also brought significant and rapid changes to the operating environment for our company. For the last few years, we have messaged our ongoing technology transformation and tailored [ph] the significant strength, diversity and depth of our management team.

Over the last two months, these forces have come together and driven Valley’s swift and decisive crisis response. Our agile technology enabled a quick and effective work-from-home transition for 93% of our non-retail employees.

Further, we leveraged our technology platform to create an efficient digital application process for the SBA’s Paycheck Protection Program, which I will highlight in more detail momentarily.

In February and early March, our finance and treasury teams were quick to lower deposit costs in response to declining interest rates. These efforts were made possible by an engaged and flexible response from our deposit operations team and branch network and help to offset earning asset yield pressure and insulate our net interest margin during the quarter.

While we were well ahead of our local competitors in our deposit repricing actions, we still saw strong growth this quarter in our non-interest bearing, transaction and saving balances, which speaks to the underlying strength of our entire deposit franchise. These actions position us well from a margin perspective entering the second quarter.

Our experienced management team also quickly identified potential industry-wide liquidity stresses and acted to fortify our liquidity position. These actions and so many others in the last few months, directly validate our strategic technology focus and our longer-term efforts to deepen and diversify our management team.

Further, I believe the current environment, coupled with our success over the last couple of months, reinforces the strategic vision that we have outlined, one which encompasses leading technology infrastructure to support the human element of banking. Banks like Valley are meaningful, meaningful to our economy, meaningful to our communities.

We provide a differentiated customer experience, which blends technology with live bankers. It’s not difficult to look to the future and understand the value of having a motivated and knowledgeable team, supported by leading-edge technology to drive relationship banking.

Before I turn the call over to Mike, I want to highlight a few of our other key responses to the COVID-19 environment. With regard to our employees, I previously mentioned that 93% of our non-retail employees have been enabled to work remotely. This has required a coordinated distribution of laptops, other hardware and remote support. Valley has also paid $1.8 million in special bonuses to our hourly and part-time employees and agreed to cover 100% of out-of-pocket medical costs associated with the COVID-19 virus.

From an operations perspective, approximately 36% of our branches are currently closed, with the rest offering either drive-up service or lobby service by appointment. We quickly adopted a rotational staffing model in our branches, which has helped us manage health risk and maximize our ability to consistently serve our clients.

There are three other key initiatives that I would like to discuss, which illustrates our team’s dedication to servicing our clients in these unprecedented times. We are helping our commercial and small business clients take advantage of the various government support programs available to them, most notably, the Paycheck Protection Program, or PPP.

As details of this program emerged, we mobilized to develop an online application solution. This eased the application process for our customers and helped us effectively manage the loan submission process to the SBA. By the time the initial phase of the PPP was exhausted a few weeks ago, Valley had originated over 5,000 SBA approved loans, totaling $1.6 billion of volume.

To put the success in perspective, our $1.6 billion of volume is more than 2.5 times the amount of PPP originations that would be expected based on Valley’s asset size. Our median originated loan size was approximately $100,000, and roughly one-third of all of our applications were for those below $50,000. This gives us a sense of our efforts to assist the smaller companies most at risk in the current environment.

We continue to work with our most challenged commercial and retail clients on forbearance solutions. As of April 26, we had approved forbearance requests on nearly 2,600 commercial loans, covering $2.6 billion.

As you can see on Slide 5, excluding taxi medallion deferrals, 97% of the approved commercial deferral balance were for pass rated loans. We have also approved over 3,600 consumer forbearance requests for nearly $450 million of principal balances. While we continue to work with our at-risk borrowers, the inflow of forbearance requests has noticeably slowed in recent weeks.

Earlier this month, we proudly launched our community recovery CD program. This online-only CD opportunity forward social distancing efforts and provides an attractive rate to new and existing deposit customers. Valley is donating 50 basis points of deposits raised under this program back to those in our communities most directly impacted by COVID-19.

We believe this is the first deposit promotion of its kind. We have currently raised nearly $45 million in deposits under this program, equating to a direct donation of $225,000 back to our local communities. We look forward to further marketing this program across our entire footprint and driving additional financial support back into our communities.

In addition to the community recovery CD, we have committed to invest $2 million in New Jersey Community Capital’s Garden State Relief Fund to further support New Jersey small businesses. We’ve also donated $200,000 to food banks in our footprint, which have provided over 2 million meals to those in need.

Throughout this presentation, we will provide additional information on our exposure to industries potentially impacted by the virus and thoughts on the other potential implications to our businesses and mitigating efforts we have taken to address those impacts head on.

