Q3 2020 South State Corp Earnings Call
And to the South State Corporation third quarter earnings call.
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I would now like to turn the conference over to well Matthew.
Please go ahead.
Good morning, and welcome to self storage third quarter earnings call. This is.
Well Matthews and joining me on this call are Robert Hill.
John Corbett, Steve you on that but of course.
For this call will be that we will provide prepared remarks, well then open it up for questions.
Yesterday evening, we issued a press release to announce earnings for Q3 of 20 <unk>.
We have also posted presentation slides that we will refer to on today's call on our Investor Relations website.
Before we begin our remarks I want to remind you of the comments. We make may include forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
Any such forward looking statements, we may make are subject to the safe Harbor rules.
Please review the forward looking disclaimer and Safe Harbor language in the press release and presentation for more information about risks and uncertainties, which may affect us.
Now I will turn the call over to Robert Hill Executive Chair.
Good morning, and thank you for being with US I'm excited to be with you today and excited for you to hear from John I will talk about the progress the team is making in building South state.
The Centerstate South state partnership was about the long term.
You can clearly see the progress being made in the short term private.
Progress what technology products efficiency, all which have us uniquely positioned for the long term.
But most importantly, it's about having a great team, which we are fortunate to have and are continuing to build.
Our board and our management team are United around the opportunities that are ahead of us and our culture is growing in a healthy way that will only make us stronger in years to come.
On corporate leadership, along this journey has been excellent and I will now turn the call over to John for more insight into the quarter.
Thanks, Robert Good morning, everyone I Hope you and your families are doing well.
In light of the challenging environment I couldn't be happier with the progress our team is making and the financial results that were producing there was a solid quarter.
Adjusting for merger cost the company produced diluted earnings per share of $1.58 cents.
For a 17% return on tangible equity.
Pre provision net revenue grew to $170 million for a pre provision return on assets of 1.8% and tangible book value per share grew at an annualized rate over 15%.
The highlights for the quarter was clearly the profitability of our mortgage correspondent banking units.
We are heavily invested in these fee based businesses when treasury rates fell after the 2016 Brexit vote and.
And now four years later these noninterest income lines of businesses are producing a healthy return on investment.
Two weeks ago, we announced another investment into our correspondent banking division.
With the acquisition of a broker dealer based in Memphis, Tennessee.
Duncan Williams is a 51 year old family for led by the sort of the founder and it's the perfect complement to the fixed income line of business that weve been building for over a decade.
Sales day currently serves nearly 700 community banks nationwide.
And Duncan Williams adds an additional 250 financial institutions to our coverage universe.
This was a negotiated transaction that Steve young and Brad Jones had been pursuing for a year and a half and were very excited to welcome Duncan and his team to South state.
While fee income has been remarkably strong we continue to be faced with industry wide loan growth and margin headwinds as we navigate through the pandemic.
The good news is that our loan pipeline bottomed out in August and is steadily rising every week.
The pipeline is now 24% higher than the low in August and it continues to grow.
As our clients become more confident in the future.
Asset quality metrics improved considerably during the quarter with loan deferrals declining to just 2% of loans.
Oh, the 2% of loans currently on deferral.
Half of those are in fact, making their interest payments.
So really only 1% of loans are the full principal and interest deferral.
And this is the second quarter in a row that we recorded only one basis point and charge offs.
As for the merger integration is proceeding on time and on budget and the encouraging thing to me is that the merger integration isn't slowing our forward momentum in the rest of the bank I can definitely feel the south state team leaning forward and eager to go it all fits to prove with this new franchise is capable of.
One area, where we continue to improve as the south state digital experience.
This month under the leadership of Ray Brooks, we rolled out our new website.
And next month.
We rolled out a new mobile banking app, but it's been in the works for over a year.
Our team is excited to offer a mobile app that rivals the largest banks in the country for customer functionality and convenience.
The pay for these digital investments.
We will be downsizing our branch network by 20 branches this quarter.
Which reduces our branch footprint from 305 branches currently.
The 285 by year end.
Which also increases our average deposits per branch to over $100 million and that's up from 40 million a decade ago.
We're also excited about the huge opportunities that are presenting themselves to recruit the very best relationship managers.
From the largest banks in the southeast South.
South State now has the scale technology and capital markets platform to be the logical alternative for middle market bankers looking to make a change away from the turmoil at the largest banks.
So when I step back and I think about our positioning and.
And the environment that we're operating in.
There are things that we can control and the things that we cannot control.
We can't control the path or duration of the cobot virus and.
We can't control the shape of the yield curve.
What we can control is the $80 million of cost savings to be achieved through a merger and branch consolidation initiatives. We can also control our investments into the future investments in technology.
That's in our mortgage and correspondent banking teams that are not dependent on the interest spread.
And finally, we can make investments a top notch relationship managers and the best growth markets in the country.
So as I think about where this franchise is headed I'm confident we're making the right strategic moves to create value for our owners our team and our communities over the next decade.
And finally, along those lines.
Me to share the news that South state has created a new executive level position.
<unk> director of corporate stewardship.
Well, Don Jones, a 21 year veteran of our company has.
He has accepted the invitation to lead our company is diversity initiatives, our college recruiting and management training.
As well as our EPS Gi community development and employee assistance programs ever.
Everyone at South State is excited for love daughter to his new role and eager to support his leadership as we create a company culture, there will be a source of pride for all of us in the years ahead.
With that I'll turn the call over to will to provide more color on the numbers.
Thanks, John our net interest margin was 322 on a taxable equivalent basis down two basis points from Q2.
