SouthState Corp

NYSE:SSB

Earnings Call Transcript 2020-Q3

[Operator]

[00:00:05] Good day and welcome to the South State Corporation, third quarter earnings call. All participants will be in listen only mode. Should you need assistance, please? Signal conference specialist by pressing the star key, followed by zero. After today's presentation, there will be an opportunity to ask questions, please note this event is being recorded. I would now like to turn the conference over to Paul Matthews, please go ahead.

[William Matthews, Chief Financial Officer]

[00:00:34] Good morning and welcome to South States third quarter earnings call, this is Will Mathew's. And joining me on this call are Robert Hill, John Corbett, Steve Young and Dan, because the format for this call will be that we will provide prepared remarks and we will then open it up for question. Yesterday evening, we issued a press release to announce earnings for Q3 of Twenty twenty. We've also posted a 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 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 chairman.

[Robert Hill, Executive Chairman]

[00:01:38] 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 and Will about the progress the team is making in building South State. This interstate south state partnership was about the long term that you can clearly see the progress being made in the short term progress with 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. John Corvus. Leadership on this journey has been excellent and I will now turn the call over to John for more insight into the quarter.

[John Corbett, Chief Executive Officer and Director]

[00:02:30] 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 we're producing. It was a solid quarter. Adjusted for merger costs, the company produced diluted earnings per share of a dollar and 58 cents for a 17 percent return on tangible equity. Our pre provision, net revenue grew to 170 million dollars for a pre provision return on assets of one point eight percent and tangible book value per share grew at an annualized rate over 15 percent. The highlights for the quarter was clearly the profitability of our mortgage and correspondent banking units. We heavily invested in these fee based businesses when Treasury rates fell after the 2016 Brexit vote. And now, four years later, these non-interest 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 firm led by the son of the founder. And it's the perfect complement to the fixed income line of business that we've been building for over a decade. S Day currently serves nearly 700 community banks nationwide and Duncan Williams as an additional 250 financial institutions to our coverage universe. This was a negotiated transaction that Steve Young and Brad Jones have been pursuing for a year and a half.

[00:04:08] And we're very excited to welcome Duncan and his team to South St.. Well, 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 percent 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 two percent of loans. Of the two percent of loans currently on deferral, half of those are in fact making their interest payments to really only one percent of loans are in 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, it's 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 on offense to prove with this new franchise is capable of. One area where we continue to improve is the South, the digital experience this month under the leadership of Ronnie Brooks.

[00:05:34] We rolled out our new Web site and next month we roll out a new mobile banking app that has 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 to 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 to 285 by year end. Which also increases are average deposits per branch to over 100 million dollars, 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 to the southeast 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 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 covid virus, and we can't control the shape of the yield curve.

[00:06:56] What we can't control is the 80 million dollars 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, investments in our mortgage and correspondent banking teams that are not dependent on the interest spread. And finally, we can make investments in top notch relationship managers in 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, I'm happy to share the news that South State has created a new executive level position of director of corporate stewardship. LaDawn Jones, a 21 year veteran of our company, has accepted the invitation to lead our company's diversity initiatives, our college recruiting and management training. As well as our ESG community development and employee assistance programs, everyone at South State is excited for LaDawn and his new role and eager to support his leadership as we create a company culture that 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.

[William Matthews, Chief Financial Officer]

[00:08:16] 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 and closing securities sales on the legacy center stage in the second quarter, NIM is not entirely an apples to apples comparison, nor is the combined business basis margin of 338 from Q2, as it includes the unmarked interstate balance sheet and income statement 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 four point four billion average for the third quarter. If you were to reduce our balance sheet cash and fed funds sold to one 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 entire state loan portfolio and the company accretion with 22 million for the quarter. And Cornum, excluding loan accretion, was 295.

[00:09:25] As noted on page six of the release, we had some measurement period adjustments as we finalized purchase accounting marks, including a reduction in the loan discount of 29 million dollars. While this improved capital, I'll remind you that it will reduce future accretion accordingly. Our loan repricing mix is 55 percent fixed, 25 percent floating and 20 percent adjustable. Our total cost of deposits continues to improve down to 20 basis points for the quarter. Our CDs are relatively short, with nineteen percent coming due in Q4, another 32 percent in the first half of 2001 and 26 percent in the second half of twenty one on non-interest income. We had a record one hundred and fifteen dollars million quarterly non-interest income led by our mortgage and correspondent banking capital markets. Our mortgage team has done a really outstanding job in the midst of a merger of two mortgage change, as well as a pandemic with record volume of one point five seven billion, 60 percent of which was purchased and strong margins, resulting in 48 million in revenue. Our correspondent banking division continues to show strong results with a 26 million dollar quarter. And on that note, I'd like to echo John's welcome to the Duncan Williams team. We're not disclosing transaction terms due to the size of this acquisition, but we are excited about Duncan and his group joining Brad Jones and his team and helping us grow this business, as well as the help it should provide in a very low interest rate environment.