Transitioning now to the financial results. In the first quarter of 2020, Valley reported net income of $87 million and earnings per share of $0.21. These results include approximately $1 million of after-tax merger expenses related to the acquisition of Oritani and over $2 million of infrequent expenses associated with Valley’s response to COVID-19.

On a pre-provision basis, results reflect continued progress on our stated goals of consistent growth and improved operating efficiency. On a year-over-year basis, we generated 24% growth in adjusted revenue, against only 11% increase in adjusted expenses. Exceptional progress on these fronts was mitigated in the quarter by a larger provision, reflecting the impact of COVID on the economic outlook.

While Mike will provide additional details, we recognize a $35 million provision in the quarter, of which roughly 50% was related to incorporating a weaker economic forecast into our reserve methodology at the end of the quarter. Even with this significant provision, our adjusted earnings per share decreased only modestly from the first quarter of 2019.

Overall, we are proud of our COVID-19 response and our first quarter achievements. Despite the challenges of the current environment, we will continue to operate the bank in the conservative manner that investors have come to expect and that has served us so well over our history. Our credit losses in the prior crisis were lower than our peers as a result of a strong credit culture and prudent approach to underwriting.

While our geography has expanded since the last crisis, our conservative lending philosophy remains unchanged. We operate in resilient demographic markets that we expect will be quick to bounce back as the environment normalizes. With this in mind, we will continue to manage items under our control and position ourselves for sustainability and success as we emerge from these challenging times.

Now I’d like to turn the call over to Mike Hagedorn for some additional financial highlights during the quarter.

Mike Hagedorn

Thank you, Ira. Turning to Slide 7, highlighting our quarterly net interest income and margin trends. Valley’s reported net interest margin increased to 3.07% from 2.96% in the fourth quarter of 2019. The first quarter’s margin includes 9 basis points of benefit from higher accretion on purchased credit deteriorated loans that resulted from the implementation of CECL.

Exclusive of this, net interest margin on an adjusted basis was 2.98%, up 2 basis points sequentially. This is a continuation of the upward trend experienced in the fourth quarter of 2019, and reflects our success in quickly reducing non-maturity deposit costs, as benchmark interest rates declined in the quarter.

On the deposit side, we continue to experience customer rotation out of CDs and into non-interest and transaction accounts. Going forward, we believe that there’s additional room to reprice CDs and wholesale funding sources lower as these liabilities mature. This opportunity is outlined on Slide 8.

Earlier Ira mentioned certain initiatives that we undertook during the quarter to build liquidity and ensure we have the balance sheet resources necessary to respond to our customers’ needs during these uncertain times.

In the last two weeks of March, we added $1.4 billion of FHLB advances with a weighted average term of 4.5 months. By utilizing swaps on a portion of the advances, the all-in cost of these advances will be roughly 20 basis points.

Subsequent to quarter-end, we added an additional $400 million of short-term FHLB advances and over $1.4 billion in brokerage CDs, with a weighted average term of 8.5 months and a weighted average cost of 1.2%. As a result of our liquidity actions, quarter-end cash and equivalents exceed $1 billion. While this excess liquidity may produce a modest near-term drag on our net interest margin, we firmly believe that these efforts are prudent, given the uncertain environment we currently face.

Slide 12 illustrates the swift reduction in non-maturity deposit costs that we drove in March. CD rates also trended lower in the quarter. And as you saw from the 12-month forward maturity schedule on Slide 8, additional opportunities exist to reprice retail CDs and wholesale funding costs lower should the current rate environment persist. On the asset side, as you would expect, we continue to see yields under pressure.

During the quarter, reported loan yields declined 7 basis points, despite a 10 basis point benefit from accelerated PCD loan accretion. Origination yields declined 17 basis points from the fourth quarter of 2019, as a result of the significant reduction in benchmark rates in the second-half of the first quarter. Despite this pressure new origination spreads increased 12 basis points in the quarter and are up nearly 30 basis points in the last six months.

Moving on, our non-interest income increased 9% from the linked fourth quarter, driven primarily by a $4 million increase in swap fees. Despite strong sequential growth, adjusted fee income was 13.5% of adjusted operating revenue during the quarter, slightly below the prior quarter’s 13.8% level. This decline in the ratio was largely a product of strong net interest income growth, partially attributable to a full quarter’s impact from the acquisition of Oritani.