Given the June merger closing date and associated purchase accounting marks pre closing security sales on the legacy Centerstate side. The second quarter NIM is not entirely apples to apples comparison, nor is the combined business basis margin of 338 from Q2 as it includes the unmarked centerstate balance sheet and encompassed.
<unk> for the 68 days of the second quarter prior to closing.
Our margin continues to be negatively impacted by the significant liquidity, we're carrying 4.4 billion average for the third quarter. If you were to reduce our balance sheet cash and fed funds sold to 1 billion, reducing deposit funding accordingly, our NIM would be approximately 24 basis points higher.
Loan yields of 435 were up 10 basis points from Q2, reflecting a full quarter of the centerstate loan portfolio and the company.
Accretion was 22 million for the quarter and core NIM, excluding loan accretion was to not a five.
As noted on page six of the release, we had some measurement period adjustments as we finalize purchase accounting marks including a reduction in the loan discount of $29 million.
While this improved capital I'll remind you that it will reduce future accretion accordingly.
Our loan repricing mix is 55% fixed 25% floating and 20% adjustable arts.
Our total cost of deposits continues to improve down to 20 basis points for the quarter.
Our Cds are relatively short was 19% coming due in Q4, I know the 32% and the first half of 21 and 26% in the second half of 21.
[noise] on noninterest income, we had a record $115 million in quarterly noninterest income led by our mortgage correspondent banking capital markets.
Our mortgage team has done a really outstanding job in the midst of a merger of two mortgage James as well as a pandemic with record volume of 1.57 billion, 60% of which was purchased.
And strong margins, resulting in 48 million and revenue.
Our correspondent banking Division continues to show strong results with a $26 million quarter and.
And on that note I'd like to Echo John's welcome to the Dunkin' Williams cheap we're.
We're not disclosing transaction terms due to the size of this acquisition, but we're excited about Duncan and his group joining Brad Jones and his team at helping US grow this business as well as the help it should provide and a very low interest rate environment.
Steve has responsibility for these noninterest income businesses.
They were able to answer questions on them during the Q and a session.
On expenses, our Eni for the quarter was $237 million, including 22 million and merger related expenses for an operating at a rate of 215 billion.
Our efficiency ratio was 55.8% excluding the merger related expenses.
Our expenses for the quarter came in a little better than we expected in part because we have begun to realize some of the merger cost saves thus far a little faster than expected through normal employee turnover and some departure of employees, who will not be retained as well as certain vendor savings we.
We expect that this cost save realization number will continue to increase each quarter with the bulk of the savings coming in 2021, particularly Q3 after system conversion.
Additionally, our expenses for a number of items were down in Q3 due to Covance business development loan related and the Oreo expenses travel expenses.
To some extent health insurance costs are all down due to cobot, but we would expect many of the it to normalize want square up beyond that health crisis.
So the Q3 run rate for several areas is lower than we would expect in a normal non cobot environment.
On merger related expenses, we have recognized approximately half of the estimated 205 million today, some of which occurred on the centerstate pre closing.
Turning to credit our net charge offs remained very low at 594000 for the quarter or one basis point annualized.
Ending npis were 33 basis points of assets down five basis points from Q2 due to a combination of payoffs and upgrades.
Our provision for credit losses was $29.8 million for the quarter 22.1 million of which was for the reserve for unfunded commitments liability.
After running two separate legacy bank Cecil models and combining the results in Q2, we consolidated onto one model and the third quarter and this consolidation of the legacy self state loans onto a different model resulted in the increase in the reserve for unfunded commitments.
For economic assumptions, we used the Moody's baseline forecast that forecast has the unemployment rate for the South Atlantic region, holding at 8.2% for Q3 Q4 of this year.
Before starting to decrease in 2021 with a forecast of 7.4% at year end 2001, and 5.4% at year end 22.
With a provision expense of almost 30 million and net charge offs of less than a million our reserve coverage. Excluding PPP loans grew to 211 basis points, including the reserve for unfunded commitments or 192 basis points, just including the reserve for funded loans.
This brings the allowance to npls to just under four times.
Slide eight outlines our loss absorption capacity ratio, which ended the quarter at 258 basis points.
As John said, our deferrals reduce significantly since our last update dropping below 2% at October 20, Threerd. Additionally, our full PNR deferrals were only 1% that date as almost half of the deferrals are paying interest.
For the effective tax rate our return to profitability in Q3 after the impact of the double count provision and other merger expenses in Q2 caused our effective tax rate to decline a third quarter to 19.6% from the second quarter was 22.6%.
Turning to capital with good profitability at a flat those still somewhat inflated balance sheet, our capital ratios group during the quarter. Our TC ratio grew to 27 basis points ending at 783, our CE tier one and total risk based ratios grew by approximately 80 and 100 basis points respectively.
Ending at 11, and a half and 13.9%.
Our ending tangible book value per share was just shy of $40 at 39, 83 up $1.50 from Q2 and up $1.63 from the year ago quarter.
I will turn it back to you John.
Alright as a reminder, we are conducting this all from different locations. So it's going to be helpful. If you direct your questions to the person that you'd like to respond. This concludes our prepared remarks and I'd like to ask the operator to open the call for questions.
Thank you we will now begin the question and answer session.
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Our first question comes from Michael Rose with Raymond James. Please go ahead.
Hey, good morning, everyone and thanks for taking my questions I wanted to circle.
Circle back to expenses will.