[00:11:01] Steve has responsibility for these non-interest income businesses, is available to answer questions on them during the Q&A session. On expenses are any for the quarter was 237 million, including 22 million in merger related expenses for an operating inside of 215 billion, our efficiency ratio was 55 point eight percent. Excluding the merger related expenses are 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 a normal employee turnover and some departure of employees who will not be retained as well as certain vendor savings. We expect that this cost stabilization 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 covid business development, loan related and expenses, travel expenses and to some extent health insurance costs are all down due to covid. But we would expect many of these to normalize once we are beyond the health crisis. So the Q3 run rate for several areas is lower than we would expect in a normal noncombat environment on merger related expenses.

[00:12:25] We've recognized approximately half of the estimated 200000 to date, some of which occurred on the interstate side pre closing. Turning to credit, our net charge offs remain very low at 500, 94000 for the quarter or one basis point, annualized ending NPAs were 33 basis points of assets, down five basis points from Q2 due to a combination of pay offs and upgrades are provisions for credit losses was twenty nine point eight million for the quarter, twenty two point one million of which was for the reserve for unfunded commitments liability. After running two separate legacy bank CEO models and combining the results in Q2, we consolidated on to one model and the third quarter. And this consolidation of the legacy Selfe loans to 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 eight point two percent for Q3 and Q4 of this year before starting to decrease in 2021, with a forecast of seven point four percent a year and 21 and five point four percent at year end 22, with a provision expense of almost 30 million in net charge offs with 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 loves.

[00:14:00] 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 reduced significantly since our last update, dropping below two percent in October 2013. Additionally, our full PMI deferrals were only one percent of that date, as almost half of the deferrals are paying interest for the effective tax rate. A return to profitability in Q3 after the impact of the double count provision and other murder expenses in Q2. Because our effective tax rate to decline a third quarter to nineteen point six percent from the second quarter is twenty two point six percent. Turning to capital with good profitability and a flat, though still somewhat inflated balance sheet, our capital ratios grew during the quarter RTC ratio 27 basis points, ending at 783 or 61. In total, risk based ratios grew by approximately 80 and 100 basis points, respectively, ending at eleven and a half and thirteen point nine percent are ending. Tangible book by per share was just shy of forty dollars at thirty 983, up a dollar fifty from Q2 and up a dollar 63 from the year ago quarter.

[00:15:20] I'll turn it back to you, John. All right, as a reminder, we are conducting this poll 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.

[Operator]

[00:15:38] Thank you. We will now begin the question and answer session to ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your hands up before pressing the keys. To withdraw your question, please, press star, then to. At this time, we will pause momentarily to assemble our roster. Our first question comes from Michael Rose with Raymond James. Please go ahead.

[Michael Rose, Raymond James]

[00:16:10] Hey, good morning, everyone, and thanks for taking my questions. I wanted to just circle back to to expense as well, you guys obviously some some really good revenue generation this quarter and the expenses were down. I understand some of it is is covered, related. But can you just help us from a run rate perspective as the economy continues to reopen? Hopefully, you know, what are some of the specific advocates we should think about? If you can just remind us how much of the cost is. I'm sorry if I missed it. How much of the cost saves so far? You've actually realized. Thanks.

[William Matthews, Chief Financial Officer]

[00:16:44] Sure, Michael. You know, 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 percent of the 80 million dollar cost. There's a call that two and a half million for a quarter, you know, in the quarter, like I said, we had you know, we don't have people out there doing business development efforts. There's a lot less travel going on.

[00:17:13] You know, there's not not much there's not much real estate foreclosure activity in those related expenses and professional expenses associated with that. Those areas are all down. And I think for a lot of us are not going to the doctor like as often as we had. So we're seeing a little bit of a decline in health insurance. And I'd say all of those items combined, you know, relative to a more normalized quarter, might be might be five million or so and a quarter roughly. And then so, you know, that's why I just wanted to be clear that, well, we're pleased that it was down to two hundred fifteen million. You know, this is an unusual environment and didn't want to add people over, interpret that as they looked as they look forward.

[Michael Rose, Raymond James]

[00:17:59] That's that's that's very helpful. And then maybe just switching to the core margin, you know, 295, I noticed some moving parts in their first full quarter, post-integration, you know, as we think about going forward. I mean, are there other areas that you guys are working on to kind of optimize the balance sheet? And then how does that relate to the ability to, you know, prevent or limit NIM compression from here? Thanks.

[Steven Young, Chief Strategy Officer]

[00:18:27] Sure, sure, Michael, it's Steve. Let me just kind of talk about a little bit in the broader context around revenue. We talked about on page 18, we have a slide in 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. You know, a year ago we were about 77 percent and then 23 percent fees. Now we're 30 percent to 70 per cent. Mhm. So I just wanted to draw your attention to that. You know, our reported margin as Willemijn was three 22, our core margin at 295. Just a couple of things on that. You know, we are core deposit funded bank in great markets. You are checking accounts make up 54 percent of deposits and our total cost of deposits this quarter was actually 20 basis points. So, you know, we continue to grow low cost deposits, our retail, our small business and our Treasury platform. But from a margin perspective, we don't have a lot of room to reduce cost, but we will go as low as we can without cutting at the core.

[00:19:36] Let me kind of speak through the components of margin first on the yield on the loan portfolio. TPG and accretion this quarter was for 16 were pretty new loan production yields this quarter in at three fifty three.