Swap fees were approximately $14 million during the quarter, as we originated back-to-back swaps on approximately $505 million of notional loans, up from $400 million in the prior quarter. Going forward, we would expect swap fees to return to a lower level, reflecting less overall activity.

Our net residential mortgage gain on sale income declined 13% sequentially, as the volume of loans sold declined to approximately $200 million from $300 million in the fourth quarter of 2019. On a positive note, gain on sale margin increased more than 50 basis points to 2.46%, which partially mitigated the volume decline.

Slide 9 provides an overview of our quarterly operating expenses and the significant progress we have made on the efficiency front. Our reported expenses decreased approximately $40 million from the prior quarter. This quarter’s reported figure includes $1.3 million of merger-related expenses, compared to approximately $47 million of infrequent expenses in the prior quarter. The pre-tax amortization of tax credit investments was roughly $3 million for the first quarter of 2020, down from $4 million in the prior quarter.

Our adjusted expenses, exclusive of tax credit amortization and previously mentioned infrequent items, were $151 million, up $6 million, or approximately 4% from the previous quarter. Roughly, one-third of the sequential expense increase is due to $2 million of COVID-related special bonus and cleaning costs accrued during the quarter. As the Oritani systems conversion occurred in mid-February, we expect full synergies to be recognized in the second quarter.

Last quarter, we told you that we were on track to achieve our adjusted efficiency goal below 51% during 2020. As you can see, we hit that mark this quarter with an adjusted efficiency ratio of 49.3%. As Ira mentioned, on a year-over-year basis, we have generated 24% revenue growth, with only an 11% increase in adjusted operating expenses.

While the COVID operating environment is uncertain, our management team remains focused on efficiently allocating personnel and financial resources to business lines and products that provide the greatest returns on our expense base.

Total loans increased 10% on an annualized basis to $30.4 billion. Growth was strongest in our commercial categories, with CRE and C&I increasing 11% and 14% annualized. As one would expect, given the environment, we did see commercial line utilization, which includes construction tick up to 46% at the end of the quarter from 44% in the fourth quarter of 2019. The most significant increase was noted in our Florida markets.

Since the end of the quarter, line utilization has been relatively stable. Meanwhile, our non-mortgage consumer portfolio declined 3% on an annualized basis, as both home equity and automobile balances fell.

From a timing perspective, growth accelerated throughout the quarter and peaked at an annualized rate of 16% in March. Loan origination in the first quarter totaled approximately $1.4 billion, up 11% from the first quarter of 2019. Since the end of the quarter, COVID-related economic shutdowns in our markets have slowed both new originations and unexpected pay downs.

As traditional origination activity has slowed, we have diverted resources to managing the demands of the Paycheck Protection Program. We received approximately 13,000 loan requests under the PPP, and under the first phase of the program, we originated 5,100 loans, totaling $1.6 billion.

Our median loan size was approximately $100,000. Our expectation is that a large amount between 80% and 85% of loans made under this program will be forgiven and off our balance sheet in the near-term. The remainder could remain on-balance sheet for two years.

As a reminder, loans originated under this program are fully guaranteed by the government. While the loans carry a modest 1% yield, the SBA will pay lenders processing fees of between 1% and 5% per loan based on the size of each originated loan. These fees will accrete through interest income over the life of each loan.

Valley originated $1.6 billion of SBA approved loans in the initial phase of this program and has generated approximately $47 million in expected processing fees from the SBA. This was an extremely successful initiative for Valley and reflected the dedication and efforts of a significant portion of our team.

The overwhelming majority of our borrowers into this program had a preexisting value relationship. However, in select instances, we leveraged our PPP strength to service new clients. In many cases, these new clients brought significant deposit relationships to Valley.

On Slide 11, we detail our outstanding loans to industries, which have primary or secondary pandemic exposure. Approximately $2 billion, or 7% of our loans are to industries that have primary exposure to the pandemic. These include non-essential doctor and surgery centers, the hospitality and foodservices industries, and retail companies.

You will know that 95% of our loans in these segments are currently rated pass under our credit methodology, and we approved deferral requests on approximately 28% of these loans. We also have identified our exposure to industries such as manufacturing and education, which may be less impacted by the virus. Again, you will note the overwhelming majority of these credits are pass rated, indicating strong positioning prior to the COVID outbreak.

While total deposits declined modestly in the quarter, underlying trends were strong as customers rotated out of CDs and into non-interest and transaction accounts. Non-interest bearing deposits increased 14% sequentially on an annualized basis to comprise 24% of total deposits, up from 23% in the fourth quarter of 2019.