You guys have obviously, some some really good Jeff revenue generation this quarter in the expense were down I understand some of it is is covered related can you just help us from a run rate perspective as the economy continues to reopen hopefully.
You know what are some of those specific add backs. We should think about if you can just remind us how much of the cost news I'm, sorry, if I missed it how much of the cost saves so far you've actually realized thanks.
Sure Michael.
Yeah, we would on the latter part of the question, we would estimate that thus far we have recognized on an annualized basis run rate about 12% to 13%.
The $80 million.
Cost and so call that two and <unk> million for quarter.
You know I.
In the quarter like I said, we had you know we don't have people.
Alistair doing business development efforts, there is lot less travel going on.
Yes, there is not not much really there's not much real estate foreclosure activity in those related expenses and professional expenses associated with that those areas are all down.
I think for a lot of us are not going to the doctor like we.
Also as we add so we're seeing a little bit decline in health insurance and I'd say all of those items combined.
Relative to a more normalized quarter might be might be 5 million or so.
In a quarter roughly and then.
So that's why I just wanted to be clear that while we're pleased that it was down to 215 million.
This is an unusual environment and didn't want to.
Yes people over interpret that as they looked at it we look forward.
No. That's very helpful. And then maybe just switching to the core margin to 95 I know, there's some moving parts in their first full quarter post integration.
As we think about going forward I mean or are there other areas that you guys are working on too.
Kind of optimize the balance sheet and then how does that relate to the ability to.
Prevent.
Or limit NIM compression from here. Thanks.
Sure sure Michael I see.
Let me just kind of talk about a little bit in the broader context around revenue we talked about earlier.
Page 18, we have acquired the deck that talks about our revenue composition over the past four quarters and what you see in there is the revenue composition has changed.
A year ago, we were about 77% NIM, 23%. These now were 30% be 70 for them. So.
Just wanted to draw your attention to that your reported margin as will mentioned was 322, our core margin to 95.
Couple of things on that.
We are core deposit funded bank in great markets, you are checking accounts make up 54% of deposit and our total cost of deposits. This quarter was actually 20 basis points. So.
Yeah, we continue to grow low cost deposits on our retail our small business and our treasury platform, but from a margin perspective, we don't have a lot of room to reduce costs, but we will go as low as we can without cutting at the core.
Let me kind of speed through the components of margin first on the yield on the loan portfolio PPP and accretion. This quarter was for 16, we're pretty new loan production yields this quarter in a 353.
So that continues to be a headwind.
As it relates to will comment on the excess liquidity. So we have about $4.4 billion of average that unfold, probably about $3 billion over a target.
It weighed on our margin about 24 basis points this quarter.
You know if you look at our pre merger our total investment portfolio was right about $4 billion or around 12% of assets.
Right prior to close we sold a billion dollars of the Centerstate portfolio, because it was going to be mark to market around one in the quarter. So as we think about the future of the excess.
Liquidity, we invested about a half a billion dollars this quarter that's.
To get its around three and a half we're likely on a path to get closer to 4 billion by the end of the year.
And then medium term our target for the investment portfolio is around 12% of assets.
Yes, that'll depend upon liquidity it will depend on yield curve, but we also want to make sure that we are not.
Not investing a bunch of capital and the lowest rate environment. We have seen so we are cautious on that particularly as the noninterest income businesses that have been performing one last comment on the securities portfolio. It was the 1.63% this quarter and we're adding purchases somewhere around one of the quarter.
So.
That would be the core margin comment the only other comment was on accretion I think we had $22.4 million. This quarter of course that was elevated we'd expect that to decrease from here.
We have a disclosure in the earnings release that shows Theres about $110 million of discount on the acquired loans.
So with that why don't I turn it over to well if you have any other comments there.
Yes, I think I just would reiterate a couple of things to make sure that we emphasize one is just a reminder, Steve gave about.
The marketing of the Centerstate portfolio in Q2, and the impact we had so you.
You basically had a couple of billion dollar bond portfolio half of what you sold and turn into cash it at 10 basis points and half of which you had the markdown to yield of about half of what it was earning before so that's.
That's that's the impact but the second is probably more important and that is just our long term focus and and trying to make sure. The decisions. We make are ones that were into like the long term. It would certainly be easy to do its earnings a bit if we took that excess cash of $3 billion and invested it.
Pick up a 110 120 basis points over where we are earning today as the fed.
But but we want to be thoughtful and do that over time and not I'm not.
Get aggressive and then regret not months or a year down the road.
If rates have moved back up so we'll be thoughtful about pulling that lever, although it does exist.
Okay. That's all that color is helpful. So I think the way to read that is maybe core margin ex.
GPP in ex accretion income.
You're going to see some pressure here, but you guys are making some investments in the loan portfolio and the pipelines that you mentioned, we will continue to grow so maybe we get to a point, where and I actually troughs on a core basis ex PDP and.
And accretion sometime next year and then starts to build from there is that the kind of the messaging and what to think about it.
Hey, Michael its Steve I think that's a fair way I think you know that that be a tailwind will be you know any of our investment purchases. The headwind is the loan book until it.
Closer to par and with elections and Covidien, although the yield curve is going to move around a lot, but that's how we're thinking about it.
Well there so thanks for taking my questions.
Our next question comes from Stephen Stephen Scouten with Piper Sandler. Please go ahead.
Hi, good morning, everyone.
Hi, Stephen good morning.
So maybe just want to get some clarification on the expenses I want to make sure I heard it correctly on the branch reductions.