[00:19:53] So that continues to be a headwind as it relates to Will's comment on the excess liquidity. So we have about four point four billion dollars of average Fed funds sold, probably about three billion dollars over a target. It weighed on our margin about twenty four basis points this quarter. You know, if you look at our pre merger, our total investment portfolio was right about four dollars billion or around 12 percent of assets. Right. Prior to close, we sold a billion dollars of the center stake portfolio because it was going to be mark-to-market, you know, around one in the quarter. So as we think about the future of that excess liquidity, we invested about a half a billion dollars this quarter to get it to around three and a half. We're likely on a path to get it closer to four billion by the end of the year. And then medium term, our target for the investment portfolios, around 12 percent of assets. That'll depend upon liquidity. It will depend on the yield curve. But we also want to make sure that we're not investing a bunch of capital in the lowest rate environment we've seen. So we are cautious on that, particularly as the non-interest income businesses that have been performing. One last comment on the securities portfolio. It was at one point six three percent this quarter and we're adding purchases somewhere around one and a quarter. So that would be the core margin comments. The only other comment was on accretion. I think we had twenty two point four million dollars this quarter and of course, that was elevated.

[00:21:33] We'd expect that to decrease from here. We have a disclosure in the earnings release that shows there's about 110 million dollars of discount left on the acquired loans.

[00:21:44] So with that, why don't I turn it over to. Well, if you have any other comments.

[William Matthews, Chief Financial Officer]

[00:21:49] Yeah, I think I just would reiterate a couple of things to make sure that we emphasize. One is is just the reminder, C.J., without the marking of this interstate portfolio in Q2 and the impact we had. So, you know, you basically had a couple of billion dollar bond portfolio, half of what you sold and turned into cash at 10 basis points, and half of which you had to mark down to a yield of about half of what it was earning before. So that's that's the impact. But the second is probably more important, and that is just our long term focus and and, you know, trying to make sure the decisions we make are ones that we're going to like for the long term. And it would certainly be easy to boost earnings a bit if we took that excess cash of three billion dollars, invested it, you know, to pick up 110, 120 basis points over where we are earning today as the Fed.

[00:22:37] But but we want to be thoughtful and do that over time and not not get aggressive and then regret that nine months or a year down the road if rates have moved back up. So we will be thoughtful about pulling that lever, although it does exist.

[Michael Rose, Raymond James]

[00:22:53] Ok. All that colors is so I think the way to read that is maybe, you know, core margin X, GPP and X accretion income, you know, probably going to see some pressure here. But you guys are making some investments. The loan portfolio and the pipelines that you mentioned will continue to grow. So so maybe we get to a point where and I actually TROs on a core basis, XP and and accretion sometime, you know, next year and then start to build from there. The the kind of the messaging and the way to think about it.

[Steven Young, Chief Strategy Officer]

[00:23:26] And Michael, it's the I think that's a fair way, I think, you know, that the tailwind will be, you know, any of our investment purchases. The headwind is the loan book until it gets closer to par. And, you know, with elections and covid and all those, the yields are going to move around a lot. But that's how we're thinking about it.

[Michael Rose, Raymond James]

[00:23:46] Good answer. Thanks for taking my questions.

[Operator]

[00:23:52] Our next question comes from Stephen Stephen Scout with Piper Sandler. Please go ahead.

[Stephen Scouten, Piper Sandler]

[00:23:59] Hey, good morning, everyone. I see this 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 costs related to the deal, but that more or less it's going to get we won't see net savings due to investments in digital and other technology investments. Is that correct? I'm going to interpret that.

[Steven Young, Chief Strategy Officer]

[00:24:27] Yes, even I think, you know, and John can elaborate further, but, ah, you know, it's hard to separate out between the merger costs we have, as well as the additional investments we're making in digital and the branch reduction. And so we you know, our 80 million dollar 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 rationalization into the digital spend would be the way I would probably describe it. John, you may have some better comments.

[John Corbett, Chief Executive Officer and Director]

[00:25:04] I think you nailed it. Well, I don't have anything to.

[Stephen Scouten, Piper Sandler]

[00:25:07] Perfect. And then how do how should we think about maybe, I don't know, a variable comp percentage on mortgage, you know, with mortgage being so elevated. How do we think about maybe. How that's representative salaries kind of in this quarter in the quarters to come, assuming that does kind of trickle down maybe with NBA forecasts next year, how we can think about the impact on salaries or maybe a efficiency ratio that you think about in that business on a variable basis?

[John Corbett, Chief Executive Officer and Director]

[00:25:36] You know, why don't I start and see maybe Steve, maybe you can comment on the efficiency ratio side so, you know, the two components to compensation expense and more is obviously one is the staff to get all of the loans through the system. And that obvious, the need for support staff in an environment like this is greater than it is in a lower volume environment. You know, with respect to the variable compensation with mortgages, you know, accounting guidance dictates that you offset against the revenue. So it's a fascinating one. So the cost of raising that loan, i.e. the commission, is a revenue offset in the margin. Now, I will admit to you that not you know, we've looked at all our peers. Not everyone does it the exact same way, but we do do it that way. And that's the way we understand the accounting guidance from from the time we spent discussing with a number of accounting firms. So so that's that's a component that probably lacks some comparability when you look at other other companies.