Similarly, interest-bearing non-CD deposits rose 23% on an annualized basis. As a result of the quarter’s strong loan growth, our loan to deposit ratio increased to 104.9% from 101.8% at the end of the fourth quarter. While total CDs declined $1.2 billion from December 31, approximately 75% of that was due to the roll off of brokered CDs, which we opted to replace with lower cost FHLB advances.

Overall, retail deposit retention has been favorable today. As mentioned, subsequent to quarter-end and consistent with our multi-phased liquidity plan, we added $1.4 billion of brokerage CDs at favorable terms.

For the quarter, interest-bearing deposit costs fell 19 basis points to 1.40%. This improvement reflects our decision to aggressively manage non-maturity deposit costs lower as interest rates fell.

However, as deposit cost reductions occurred late in the quarter, it may be more useful to point out that in April, our funding costs are trending approximately 50 basis points lower than the first quarter. Largely as a result of enacting our liquidity plan, total borrowings increased by $1.7 billion in the quarter, with the majority of that growth coming late in the quarter.

Specifically, in the last two weeks of the quarter, we added $1.4 billion of FHLB advances, with a weighted average maturity of 4.5 months. As a result of utilizing swaps on a portion of the advances, the net cost to this $1.4 billion is just 20 basis points.

This quarter, we have approximately $2 billion of CDs at a weighted average cost of 2.1% and $2.5 billion of brokered CDs at a weighted average cost of 1.7% expected to mature. Assuming market rates remain relatively stable, we would expect an additional repricing benefit from these maturities, even as we continue to ladder out our funding sources to remain relatively neutral from an interest rate risk position.

Slide 13 of our presentation details our CECL implementation. Our allowance for credit losses increased nearly $130 million between December 31 and March 31, with the increase coming in two phases. On January 1, our allowance for credit losses increased by $100 million as a result of day one CECL adjustments. This was comprised of $38 million for non-PCD loans and unfunded commitments and $62 million for acquired PCD loans.

Exclusive of the PCD reclassification, the transition from incurred loss methodology to life of loan loss methodology added approximately 13 basis points to our reserve. Then during the quarter, we saw an additional $30 million reserve build, which increased our allowance inclusive of PCD to 0.96% of loans. This reflects a $34.7 million provision and $4.8 million of net charge-offs.

Roughly, $6 million of the quarter’s provision was related to lower valuations on taxi medallion loans. Another 50% was due to the incorporation of updated economic forecasts from Moody’s inclusive of the effects of COVID-19 into our multi-scenario CECL model, as well as the conservative reweighting towards Moody’s recession scenarios.

In general, our economic forecast assume a steep drop in GDP in the second quarter of 2020 and a relatively gradual U or L-shaped recovery taking several quarters. From an unemployment perspective, our forecast generally assumes double-digit unemployment for the next few quarters. Future provisioning activity will be largely dependent on the degree that economic outcomes track our expectations.

Slide 14 provides an insight into the quarter’s credit metrics. On a reported basis, our non-accrual loans more than doubled to $206 million, or 0.68% of total loans. Roughly, 65% of the sequential increase, accounting for $74 million was due to the reclassification of acquired PCI loan pools to individual PCD loans with related loan reserves under the CECL methodology.

An additional 33% of the non-performing asset increase was due to the transition of $37 million of previously accruing taxi medallion loans to non-accrual status during the quarter. Exclusive of these two items, non-accrual loans would have been unchanged at 0.31%.

You can see the growth in our capital ratios and tangible book value on Slide 15. Our tangible common equity ratio declined to 7.3% from 7.5% at December 31, but remained significantly higher than 6.6% a year ago. The reduction from December is primarily a result of strong asset growth in our excess liquidity position. We estimate that our excess liquidity dragged on our tangible common equity ratio by approximately 11 basis points.

Recall that the tangible common equity ratio was also impacted by about $28 million as a result of the non-PCD portion of our day one CECL adjustments. We believe that we have sufficient capital to support our growth opportunities and to absorb additional provisions should our economic outlook deteriorate further.

Depending on the timing of PPP loan forgiveness, we could see further tangible equity capital ratio declines in the second quarter. All else equal, we estimate that each $500 million of PPP loans remaining on the balance sheet would temporarily reduce our tangible common equity ratio by 10 basis points. However, we expect the majority of these loans to be forgiven in the near-term, and there will be no impact to regulatory ratios.