It sounds as though that's incremental to the cost saves related to the deal, but that more or less it's going to get we won't be net saving due to investments in digital and other technology investments is that is that correct.
Interpret that right.
Yes, Stephen I think you know.
John can elaborate further but are you know it's hard to separate out.
Between the the merger cost saves, we have as well as the additional investments, we're making in digital and the branch reduction and so we.
Our $80 million goal includes all three of those both both the reduction in expenses from the branch reductions as well as the additional investments, we're making in improving our technology and really it's more of a reallocation of the branch route rationalization entered the digital spend would be the way I'd probably describe it John you might have some that are comments I think you know.
Well I don't have anything to add.
Perfect Perfect and then how do how should we think about maybe.
I don't know a variable comp.
Percentage on mortgage with mortgage being so elevated how do we think about maybe.
How that is represented in salaries kind of in this quarter in the quarters to come I'm, assuming that does kind of trickle down maybe would then be a forecast next year. How we can think about the impact on salaries and maybe a efficiency ratio that you think about in that business on a variable basis.
Yes, why don't I start and Steve maybe Steve maybe you can comment on the efficiency ratio side.
So you know Joe the two components to it.
Compensation expense the mortgage obviously, one is the staff to get all of the loans.
Loans through the system and that.
I wish the need for support staff in an environment like this is greater than it is in a lower volume environment.
With respect to the variable comp associated with mortgages.
No accounting guidance.
Dictates that you offset against the revenue so it's a bad it's not any one.
So the cost of raising that loan I either commission is a revenue offset and the gain on sale margin now I will admit to you that not we've looked at all our peers not everyone does it's the exact same way, but we do do it that way and that's the way we understand the accounting guidance.
From the time, we spent discussing with a number of accounting firms. So so that's that's a component that probably like some comparability when you look at other other companies.
Some other companies I say.
Yeah, and Steve and I, just you know to your point mortgage you know for the industry had it had a great quarter, we're really soon.
Super proud of our group the integration of those team Tom Britain Stephens leadership, they're just doing a great job of integrating those teams. So the production was very large but you know the gain on sales very large so if you think about efficiency ratios.
We'd expect that over time that margin, which are a record EPS at ever every company right now.
Would move back toward 3%, even though the production as we think about these historical levels may move back you know 20, 25% over time, yes, hopefully that kind of help guide you through the.
The efficiency, obviously is really good right now because the margins are so large that margins will come in.
But our in our volume will come down a little bit.
Got it Okay and then just maybe last one for me as it pertains to growth and maybe this is.
Kind of a John question, but maybe also someone up it looks like there was maybe a big migration from the acquired the acquired book into the non acquired book I'm, just yes, or maybe not maybe if you can comment on that the big reduction inquired acquired non credit impaired and then just kind of with the pipeline building, how you think about net growth.
In this environment, which obviously is a little tenuous still at bats, I guess such as that so just kind of commentary there would be helpful.
Yeah I'll comment on the first question and will chime in to clean up my accounting knowledge, but I think Steve you talked about a decline in the acquired book in a rise in the non acquired book I mean, you remember how this works the acquired book only runs off you never add to it so.
So all of the center stage loans that came in under the fair market value accounting they'd only decline in all of the loans that are being generated by both sound state and legacy Centerstate all of that goes into non acquired so I think you'll continue to see that.
That mix were one portfolio is going down the other one is going to have see outsized growth because now it's got double double the production.
But from a growth standpoint, you know, we've got a pretty volatile two quarters here. So.
Hard to be precise in forecasting, but let me see if I can unpack the components for you a little bit here and I think it's important to separate.
The commercial portfolio from the residential portfolio and I'll start with the residential if you looked at our residential and home equity.
But.
At the end of the second quarter, we saw 150 million dollar declines would annualize out to like 10%.
Well on the same token we.
We had a record residential production of $1.6 billion, we had 150 million run off.
But yet we produced 1.6 billion well the economics as Steve mentioned that the gain on sale being 4% is just unprecedented so it really doesn't make sense for us from an alco perspective to put on 30 year fixed rate loans on our books at 2.75% the right thing to do for Nalco standpoint there.
Right thing to do for our clients is to.
Move those loans to the secondary market. So that has been a headwind residential to our loan portfolio, but it's not been a headwind to the income statement in totality.
On the commercial side.
The way I'd have you think about that is you.
I recognize that a commercial loan pipeline is a 90 day pipeline. So loans you close in the third quarter or typically loans, where they enter the pipeline in the second quarter. So the yeah. What was the pipeline in the second quarter was dead. So it's not.
It doesn't surprise us that.
Total commercial portfolio would be down in the third quarter, but having said that with in the commercial portfolio. We were encouraged that we were up the c. and I portfolio was up during the quarter and owner occupied commercial real estate was up in the quarter. So it's important to think about those components, but as you as you think.
Forward.
How about the pipeline.
The pipeline is climbing now between 100 and $200 million a week.
And let me step back and put it in perspective for you.
Pre coded at the end of the first quarter the pipeline was $3.4 billion.
We hit a low in August at $2.4 billion.
Since that loan in August the pipelines back up to 3 billion. So a 24% increase in the pipeline and we're feeling good that that's going to translate into the fourth quarter. The first quarter of next year and to increase production I don't think its going to be any kind of rapid growth in the loan portfolio, but I think we will turn the corner and start seeing.
I mean, some modest growth.
Great. Thanks for all the color and congrats on a very good quarter and a lot of progress already right.
Thank you.
Our next question comes from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.
Hey, good morning, everyone.
Hey, good morning.
Just.