[00:26:42] Some of the detainees, I should say, in and in Steven, I just, you know, to your point, mortgage, you know, for the industry had had a great quarter.

[Steven Young, Chief Strategy Officer]

[00:26:50] We were really super proud of our group, you know, the integration of those teams, Tom Brady and Stephens leadership, they're just doing a great job of integrating this team. So the production was was very large, you know, the gain on sales very large. So if you think about efficiency ratios, you know, I would expect that over time, that margin, which are a record at every every company right now, which would move back toward three percent, even though the production, you know, as we think about these historical levels, may move back, you know, 20, 25 percent over time. Yeah, hopefully that kind of helps guide you through. You know, the efficiency obviously is really good right now because the margins are so large, the margins will come in, but higher in our volume will come down a little bit.

[Stephen Scouten, Piper Sandler]

[00:27:40] Ok, and then just maybe last one for me as it pertains to growth, so maybe this is kind of a John question, but maybe also someone else, it looks like there was maybe a big migration from the acquired the acquired book into the non acquired book, or maybe not.

[00:27:55] I mean, if you can comment on that, the big reduction in inquired, acquired, noncredit impaired and then just kind of with the pipeline building, how you think about, you know, net growth in this environment, which obviously is a little tenuous still at best, I guess I should say. So just kind of commentary there would be helpful.

[John Corbett, Chief Executive Officer and Director]

[00:28:12] No comment on the first question and will chime in to clean up my accounting knowledge, but I think, Stephen, you talked about a decline in the acquired book and a rise in the non acquired book. I mean, you remember how this works. The acquired book only runs off. You never had to it. So all of the center stage loans that came in under the fair market value accounting, they only decline. And all of the loans that are being generated by both South State and Legacy Center say all of that goes into non acquired. So I think you'll continue to see that that mix where one portfolio is going down, the other one is going to 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, both at the end of the second quarter, we saw one hundred and fifty million dollar decline. So an annualized down to like 10 percent. Well, on the same token, we had a record residential production at one point six dollars billion. So we had 150 million run off. But yet we produced one point six billion. Well, the economics, as Steve mentioned, of this gain on sale being at four percent is just unprecedented. So it really doesn't make sense for us from an outside perspective to put on a 30 year fixed rate loans on our books at two point seventy five percent. The right thing to do for Alfio standpoint, the right thing to do for our clients is to move those loans to the secondary market.

[00:30:07] 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 have you think about that is, you know, recognize that a commercial loan pipeline is a 90 day pipeline. So long as you close in the third quarter are typically loans where they enter the pipeline in the second quarter to the you know, 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, within the commercial portfolio, we were encouraged that we were up. The CNI 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 about the pipeline, the pipeline is climbing now between one hundred and two hundred million dollars a week. And let me step back and put it in perspective for you. Pretty covid at the end of the first quarter. The pipeline was three point four dollars billion. We hit a low in August at two point four dollars billion. Since that low in August, the pipeline is back up to three billion. So a twenty four percent increase in the pipeline. And we're feeling good that that's going to translate into the fourth quarter in the first quarter of next year into increased production. Don't think it's going to be any kind of rapid growth in the loan portfolio, but I think we will turn the corner and start seeing some modest growth.

[Stephen Scouten, Piper Sandler]

[00:31:56] Great, thanks for all the color and congrats on a very good quarter and a lot of progress already.

[John Corbett, Chief Executive Officer and Director]

[00:32:01] Thank you.

[Steven Young, Chief Strategy Officer]

[00:32:01] Thank you.

[Operator]

[00:32:05] Our next question comes from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.

[Kevin Fitzsimmons, D.A. Davidson]

[00:32:12] Hey, good morning, everyone. Hey, good morning. Just wondering, I'm correspondent banking, given the strength, you know, the full quarter impact of that coming in and the business doing well, but also the acquisition that you guys announced, just curious what how sustainable you view that pace 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.

[Steven Young, Chief Strategy Officer]

[00:32:51] Thank you. Kevin, this is Steve. You know, one of the things I just remind us, I mean, we really like the diversification of these income businesses. If you think about mortgage correspondant, capital markets and wealth, you know, none of those businesses make up over more than 10 or more than 12 percent of our total revenue. So we like the diversification within each one as it relates to the core product group. You know, if you look at the trailing 12 months under price leadership is the the division is down 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 dollars in our capital markets product and about five million dollars in payments. So if you think about the future, I would think that, you know, the record year of 80 million dollars in our capital markets, business likely with loan volume in the industry being where we're probably will be next year, we'd expect that to come off a little bit, you know, call it 20, 25 percent, just like mortgage probably will.

[00:34:01] But, you know, just to go into Duncan Williams, you know. As we talked about our already, you know, Duncan Williams has about 250 financial institution clients, you put that with our 700.

[00:34:17] That's about a thousand financial institutions. Last year, in 2000, 99, Duncan reported at about 27 million dollars in revenue came just from a modeling perspective. As we model the deal, we typically try to run these non capital intensive businesses around the 75 percent efficiency ratio business. So hopefully that's helpful. And your your your your modeling service, you think about the pluses and minuses, you know, going into next year, I think you're going to see some of the capital markets activity likely decline a little bit. But, you know, with the opportunity to increase relatives, our fixed income opportunity with our own group, as well as, you know, Duncan Williams and the replacement of revenue there. And then I think long term, I think we're just excited to see, you know, the synergies between the two teams as as we have products and services from both groups that eventually we can cross volunteers. Clearly, you know, that's not going to happen in the next six months, but that's the long term, you know, approach. So hopefully that's helpful for you.