Last quarter, we provided 2020 guidance for key elements of our business. On an annualized basis, our first quarter results exceeded our guidance for loan growth, net interest income growth and efficiency putting us on track for a very strong year. However, with the backdrop of this global health crisis, we have decided to eliminate our guidance.

While we continue to learn more each day about the potential impact of this global health crisis on the banking industry and Valley specifically, there’s simply too much uncertainty to confidently provide financial guidance to our analysts and investors.

With that, I’ll now turn the call back over to Ira for some closing commentary.

Ira Robbins

Thanks, Mike. Obviously, our prepared remarks this quarter are somewhat different from what we have provided in the past. These are unique and challenging times. However, I would like to reiterate that on all fronts, Valley’s response to the crisis has been swift and decisive and early outcomes have been positive, all largely reflective of a strong leadership team we have assembled.

I firmly believe in times like this, our ability to be agile, proactive in our focus, steadfast in our strategy and commitment to Valley combination being an unbelievable differentiator for Valley and our shareholders. We will continue to operate with a sense of urgency and navigate the uncertain future with an eye to the future and the unbridled opportunities now available.

With that, I’d now like to turn the call back over to the operator to begin Q&A. Thank you.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Frank Schiraldi with Piper Sandler. Please go ahead.

Frank Schiraldi

Good morning, guys.

Ira Robbins

Good morning, Frank.

Mike Hagedorn

Good morning.

Frank Schiraldi

Just on – I wonder if you could talk a little bit about your provisioning – your thoughts on provisioning going forward. It sounds like you’ve captured sort of a lot of what the models spinning out right now – currently in terms of this first quarter provision. But is there another leg up in your mind later in the year when you start to see some of these quantitative factors form in terms of if it’s – whether it’s increased NPAs or ultimately increased charge-offs? Thanks

Mike Hagedorn

Hi, Frank, it’s Mike. I’ll take a stab at this one. The CECL models, regardless of who has them are primarily dependent upon the loss history. So these are probability of default, and then loss given default models. So the loss history that you have built into your model is going to be the primary driver of what your future view your life of loss loan would be.

However, I do want to point out, and I hopefully talked about this in my prepared remarks. We made a change late in the quarter to look at a more severe scenario as more and more information was coming out related to COVID. And so we use a blended model of various economic forecasts from Moody’s to come up with that economic forecast. And in the end, that change resulted in GDP reductions of 24% in the second quarter and U3 unemployment of 12.5%, which we think right now that should cover, as we see it today, the loan losses.

Ira Robbins

And maybe just following-up a bit on that, Frank, if we were to use the Moody’s model as of mid-April, we would have only seen about a $5.5 million increase when that reserve number was. So I think we were pretty aggressive.

Back to your point regarding the quantitative metrics, I think, that’s the challenge for all of us and looking at what the reserves look like today. We’re not going to know until third quarter until many of these loans come off of deferral as to what the impact is to some of this quantitative metric that Mike talked about before.

Frank Schiraldi

All right. Okay. And then just a follow-up. In terms of – as you guys are doing your internal stress testing, when you look at your severely adverse scenario, anything you can share with us in terms of how comfortable you are with what sort of capital cushion you’re left with after losses in that scenario? And how comfortable you are with the dividend in a scenario like that? Thanks.

Mike Hagedorn

Sure. So if you look backwards at the 2018 severely adverse scenario, we believe, based upon that, that our 0.96% reserve would cover approximately 0.87 times the cumulative severe loss rate. From our looking at other people that have reported so far, we think their numbers are closer to 0.5x or 0.6x. So we think we’re in a pretty good position there.

And I would say, ultimately, the Moody’s S3, which would be the more significantly adverse scenario, we’re at 0.91. So on a relative basis, we feel pretty good about where we came out.

Frank Schiraldi

Okay. And then the dividend in terms of in those scenarios, I would assume, given where you come out that the dividend is part of that stress testing?

Ira Robbins

Absolutely and we run, obviously, as Mike alluded to a lot of different stress tests over the years, a lot of them based on the severely adverse scenarios that were provided by the FRB, as well as our own internal stress test, focused on some of the other variables that we think drive performance within the organization.

Right now, when we look at those stress performances, we think we have sufficient capital. I’ll just highlight. Last year, at this time, we were sitting at 6.63% as a TC to TA. Today, we’re sitting at 7.30% – 7.31%. Our Tier 1 leverage ratio went from 7.58% to 8.24%. Tier 1 risk-based went to 9.38% to 9.95%.

If you go back to when we started back in 2007-ish timeframe, we were only sitting at a TC of 6% when we entered the last major recession. So I think, as an organization, we’re in a much stronger position than we were previously.