Wondering on correspondent banking given that the strength you know the full quarter impact of that coming in and the business is doing well, but also.
The acquisition that you guys announced just curious what.
How sustainable you view that piece of revenues going forward, just any kind of seasonal or.
Cyclical.
Forces, we should be aware of but also.
With the deal are there are there other bolt on deals like this you guys are looking at in that area. Thanks.
Sure. Thanks, Kevin This is Steve you know well.
One of the things I just.
Remind us I mean, we really like the diversification of these fee income businesses.
If you think about mortgage correspondent capital market and well none of those businesses make up over.
More than 10 or more than 12% of our total revenue. So we like the diversification within each line.
As it relates to the coarse product group.
You know if you look at the trailing 12 month under Brad's leadership, Yeah. The the division has done about $105 million or so of revenue. If you look at the components of that about 20 million of it is in fixed income about $80 million in our capital markets product in about $5 million.
Payments.
So as you think about the future I would think that you know the record year of $80 million in our capital markets business likely with loan volume in the industry being where were probably will be next year, we'd expect that to come off a little bit call. It 20% to 25% just like mortgage probably will.
But you know just to go into Duncan Williams.
No.
As we talked about our already you know.
Duncan Williams.
Has about 250 financial institution clients, you put that with our 700, that's about a thousand financial institutions last year in 2019, Duncan reported about $27 million in revenue.
And just from a modeling perspective, as we model the deal we typically try to run the non capital intensive businesses around the 75% efficiency ratio business. So hopefully that's helpful. In your your your your modeling. So if you think about the pluses and minuses going into next year, I think you're going to see.
Yes, some of the capital markets activity likely decline a little bit, but you know with the opportunity to increase relative to our fixed income.
Opportunity with our own group as well as Dunkin Williams and the and the replacement of revenue there and then I I think long term I think we're just excited to see the synergies between the two teams as as we have products and services from both groups that eventually we can cross selling it clearly.
That's not going to happen in the next six months, but that's the long term approach. So hopefully that's helpful for you.
That's great Steve. Thanks appreciate the color.
Just just one other a broader question about reserve Bill do you know I appreciate all the detail on the.
The level, you've taken the reserve ratio too and then more broadly when you look at loss absorption as you guys are describing it so that being said if it's net charge offs are staying low as they are we don't get any real.
Big change in some of the economic indicators for your seasonal models should we.
Assume reserve build was mostly in the rearview for you guys or is it if it's if you know you see we still think there are losses coming it's just they're not coming yet they maybe it will be later next year.
Still may make sense for you all to incrementally builds in the next few quarters. Thanks.
Yeah, Kevin I'll I'll start this is dan or anybody else wants to jump in.
Certainly do so but you know that's the thing about Cecil of course, and it's interesting that we all implemented this new life of loan model license.
Oh and shortly before hitting this pandemic, but you know the theory behind it is that we reserved fully for.
For the economic forecasts the losses that would be.
Driven by these economic forecast and loss loss drivers in your model over the over the forecast period in which case.
Theory would tell you that today, you've got every dollar in your reserve that you see and that should be true of everyone Who's adopted Cecil absent a change in in.
In that forecast.
So.
Broadcasting from there if the.
Economic forecasts don't worsen.
Then our reserves should be adequate now theres lot of cloudy.
Got instead it to the Crystal ball right now with what appears to be increase.
Increases in Koby cases, and who knows what that's going to do to some of the forecasts of unemployment and other loss drivers going forward, but you know sitting here today.
The way the seasonal model is supposed to work we should be fine if I'm.
I mentioned in my comments the the model change. So the you know given the timing of our clothes and we had to do really a sum of the parts methodology for June Thirtyth, you couldn't really convert over to new model and go through the model validation process.
Before then and so when we when we did consolidate this quarter. That's what drove the majority of the provision expense 22 million of it was based on the different methodology for the reserve for unfunded commitments.
So so absent that you know the quarter's provision expense would have been you know six or $7 million.
In terms of lost well they should Dan you might want to you might want to comment.
Do you have on on Kevin's question about where we think losses.
In the in the industry are heading in the in the future.
Yes, just from a future loss perspective, you know the last two quarters have been very good from a charge off perspective, and I don't anticipate any material change in.
And that you know here in the fourth quarter.
It's more first second third quarter.
Depending upon how.
The pandemic plays out and what the impact.
You know that may have in the future on credit right now.
Yeah as charge offs et cetera, you know kind of looks strong.
Okay. Thank you guys.
Our next question comes from Catherine Mealor with KBW. Please go ahead.
Thanks, Good morning, good morning Gordon.
One follow on on the asset quality you mentioned in your slide deck that classified increased this quarter can you just give us a little bit of color around other categories that drove that increase this quarter.
[noise], Daniel I'll take that yes, sandbox I'll take that.
Question.
You know the pandemic created economic headwinds that put a lot of loans on deferral in Q2 and Q3 as good risk managers, we did a comprehensive review with the credit administrators and market residents in August of all of our loans over $1 million that were either and.
Hi risk categories were our were on deferral.
As a result of this review.
Made changes to the risk rating grades so that we could ensure that we have the.
<unk> allowance and also knowledge you know impact that the economic.
Headwinds have had on some of the borrowers you know clearly there is more stress in the hotel will look across.
For the entire industry and so that's what's driving these these numbers primarily that make up the.
Majority of the classified and criticized recognizing the headwinds there.
You know the severity of any losses is mitigated by the approximate 5% PCB Mark on the legacy yes.