[Kevin Fitzsimmons, D.A. Davidson]

[00:35:26] That's great, Steve. Thanks, appreciate that color. Just just one other broader question about reserve Bill. You know, I appreciate all the detail on the the level you've taken the reserve ratio to. And then more broadly, when you look at loss absorption, as you guys are describing it. So that being said, 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 model, should we assume reserve build this mostly in the rear view for you guys, or is it if we still think there are losses coming, it's just they're not coming yet. They maybe will be later next year. It still may make sense for you all to incrementally build in the next few quarters. Thanks.

[John Corbett, Chief Executive Officer and Director]

[00:36:18] Yeah. Kevin, I'll start then. Or anybody else want to jump in and certainly do so. But you know, the thing about Cecil, of course, and it's interesting that we all implemented this new life of low model life of, you know, and shortly before hitting this pandemic. But, you know, the theory behind it is that we reserve fully for the economic forecast the losses that would be driven by the economic forecasts and lost lost jobs and model over that forecast period, in which case that theory would tell you that today you've got every dollar in your reserve that you need. And that should be true of everyone who's adopted seasonal absent a change and in that forecast. So, you know, forecasting from there, if if the economic forecasts don't worsen, then, you know, our reserves should be adequate now. There's a lot of cloudy, according to the crystal ball right now, with what appears to be increases in Kovik 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, you know, I mentioned in my comments the the models change. So the you know, given the timing of our closing, we had to do really a sum of the parts methodology for June 30th. You couldn't really convert over to a 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 methodologies for the reserve, unfunded commitments. So so absent that, you know, the quarter's provision expense would have been, you know, six or seven million.

[00:38:12] In terms of law, will they shut down? You might want to you might want to comment on Kevin's question about where we think losses. In the industry heading into the future.

[Dan Bockhorst, Chief Credit Officer]

[00:38:26] Yeah, just from a, you know, future loss perspective, you know, the last two quarters have been very good from a charge of perspective and I don't anticipate, you know, any material change in that here in the fourth quarter. You know, it's, you know, more first, second, third quarter, depending upon how the pandemic plays out and what impact, you know, that may have in the future on credit. But right now, you know, NPAs, charge offs, et cetera, you know, credit looks strong.

[Kevin Fitzsimmons, D.A. Davidson]

[00:39:07] Ok, thank you, guys.

[Operator]

[00:39:13] My next question comes from Catherine Moore with KBW. Please go ahead.

[Catherine Mealor, KBW]

[00:39:20] Thanks. Good morning.

[John Corbett, Chief Executive Officer and Director]

[00:39:20] Good morning. Born in. We follow up on the asset quality you mentioned in your slide deck that classifieds increase this quarter. Can you just give us a little bit of color around the categories that drove that increase this quarter?

[Dan Bockhorst, Chief Credit Officer]

[00:39:38] Then you would think that, yes, they because I'll take that question, you know, the pandemic created economic headwinds, you know, put a lot of loans on deferral and Q2 and Q3, you know, as good risk managers, we did a comprehensive review with credit administrators and market presidents in August. Of all of our loans, over one million dollars that were there in high risk categories were are were on deferral. As a result of this review, we made changes to the risk rating grades so that we could ensure that we have the appropriate allowance and also acknowledge the impact that the economic headwinds have had on some of the borrowers. You know, clearly there is more stress in the hotel book across the entire industry. And so that's what's driving these these numbers primarily to make up the majority of the classified and criticize, recognizing the headwinds there. You know, the severity of any loss is mitigated by the approximate, you know, five percent pizzuti mark on the legacy center state bank loans, plus the overall 55 percent LTV in the hotel portfolio. You know, from where we are today, you know, the economy continues this rate of recovery. We don't anticipate any material change in the level of criticize are classified assets in the immediate future quarters.

[Catherine Mealor, KBW]

[00:41:17] Ok, great. And on the hotel book, any kind of update on what you're seeing is as some of your properties in terms of occupancy rates and maybe kind of a difference between what you saw this past quarter and your your coastal properties versus your metro market.

[Dan Bockhorst, Chief Credit Officer]

[00:41:33] Yeah, the hotel bookings is performing better than we anticipated in about two thirds of the portfolio is in, you know, leisure segment, you know, vacation areas, coastal waterways that are, you know, destinations within driving distance of a large segment of the southeast population. And the summer was fairly good. You know, occupancy levels and those categories, you know, exceeded 60 percent and in some cases were greater than 80 percent. So and you combine that with, you know, deferrals and TPP 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 better operate, you know, in this environment, you know, the business segment, which makes up about one third. You know, we've seen occupancy levels, you know, typically in in the low to mid 50 percent range, some might be 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.

[Catherine Mealor, KBW]

[00:42:53] A helpful one and then maybe one other question on just big picture CapitalSource, a lot of banks are starting to talk about buybacks. I don't think many banks of your size will start buybacks this year. But how are you thinking about what you're looking for to be able to start to think about reengaging in the buyback activities and then into next year together?