Operator

Thank you. Our next question will come from Steven Alexopoulos with JPMorgan. Please go ahead.

Alex Lau

Hi, good morning. This is Alex Lau on for Steve.

Ira Robbins

Good morning, Alex.

Alex Lau

First question on NIM. So with pressure coming on from the earning asset yield side, how do you think about how much deposit costs can offset this? And what do you think about the trajectory of net interest income and NIM into the next quarter?

Mike Hagedorn

So first, I would say that, we’re working hard to protect our NIM, and we have some tailwinds, I think, that make us a little unique right now in the space. First, as you see on Page or on Slide #8, you can see the repricing that we have that’s going to occur in the second quarter for both our originated CD book, as well as the brokerage CD book.

When you look at that and combine it with the non-maturity and, frankly, all other deposit repricing that we did, and we did that early when the Fed reduced rates and we were fairly aggressive. And as I said in my prepared remarks, we went from a total cost on the non-maturity side of 1.04%, another 50 basis points down. We think we are doing about as good a job there as we can to protect the NIM. While admitting clearly that on the earning asset side, yields are going to go down, but also we put floors in to kind of protect the NIM there as well.

Alex Lau

Thanks for that. And then just on your Slide 11, where you give COVID exposures by loan segments, you mentioned that there’s 70% of that are secured by real estate. In this breakdown, in this table, are there any segments that have a larger exposure to those not secured by real estate? And could you give some color on credit quality if there is?

Tom Iadanza

Yes, sure. This is Tom Iadanza. Looking at those high-risk and I’ll just pick the hotel and hospitality as the first one. 45% of our portfolio has requested has been approved for deferment. 100% of that portfolio is secured by real estate, with an origination loan to value of 59%.

When you kind of go down each and every one of these, the only one that probably has a low percentage that retail trade, which represents auto dealerships. 50% – a little over 50% of that portfolio is real estate secured, the balance is floor plan. But in general, it’s not a big portion of the deferment, it’s not a big portion of our overall portfolio.

In the restaurant space, very similar trend to the hotel space, pretty much 100% secured by real estate, loan-to-value more in the 65%. In each of these categories, we carry personal guarantees. So we believe it’s fairly well protected. But there’s still uncertainty as to when they come out. In Florida, they announced – the governor announced that he is going to allow restaurants to open shortly, but with a lower occupancy than they would be normally permitted to have.

Operator

Thank you. Our next question will come from Matthew Breese with Stevens. Please go ahead.

Matthew Breese

Hey, good morning.

Ira Robbins

Good morning, Matt.

Mike Hagedorn

Good morning, Matt.

Matthew Breese

Just going back to the reserve. Is there any unamortized marks that you have? And could you quantify that?

Mike Hagedorn

Well, there are $6.3 billion of PCD loans remaining in the mark and that is $87 million over eight years. Other than that, no. So…

Matthew Breese

Okay.

Mike Hagedorn

…if you think about that, that’s gong to – we think that’s going to level off. Obviously, we don’t control those loans prepay and you’d accelerate. But no, we think that’s going to level off.

Matthew Breese

And should we think about that $87 million combined with the allowance as it stands today?

Ira Robbins

You certainly could if you want to. It obviously doesn’t go through allowance. It goes through interest income and then finds its way hopefully to retained earnings. But you could.

Matthew Breese

Okay.

Tom Iadanza

It does go and talk calculations on that. So when you look at how we’re thinking about it, when you look at LGDs and PDs and what we think we need to reserve, that $87 million is definitely not a component of it.

Matthew Breese

Okay. And then, can you talk a little bit about what happened with the early-stage delinquencies this quarter, commercial real estate, especially? What happened? Why the increase? Can you just give us some color on the larger credits and relationships that you referenced?

Tom Iadanza

Sure. It’s Tom again. There was about $48 million increase in the commercial real estate space. $20 million of that was administrative, current for payments, but the loan had matured. All of that has been renewed and is now off past due. The remaining balance was just a mix of low loan-to-value loans that are chronically late in that 30-60 [ph] bucket, but they pay, they stay within those buckets. And our loan-to-value on those is probably sub-40%. And there’s no large – no single large exposure within that category. It’s a group of smaller loans.

Operator

Thank you.

Tom Iadanza

I’m sorry. Go ahead.

Operator

No, you go ahead, sir.