Centerstate bank loans, plus the overall, 55% LTV in the hotel portfolio.
You know from where we are today you know the economy continues its rate of recovery or we don't anticipate any material change in the level of criticized or classified.
Assets in future.
Future quarters.
Great and I'm going to tell but any kind of update on what you're seeing in some of your properties in terms of occupancy rate.
And maybe kind of a difference between what you saw this past quarter in your head your coastal property there.
And then just near Metro market.
Yeah, you know, though the hotel bookings is performing better than the anticipated in about two thirds of the portfolio is and leisure segment dictation areas coastal waterways that are you know destinations within driving.
Since I'm, a large segment of the southeast population and the summer was fairly good occupancy levels and in those categories.
You did 60% and in some cases were greater than 80.
80%. So when you combine that with that you know deferrals and the PPP funds.
You know so with this improved performance allowed you know a lot of these borrowers to stabilize and build some liquidity as well as you know they've adjusted expenses to better operate you know in this environment you know the business segment, which makes up about one third you have seen occupancy levels.
You know typically in a in the low to mid 50% range somewhere a little bit lower you know those are the ones that are that are struggling you know a little bit more and have a little bit more headwinds.
Okay very helpful. And then maybe one other question and just.
Because your capital thoughts a lot of banks are starting to talk about buyback I don't think many banks of your size will start buybacks is this here, but how are you thinking about what what you're looking for on to be able to start to think about reengaging in the buyback activity as we move into next year.
[noise] Kathryn it's John maybe I can comment and we'll feel free to chime in.
Well a lot of uncertainty to the summer plus in our situation, we were putting two large balance sheets together or wanted to see where these capital ratios shook out you know we did raise some sub debt in the second quarter of the year to bolster the capital position. If you look at as we look pretty good relative to our peers on C.T. Rowe.
One and total risk based capital.
One ratio Thats, a little bit lower is a tangible common equity I think it ended the quarter around 7.8%, if we keep profitability somewhere where it's at today that should exceed 8% headed into 2021. So you know if credit is benign in 21 is it.
We're feeling like it might be now that having that extra capital getting Tc back above 8% I feel like it gives us some optionality to look at a buyback right out the dividend I think it's yielding about a 3% we're paying back about a third of the earnings I feel pretty good where the dividend is but I think that.
The growing capital base capital formation is going to give us some options going into 2021.
Great. Thank you congrats on a great quarter. Thanks.
Thank you.
Thank you.
Our next question comes from Brody Preston with Stephens. Please go ahead.
Hi, good morning, everyone.
Good morning this morning.
I just want to circle back on the on the expenses real quick. So appreciate the 5 million or so in business development that scored it sort of not in the quarterly run rate right now, but and correct me if I'm wrong theoretically that should have also been somewhat missing from the from the Twoq you sort of pro forma run rate up to 25.
Just given you know the world there's still a.
Locked down at that point or you know just coming out of a lot down and so I.
I guess you know, it's still really good cost saves and you mentioned, the two and a half million or so from.
[noise] from the SBC SFL sort of cost savings.
And so I guess was there anything else that you all sorta did that drove you know.
The larger sort of reduction in expenses this quarter.
So brody as well I'll, let me clean up a little bit just to make sure. So that that Bob Miller I mentioned that was more than just business development. It was.
Included or any loan related foreclosure relate all those kind of expenses and then included professional fee reductions you know not all related sort of activity levels being lighter and I looked down the business develop and that's what this is Q2 versus Q3, and I think part of it and well walk you know Q2, you probably have.
Some Q1 expenses you know.
Boy credit card and stuff like that that that are those.
Those bills are received and paid in Q2, so that's probably a little bit of noise. There you.
No in terms of the full thought maybe it was not business development just to just to be clear on that.
You know we.
I would say Q2 had probably a little higher expenses associated with with our co. Good reaction or just getting things geared up in terms of responding with our facilities and things like that so that that was a little bit of that I think that would be decline from Q2 to Q3.
But I just what my comments were just to try to give you a little more clarity on.
It feels to me like like to 15 is not a permanent run rate given the unusual environment in which we're operating in if we move back to a more normalized environment, we're going to be out calling on on customers. Greg appointing his team are going to be hitting the road and spending some money on the business development side, you know a foreclosure activity is going to come back.
Back in and then industry some expense, we'll spend a little more money on that so I, just I kind of want to just make sure that.
That idea was out there.
Well I'd just add I, just add to that I mean, yeah. We showed in the deck that combined business basis. The answer there and if you think about you know sometimes our fee revenue businesses, new yeah. These expenses up and down on the variable side.
Our revenue revenue was up under fee income by about $6 million six and a half million dollars a lot of that related good MSR adjustment. So if you think about you know the variability of the fee income there really wasn't from a commission perspective, much difference in quarter, two and quarter three so the quarter to expenses would.
Yeah on a combined basis outside of our cost sales would be pretty reflective of the run rate, where we're at so sometimes the fee income businesses move that around a little bit but really in the third quarter did not so hopefully that's helpful commentary there.
Okay, all right understood. Thank you for that.
And then on PPP I think Youd mentioned that you had 2.4 billion still on the balance sheet I'm wondering to get a sense for the timing of that but then also could you I don't know if you've looked at this at all but do you have any sense for how much of those deposits are still sitting on the balance sheet.
You know I'll start by saying this.
Brady that.
Our with respect to PPP, our Crystal ball is probably more cloudy than some of the other commentary I've heard both good but what I'll tell you. What we know we will we have about 20% of our loans in the forgiveness process has entered the biggest process you know during the quarter, we recognized about 8 million of the net.