[John Corbett, Chief Executive Officer and Director]

[00:43:16] Is John. Maybe I can comment and will feel free to chime in. You know, a lot of uncertainty this summer. Plus, in our situation, we were putting too large balance sheets together, wanted to see where these capital ratios should go. You know, we did raise some subset in the second quarter of the year to bolster the capital position. If you look at us, we we look pretty good relative to our peers on siete, one in total risk based capital. The one ratio that's a little bit lower is tangible common equity. I think it ended the quarter around seven point eight percent. If we keep profitability somewhere where it's at today, that should exceed eight percent headed into two thousand twenty one. So, you know, if credit is as benign in twenty one as we're feeling like it might be now that having that extra capital getting EPS back above eight percent, I feel like it gives us some optionality to look at a buyback. Right now, the dividend, I think it's yielding about three percent. We're paying back about a third of the earnings. And 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 Twenty twenty one.

[Catherine Mealor, KBW]

[00:44:33] Thank you. Congrats on a great quarter.

[John Corbett, Chief Executive Officer and Director]

[00:44:35] Thank you.

[Steven Young, Chief Strategy Officer]

[00:44:35] Thank you.

[Operator]

[00:44:38] Our next question comes from Brody Prestonwood Stephens. Please go ahead.

[Unidentified Analyst]

[00:44:44] Hey, good morning, everyone. Good morning. Good morning. I just want to circle back on the on the expenses real quick. So appreciate the five million or so in business development. That's 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 two. Q sort of pro forma run rate of 225 just given, you know, the world was still, you know, locked down at that point or, you know, just coming out of a lockdown. And so I guess, you know, it's still really good causes. And you mentioned the two and a half million or so from from the successful sort of cost savings. And so I guess, was there anything else that that you all sort of did that drove, you know, the larger sort of reduction in expenses this quarter?

[William Matthews, Chief Financial Officer]

[00:45:40] So various will let me clean up a little bit just to make sure so that that five minute hour I mentioned, that was more than just business development, it was included, you know, or any loan related foreclosure, all those kind of expenses and included professional fee reductions, you know, not all related sort of activity levels being lighter. And I was down to business. And that's but this is Q2 versus Q3.

[00:46:05] And I think part of this as well. Well, you know, Q2, you probably have some Q1 expenses, you know, employee credit card or stuff like that, or those bills are received and paid in Q2. So that's probably a little bit of noise there. You know, in terms of the full part of it was not business development. Just to be clear on that, you know, we I would say, you know, Q2 had probably a little higher expenses associated with with our covid reaction, just getting things geared up in terms of responding with our facilities and things like that. So that that was a little bit of a I would think that would be decline from Q2 to Q3. But, you know, I just love my comments were just to try to give you a little more clarity on it feels to me like like 215 is not a permanent run rate, given the unusual environment in which we're operating. And if we move back to a more normalized environment, we're going to be calling on customers. Greg, what point in his team are going to be hitting the road and spending some money on the business development side? You know, foreclosure activity is going to come back, come back in an industry to some extent. 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 in the past.

[John Corbett, Chief Executive Officer and Director]

[00:47:24] I'd just add to that. I mean, you know, we showed in the deck the combined business basis, the expenses there. And if you think about, you know, sometimes our Fioravanti businesses move, you know, these expenses up and down on the variable side, you know, our revenue was up under the income by about six million dollars, six and a half million dollars. A lot of that related to the MSR adjustment. So if you think about, you know, the variability of the fee income, there really was, from a commission perspective, much difference in quarter to in quarter three. So the quarter to expenses would be, you know, on a combined basis outside of our cost base would be pretty reflective of the run rate where we're at. So sometimes the fee income doesn't move that around a little bit, but really in the in the third quarter did not. So that's helpful commentary, too.

[Unidentified Analyst]

[00:48:15] Ok. All right. Understood. Thank you for that. And then on TPP, you know, I think you've mentioned, you know, two point four million still on the balance sheet, wanting 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 balance sheet?

[Dan Bockhorst, Chief Credit Officer]

[00:48:39] You know, I'll start by saying that, you know, our with respect to our crystal ball is probably more cloudy than some of the other commentary I've heard folks give. But what I tell you what we know is we have about 20 percent of our loans in the forgiveness process have entered the procurement process. You know, during the quarter, we recognized about eight and a half million of the net fee EPS, leaving us about fifty three million, fifty three point three, 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 SBA will respond. Will there be another bill passed post-election that may include some sort of forgiveness? But I would say our expectation with all those qualifiers 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 for you on how much of those supplies are still in the balance. Yes, that's a good question. But John or Steve may have a feel for that.

[Steven Young, Chief Strategy Officer]

[00:49:54] Yes, really. I think, Steve, I just the point here is that we don't know the exact answer. But I mean, it's pretty obvious when you look at the big picture on page 19 of the deck, which shows the deposits from the first quarter to the second quarter. And what you see is four point two billion dollars before there.

[00:50:11] And and that's when all the money was going out and we're flat from there. So the way I would characterize it as, yeah, deposits from those companies, although we don't have a specific answer, really haven't haven't spread out yet. And our deposits are flat after that big ramp in Q2.