Tom Iadanza

There is a residential piece in there and is about $18 million. Nine of that is current for payment now and removed. And the other was deferments requested prior to the end of the quarter, but we didn’t process until April.

Operator

Thank you. Our next question comes from Collyn Gilbert with KBW. Please go ahead.

Collyn Gilbert

Thanks. Good morning, everyone.

Ira Robbins

Good morning, Collyn.

Collyn Gilbert

Just to touch on the reserves and your CECL outlook. And kind of Mike, as you had indicated, so much of what drives the CECL model is your historic loss rates. Overall, when you gave that 91% or so of the reserve now accounts for the Moody’s S3 forecast, that’s really impressive. I think, I guess, my question is, just how are you quantifying the change in the book, right? I know, Ira and I know the culture at Valley, like you guys are so committed to your conservative underwriting standards. But the reality of it is the book changed, right? You’ve moved into different geographies, a lot of the growth or – you’ve accelerating your growth over the last couple of years. So you could argue late cycle asset adds. Just kind of walk us through that, how you’re thinking about the change in the portfolio today relative to what it was pre and post-crisis?

Ira Robbins

Let me just start and then I’ll turn it over to Mike and Tom. Look, we’re definitely acknowledging we are in some different geographies than what we were in prior. But keep in mind when we went into Florida, we are pretty selective about the banks that we looked to emerge with and then even further selective as to the assets that we put on.

If you recall on the CNL transaction, we actually throughout – or not throughout, but let run off about 15% of the book just because it was an asset classes that we weren’t comfortable with. We have a specific asset credit philosophy within this organization, and that does not change irrespective of what geography that we’re in.

The borrowers that we look to, those are the people that are the ones that are supporting the individual loan. It’s not a transaction, what the borrower’s exposure is when it comes to contingent liabilities, what their liquidity looks like. These are our core philosophies that we have within the entire organization that we propelled across the entire geography that we’re in.

I think we’ve been in some of these geographies for a long enough time that the book represents how we lend, who we are and not necessarily what traditional experience would have been for some other lenders in these markets. And Mike and Tom have some other thoughts.

Mike Hagedorn

Coming into this earnings season, we knew that people were going to have a difficulty. And when I say people, I mean, on the analyst side, we’re going to have difficulty trying to look at what does a 0.96% allowance coverage ratio at Valley? What does that mean when you look at it across the universe of other mid-size banks?

I would just point you to the fact that our allowance as a percent of loans increased 75% from fourth quarter to first quarter. And by our estimation, our peer group only was up 50%. Why is there a 25% differential? Two things mostly driving this. One, the fact that we used a pretty severe Moody’s economic forecast, a combination of several of their forecast.

And then maybe more importantly, to your question Collyn, we also use a – we should have talked about this earlier. We use a qualitative overlay on top of the model as well to account for things that aren’t accounted for in the history in the portfolio. One of those being the Florida portfolio, as an example. So we put on additional loss history for the industry, because we don’t have it ourselves to increase our reserves as well.

Tom Iadanza

And just to add a little bit to that, Collyn. When you look at the metrics of our portfolio, there is no concentration by region, by loan type, by size, we’re still very granular. Our production in the first quarter, our average real estate loan is less than $3 million on our average C&I loan is less than $1 million. So we continue to do the same things that we’ve always done.

Looking at it, over 50% of our business is generated from a long-term valued customers. And the balance comes from new customers that we actively been soliciting for years and are all well known to people within the bank. So it is about relationship banking. It is about knowing and it is about being very granular in how we proceed and how we do our business.

Collyn Gilbert

Okay. That’s great, additional color. And then just my one follow-up to that would be, and you sort of touched on this. But just as we look at your Slide 11, where you go through the exposed loan segments, obviously, how Florida and New Jersey and New York are behaving through this pandemic are very different? Just curious as to if you have kind of the geographic split between what’s up in these markets versus what’s in Florida in terms of your loan exposures, and then also to where you’re seeing deferral requests?

Tom Iadanza

Yes, sure. The deferral request is pretty much along the lines of the percentage of portfolio we have in each market. We’re not seeing any higher in any one of the regions. Our hotel portfolio, which I described earlier being real estate secured lower loan-to-value going into this is for the most parts more Florida-related than New York, New Jersey-related as is our restaurant portfolio, which again, I described as reliance on real estate at a 65% loan-to-value. Other than that, it’s as dispersed as you would expect within the regions.

Operator

Thank you. Our next question comes from Steven Duong with RBC Capital Markets.