Fee PPPC, you, leaving us about 53 million 53.3, I think remaining at the end of the quarter.
You know it is really hard to tell you know when that forgiveness process will really kick into gear how quickly the s. be able to respond will there be another bill passed post election that may include some sort of forgiveness, but I would say our rough expectation would almost call. It.
Ours is you're probably looking at a Q1 and Q2 concentration and I don't know at this point, whether it's more heavily in Q1 or Q2, but that would be our best guess today.
I don't have a figure for you for you on how much of those deposits are still on the balance yet that's a good question, but Jon or Steve may have a feel for that.
Yeah, sorry, I said, Steve I'd, just point, you're right. We don't know the exact answer but I mean, it's pretty obvious when you looked at the big picture on page 19 of the deck, which shows the deposits for the first quarter to the second quarter and what you see is $4.2 billion.
[laughter].
They are and and you know that's been all the PPP money was going out and were flat from there. So the way I would characterize it as.
Yeah, the deposit from those companies, although we don't have a specific EPS are really happy to have it set out that at our deposits are flat after that big ramp in Q2.
Okay understood I guess I'm, just trying to think about the potential deployment of excess liquidity and so it you know you've got for you know 3 billion and I sort of excess liquidity like you said it on the balance sheet.
But I guess, just thinking about the deployment of that either until loans or securities throughout 2021.
You know I guess as those PPP deposits flow out.
Well, I guess that would sort of flow out with it or do you I guess do you estimate that you sort of have excess liquidity is still on the balance sheet that can be deployed into earning assets beyond the PPP deposits.
Yeah, Buddy I think the you know the answer is we don't know I you know I think what our target. If you looked at our company's as separate companies. We ran our investment portfolio was 12% of that but that's how we now we've traditionally done it.
Yeah when.
When we had a lot of excess liquidity in the <unk> and the financial crisis, we probably ran it closer to 15, but I think right now we're in a wait and see mode. Yeah, we need to build the securities book backup to that medium term, 12% number.
And then see where the landscape it and see how those PCB funds because I do think it's uncertain and we just want to be thoughtful as we do it.
And I would I would add and I would say, Steve I would also just add to that that.
Well certainly a portion of the excess liquidity is BPP. It's also just the liquidity that the fed is pumped into the economy you know some of those.
TPP loan fundings have been used to pay payroll and things like that but I think well, there's just an excess amount of liquidity that stick with US right now based on the actions the fed has taken over and above the PPP.
Okay understood and on Duncan Williams, you know, thanks for giving the $27 million in revenue last year, just trying to get a sense source their business as a I.
I guess been negatively impacted this year as a result, the coated or how the how they've been fairing year to date.
Yeah, we won't give the public numbers, but just you know I'll talk about our fixed income business. Our fixed income business is up this year and it's really primarily because there's just more excess liquidity sitting in the in the financial faith. So as you think about all the excess liquidity, we're talking about it needs to be invested at some point so.
Our client and so I think you know, even though financial institutions like ours with them pretty hesitant to go too fast on that at some point you know next year or the year. After you'll start seeing that deployed. So I think this is another good business to be in the head hedging with because I think that.
Fixed income revenue would probably be a little stronger than that but yes, probably too early to tell.
Okay, and then the 110 or so in loan discounts is that the total discount or is there something else beyond that.
That's the total.
Okay, and so just you know one.
Wanted to ask so it was 22.4 million in P.A., Oh loan accretion income this quarter I guess, just thinking about what the quarterly run rate moving forward yeah understood that is supposed to step down, but what should the quarterly run rate on PAA look like you know, perhaps for Fourq, you and when do you sort of expect.
Those goes down those loan discounts to be fully.
Accreted into income.
<unk>.
Bill you want to pick that Oh, well.
Well I was hoping you it's Dave [laughter].
I'm chuckling brought it up.
I understand why you know if you back.
Three months ago, I would not have come well not guess 22 million. It's just a hard number two.
To predict based upon when payoffs occur pay downs occur and things like that.
But its clearly going to it should decline from here and your modeling over the weighted average life of that portfolio, but then the weighted average life ends up being.
In my experience over years of acquisitions always ends up being shorter than what you. What you had modeled but if I were to throw out a number for you I would worry that I would be doing that number with more precision than.
Then would be appropriate given the difficulty but you know if you like you know the best way to do is just model up whatever you think or whatever his life would be for that acquired portfolio when.
And that would sort of guide you to do a number but.
Yeah, I wish I could give you a better number but I really don't feel comfortable doing so.
Okay do you have to do you know the weighted average life off the top yet.
I do not actually I don't but you know the type of lending we do you know your and again this would be from.
From originations they type of lending we do you generally think about it being that you know three to five year range, but.
Oh, yes.
Yeah. This will I'd say again for the Centerstate book prior to merger. It was around 3.3 years and was the average life. So I think that's probably a decent season.
To that point.
All right great. Thank you for taking my questions everyone I appreciate it.
Thank you.
Our next question comes from Christopher Marinac with Janney Montgomery Scott. Please go ahead.
Hey, Thanks. Good morning, Thank you for the color on the problem assets on the prior calls I just want to drill down into the kind of classified and criticized trends just to understand.
Do you see a path where those loans get upgraded in the next couple of quarters or do you think it's going to be more sort of stagnant for a while to get more visibility on the recession kilobit et cetera, and then those will migrate back later.