[Unidentified Analyst]

[00:50:32] Ok, understood, I guess I'm just trying to think about the potential deployment of excess liquidity, and so, you know, you've got four, you know, three billion and sort of excess liquidity, like you said, on the balance sheet. But I guess just thinking about the deployment of that, either into loans or securities throughout Twenty twenty one, you know, I guess as those deposits flow out, well, I guess that would sort of flow out with it. Or I guess do you estimate that you sort of have excess liquidity still on the balance sheet that can be deployed into earning assets beyond the pop deposits?

[Steven Young, Chief Strategy Officer]

[00:51:10] Yeah, I think, you know, the answer is we don't know. You know, I think what our target if you looked at our companies, separate companies, we ran our investment portfolios, 12 percent of assets.

[00:51:21] That's how we've always traditionally done it. You know, when we had a lot of excess liquidity in the financial crisis, we probably ran it closer to 15. But I think right now we're in the wait and see mode. You know, we need to build the securities back up to that medium term, 12 percent number and then see where the landscape is to help us keep funds, because I do think it's uncertain and we just want to be thoughtful is to do it.

[Dan Bockhorst, Chief Credit Officer]

[00:51:47] And I would I would I would say, Steve, I would also just add to that that, you know, while certainly a portion of the excess liquidity is cheap, it's also just the liquidity that the Fed has pumped into the economy. And, you know, some of those PCP's loan fundings have been used to pay payroll and things like that. But I think there is just an excess amount of liquidity that with us right now based on the actions the Fed has taken over and above the EPS.

[Unidentified Analyst]

[00:52:16] Ok, understood, and on Duncan Williams, you know, thanks for giving the 27 million in revenue last year, trying to give a sense for their business has, I guess, been negatively impacted this year as a result of covid or how how they've been faring year to date.

[Steven Young, Chief Strategy Officer]

[00:52:34] 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 financial space. So if you think about all the excess liquidity we're talking about, it needs to be invested at some point. So do our clients. And so I think, you know, even though, you know, financial institutions like ours have been pretty hesitant to go too fast on this 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, you know, hedging with, because I think the fixed income revenue will probably be a little stronger than that. But, you know, it's probably too early to tell.

[Unidentified Analyst]

[00:53:20] Ok, 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. Ok, and so just, you know, wanted to ask those, you know, twenty two point four million in pay or, you know, an increase in income this quarter, I guess just thinking about the quarterly run rate moving forward, you know, understood that it's supposed to step down. But what should the quarterly run rate on P.A. look like? You know, perhaps for four to you? And and when do you sort of expect those goes down, those long discounts to be fully accreted into income?

[Steven Young, Chief Strategy Officer]

[00:54:07] Will you want to take that?

[William Matthews, Chief Financial Officer]

[00:54:08] Well, you know, I'm I'm I'm really that, you know, you understand why you know, if you'd asked me three months ago, I would not have come. I would not have guessed. Twenty two million. It's just a hard number to predict based upon when payoffs occur, pitons occur, things like that. But it's clearly going to it should decline from here. And, you know, you model it over the way the 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 models. 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 would be appropriate, given the difficulty. But, you know, if you you know, the best way to do is just model of whatever you think of whatever life would be for that acquired portfolio. And that would sort of guide you to a number. But, you know, I wish I could give you a better number, but I don't feel comfortable doing so.

[Unidentified Analyst]

[00:55:17] Ok. Do you have to do you know the weighted average life off the top of your head?

[William Matthews, Chief Financial Officer]

[00:55:22] I do not actually, I don't.

[00:55:24] But, you know, the type of lending we do. And again, this would be from from regulation based, the type of lending we do. You really think about it being that, you know, three to five year range, but yeah.

[Steven Young, Chief Strategy Officer]

[00:55:39] Well, I'd say get for the center, say, look, prior to merger, it was around three point three years was the average life. So I think that is probably a decent of point.

[Unidentified Analyst]

[00:55:51] All right, great. Thank you for taking my questions, everyone. I appreciate it.

[John Corbett, Chief Executive Officer and Director]

[00:55:54] Thank you.

[Operator]

[00:55:58] Our next question comes from Christopher, Maryna, with Jenny McCarthy. Scott, please go ahead.

[Christopher Marinac, Janney Montgomery Scott LLC]

[00:56:04] Hey, thanks. Good morning. Thank you for the the color on the problem, assets on the prior calls. I just want to drill down to the kind of, you know, 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, get more visibility on the recession, covid, et cetera, and then those will migrate back later?

[John Corbett, Chief Executive Officer and Director]

[00:56:30] Damn, get back a little bit, a combination of both.

[Dan Bockhorst, Chief Credit Officer]

[00:56:35] You know, I do think there's an opportunity for some of those classified loans to, 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, pass a six month to nine months to see those start to get upgraded as we get a little bit more visibility. But I don't anticipate, you know, those to also I don't anticipate those to migrate and get and get downgraded.

[Christopher Marinac, Janney Montgomery Scott LLC]

[00:57:17] Got it. That's that's all. So, again, the reserve bill really kind of counsel that into effect now as these downgrades, correct? Got it. OK, 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?