Steven Duong

Hi, good morning, guys. Just going on that regional breakout, do you guys have the breakout of what’s actually in New York City itself for that COVID exposure?

Mike Hagedorn

Yes. We have it broken out by location and by type. The largest exposure in New York City are that we’re realizing our ambulatory centers. We don’t have a big restaurant or hotel exposure in New York City, if any at all. So it’s mostly ambulatory centers, which is a relatively small dollar amount. I think it’s in the $90 million range where we have those in the Manhattan market.

We break it into three. 80% of it is affiliated with large hospital systems or necessary care being cancer treatment or knee replacement and 20% is broken into elective surgery. So when you look at that, the hospital affiliations will be fine and they’ll come back. The necessary care will be fine and they’ll come back. The cosmetic care will take a little bit longer to come back.

Each of that portfolio is secured, that portfolio carries guarantees from the hospital systems, as well as the physicians that are all and on the latter category. But we haven’t really seen much in office. We haven’t really seen much in multifamily coming out of the Manhattan market.

Steven Duong

Great. That’s – appreciate the color on that. And then your CET1 ratio just declined a little bit. Was that just purely the adoption of CECL?

Ira Robbins

I think that was a little bit of the adoption of CECL. But keep in mind also, we put on additional liquidity during the period and the additional liquidity had a negative impact as well during that first quarter.

Steven Duong

Great. Thanks, Ira.

Ira Robbins

Yep. Thank you.

Operator

Thank you. Our next question will come from David Chiaverini with Wedbush Securities.

David John Chiaverini

Hi, thanks. A couple of questions. Starting with the discussion on NIM. It was mentioned earlier in the call about how the deposit inflows positions Valley well for the second quarter. And then later on it was mentioned about how the excess liquidity that’s coming on the balance sheet could pressure NIM in the second quarter and then furthermore, April funding costs being down 50 basis points, certainly a good thing. So long way of saying, are you willing to disclose how much – when we look at April, the earning asset yield, are you able to disclose how much the earning asset yield is expected to come down thus far in April?

Mike Hagedorn

Not at this point, obviously, because we’re disclosing first quarter results. But clearly, the the pressure of just rates coming down generally are putting pressure on our earning asset yields. And as we said, we have a lot of cash built up.

You might ask, why did we do that? Early on in this crisis, we decided that putting on some amount of liquidity was just prudent, because it was so uncertain as to where this was going to go. And keep in mind that was before things like the PPP Liquidity Facility even existed.

So one of the things that we feel pretty strong about is, we have the ability right now to fund all of our PPP loans with the liquidity we’ve built up without even using any of the government’s facilities. Now we may do that. I’m not saying we wouldn’t use it. I’m just saying that our liquidity build put us in a position where we had options.

David John Chiaverini

That’s helpful. Thanks. And then my follow-up is on expenses. You mentioned about how the full synergies from Oritani should be achieved in the second quarter with the conversion – the system’s conversion in the first quarter. Can you remind us how much in expense savings you’re expecting to get from that?

Mike Hagedorn

We’ll have to get back to you with an exact number. I can give you one of the main components of it that I think you would probably care to know about. Oritani salary expense for the month of December, remember, we only had them for about one month in the fourth quarter was $1.3 million.

And so on a quarterly basis, that would be $3.9 million. But the Oritani salary expense in the first quarter was only $1.8 million, so that’s roughly 54%. And I know on a total basis, our total cost savings right now are running around 70%, just in the first quarter. So we’re almost all the way there and we’ll get the rest of that in the second quarter.

Tom Iadanza

Yes. And just to add, we identified between Oritani and Valley nine branches to the closed through the integration and merger, and those branches weren’t closed until March.

Ira Robbins

And if you keep in mind those numbers weren’t even in the forecast, the cost saves that we provided. So we’ve already well achieved, many of the cost saves or actually all the cost saves that we identified when we announced the merger. I think to Tom’s and Mike’s point, the economic benefit is going to be much more recognized in the second quarter than what it is in the first quarter.

Operator

I’m showing no further questions in the queue at this time. I would now like to turn the call back over to management for any further remarks.

Ira Robbins

So we want to thank you for taking the time to listen in. I know our prepared comments were a little bit longer than what they usually are. I know the document that we provided is a little bit longer as well. But we wanted to make sure that there was transparency with the entire investor community as to what’s going on in our organization, so that you have a clear look through as to what’s happening here. I want to thank Travis Lan who recently joined us for putting together a lot of the information and Rick Kraemer for all your help as well. Thank you very much.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect and have a wonderful day.





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