Dan Yeah, the Dambach course, I I pick a little bit a combination of both you know I'd think.
There is an opportunity for some of those classified loans to a you know get upgraded sooner than later.
And then the ones that are in the criticized category you know probably a little bit you know maybe longer you know path to a six month to nine month to see those started yet or upgraded as we get a little bit more visibility, but I don't.
We anticipate you know those through all so I don't anticipate goes to migrate and get a good downgraded.
Got it that's that's help so again the reserves build really kind of council that into effect now asms. These downgrades.
Correct.
Got it okay. Thanks for that Dan and then just a follow up for whomever on the TPP. What are you seeing on Friday is that an issue to worry about do you need to set aside reserves for that even if it's not material at this point.
You know <unk> is it just the fact that it hasn't really been a conversation and any of our various risk means the what whatnot would leave me to answer Chris that the when it's really not a factor for us not knock on wood as I say that.
But I think we built some pretty good process season had involvement of.
The local teams you know, which is the strength of our company throughout that process. So hopefully we would be less subject to that.
Then than others I don't I don't think we've seen.
Much of that or Jon or Steve you have Dan deal a better answer.
Well this is John that I.
I think I've asked that question and so far I'm, receiving confident the fact that they're not seeing trends abroad. So it's still early but that's where we that's what we're here now.
Great I appreciate that thanks again for all the time. This morning, you bet. Thank you Chris.
Again, if youd like to ask a question. Please press Star then one.
Our next question comes from Jennifer Demba with true. Please go ahead.
Thank you good morning, I think Gordon Todd.
It's all the topics it really been covered but I'll ask one more.
You announced another 20 branches you're cutting can you just talk about your willingness to see reduced more branches or corporate real estate. That's not currently planned right now in.
In order to.
Offset revenue challenges should there be any.
Jennifer John.
You know with our merger there really wasn't branch overlap. So I think both companies the path of acquired a lot of banks with branch overlap and we put branches together.
But setting that aside there there is a secular trend I think you're seeing the history with both companies that each year looking to rationalize.
Rationalize the branch network in fact.
If you go back over the last decade, or slide page 20 of the deck.
If you take the two companies put them together there were about 85 branches a decade ago Weve acquired 420 branches, but weve consolidated 212, so weve consolidated about half of everything that we've purchased so this has been an ongoing trend and we think that that will continue to be an ongoing.
The trend.
You've heard other folks talk Jennifer about the cobot driving more and more digital adoption interesting. We opened all of our branches and the company. This month they've been closed for I think since March so call. It six months at the office has been closed.
We opened this month I I've talked to some of the the president and said well now that were open well.
What's happened with the traffic inside it's a remarkably slow that customers have become accustomed to doing business in the drive through doing business digitally and they are in the traffic has not picked up considerably in the lobby now that we're open on the digital side just some stats for you.
Year over year digital deposits are up 67%.
Year ago. Yeah. This is people taking a picture of their check on their telephone we were doing about 15% of our deposits that went up 25%.
As far as actually opening new checking accounts online that's up 170% year over year. It was 10% of our accounts a year ago announced 27% of our accounts and consumer loans opening up online is up 90% year over year, a year ago. It was about 10% of our consumer loans down 19%. So I I think is.
We think about the future we will continue to evaluate the rotation of brick and mortar expense into digital expense.
On the other corporate real estate upfront when we did the merger and we analyzed our operation Center space.
We've got two major operations centers, one in Charleston, with a few hundred people in one in Winter Haven, Florida with a few hundred people, but an EPS in actuality, we have 17 tone.
Total operation centers was 15 smaller ones well that's those support teams have been working from home for six months and it's been working fine. So I think it's very likely that as we go through the sufficiency project with the merger that we may see a significant reduction in the number of those smaller operations center.
So these are the secular trends you're hearing from others and definitely there is a lever for us to continue to pool on a on a year by year basis.
One more question John do you think your revenue producers are as productive working from home as they are right now.
Yeah. Good question I mean, our our two quarters here our loan production is down so you've got to say well is that because the revenue producers aren't as productive or is that because the economy got shutdown. So I'd like to believe that that there's productive I mean.
Let me answer a different way go back to the PPP process. Okay.
The economy was shut down there there were working from home. We did 20000 loans in a period of about I want to say it was like three weeks. So I think that's the case study TTP fit the ability to be productive is there at least in that kind of crisis moment, but I think our release.
You should managers love to get in front of their clients. So I think that slowly starting to open up into the long term you are probably going to see a mix or in person and also more digital contact. Good news is on the R&D front, we're having a lot of success now recruiting and there's a lot of turmoil in the biggest bank. So.
It's a new world, we're all trying to figure out how much time to spend in front of a zune called and how much time has been in person yeah. Jennifer I'd just add just you know anecdotally.
Anecdotally on somebody's, Eli the business, whether it be mortgage fixed income capital markets, they're all working remotely and having record production. So I think.
No.
The the ability to get in kind of the clients is a little harder, but at the same time, yeah. I think we're all figured out that you can do some of this war remotely side, Yeah, I think there's pluses and minuses out about that.
That's great color. Thank you.
This concludes our question and answer session.
I would like to turn the conference back over to John Corbett for any closing remarks.
All right. Thanks. Thanks, a lot. These are great questions and I hope, we've been able to provide some clarity. This morning, we're going to be participating in the Piper Sandler conference in a couple of weeks.
But in the meantime, if you have any questions as you update your models. Please feel free to reach out to either will recede. Thanks for joining us This morning, and I Hope you have a great day.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.