[Dan Bockhorst, Chief Credit Officer]

[00:57:42] You know, just the fact that it hasn't really been a conversation in any of our various risk means what whatnot would leave me to answer, Chris, that it's really not a factor for us. And I'm not comfortable with, as I say that. But I think we built some pretty good processes and had involvement of of local teams, you know, which is a strength of our company throughout that process. So hopefully we would be less subject to that. Then, you know, there's I don't think we've seen much of that, John. Steve, you have a hell of a better answer.

[John Corbett, Chief Executive Officer and Director]

[00:58:20] Well, this is going on at times, I think I've asked that question, and so far I'm receiving confidence back that they're not seeing trends of fraud. So it's still early, but that's where we that's what we're here now.

[Christopher Marinac, Janney Montgomery Scott LLC]

[00:58:35] Great, I appreciate that. Thanks again for all the time this morning.

[John Corbett, Chief Executive Officer and Director]

[00:58:38] You bet.

[Steven Young, Chief Strategy Officer]

[00:58:38] Thank you, Chris.

[Operator]

[00:58:42] Again, if you'd like to ask a question, please, press star, then one for our next question comes from Jennifer Dumbell with Truworths. Please go ahead.

[Unidentified Analyst]

[00:58:53] Thank you. Good morning. I think our top political topics have 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 to reduce more branches or corporate real estate that's not currently planned right now in order to offset revenue challenges? Should there there be any?

[John Corbett, Chief Executive Officer and Director]

[00:59:21] Jennifer, it's John. You know, with our merger, there really wasn't branch overlap, so I think both companies in the past have acquired a lot of banks with branch overlap and we've put branches together. But setting that aside, there is the secular trend. And I think you're seeing this history with both companies that each year looking to rationalize, rationalize branch network. In fact, if you go back over the last decade, there's a slide page 20 of that deck. If you take the two companies, put them together. There were about 85 branches a decade ago. We've acquired 420 branches, but we've consolidated 212. So we've consolidated about half of everything that we've purchased.

[01:00:09] So this has been an ongoing trend and we think that that will continue to be an ongoing trend. You've heard other folks talk, Jennifer, about the covid driving more and more digital adoption. Interesting. We opened all of our branches in the company this month. They've been closed for, I think, since March. So call it six months that the office has been closed. We open this month. I've talked to some of the presidents and said, well, now that we're open, what's happened with the traffic inside is a remarkably slow that customers have become accustomed to doing business in the drive thru, doing business digitally. And they are the traffic has not picked up considerably in the lobbies. Now that we're open on the digital side, just some stats for you. Year over year, digital deposits are up 67 percent.

[01:01:06] A year ago, you know, this is people taking a picture of their check on their telephone. We were dead. About 15 percent of our deposits went up 25 percent. As far as actually opening new checking accounts online, that's up 170 percent year over year, it was 10 percent of our accounts a year ago now. Twenty seven percent of our accounts and consumer loans opening up online is up 90 percent year over year. A year ago was about 10 percent of our consumer loans, about 19 percent. So I think as we think about the future, we'll continue to evaluate the rotation of brick and mortar expense into digital expense. On the other corporate real estate front, when we did the merger and we analyzed our operations center space, we've got two major operation centers, one in Charleston with a few hundred people and one in Winterhaven, Florida, with a few hundred people. But in actuality, we have 17 total operation centers. There's 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 this efficiency project with the merger, that we may see a significant reduction in a number of those smaller operation centers. These are secular trends. You're hearing from others. And definitely there's a lever for us to continue to pull on a on a year by year basis.

[Unidentified Analyst]

[01:02:36] One more question, John, do you think your revenue producers are as productive working from home as they are or continue office?

[John Corbett, Chief Executive Officer and Director]

[01:02:46] A good question, I mean, are two quarters here are Lone Productions 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 shut down? So I'd like to believe that that they're as productive. I mean, let me answer differently. Go back to the TPP process, OK? The economy was shut down there. They 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. TPP and the ability to be productive is there, at least in that kind of crisis moments. But I think our our relationship managers love to get in front of their clients. So I think that's slowly starting to open up into the long term is probably going to see a mix of in-person and also more digital contacts.

[01:03:42] Good news is on the R.M. front. We're having a lot of success now recruiting and there's a lot of turmoil in the biggest banks. So it's a new world.

[01:03:53] We're all trying to figure out how much time to spend in front of a Zoome call and how much time to spend in person.

[01:03:59] Jennifer Asia-Pac, just, you know, anecdotally on some of these Feliza business, whether it be mortgage, fixed income, capital markets, they're all working remotely and having record production. So I think, you know, the ability to get in front of the clients is a little harder. But at the same time, you know, I think we're all figuring out that you can do some of this more remotely. But, you know, I think there's pluses and minuses out of both of.

[Unidentified Analyst]

[01:04:27] That's great, Kelly. Thank you.

[Operator]

[01:04:33] This concludes our question and answer session. I would like to turn the conference back over to John Corbett for any closing remarks.

[John Corbett, Chief Executive Officer and Director]

[01:04:42] 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 or Steve. Thanks for joining us this morning and I hope you have a great day.

[Operator]

[01:05:06] The conference is now concluded. Thank you for attending today's presentation, you may now disconnect.