Good day, welcome to the SouthState Corporation third quarter earnings call. All participants will be on listen-only mode. Should you need assistance please contact the conference specialist by pressing the star key followed by zero. After today's presentation, there will an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Will Matthews. Please go ahead.
Good morning, and welcome to SouthState's third quarter earnings call. This is Will Matthews, and joining me on this call are Robert Hill, John Corbett, Steve Young, and Dan Bockhorst. The format for this call will be that we will provide prepared remarks, and we will then open it up for questions. Yesterday evening, we issued a press release to announce earnings for Q3 of 2020. We've 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 that 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.
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 SouthState. The CenterState-SouthState partnership was about the long term. 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. 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 Corbett's 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 we're producing. It was a solid quarter. Adjusting for merger costs, the company produced diluted earnings per share of $1.58 for a 17% return on tangible equity. Our pre-provision net revenue grew to $170 million for a pre-provision return on assets of 1.8%. Tangible book value per share grew at an annualized rate over 15%. The highlight 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, Inc. 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. SouthState currently serves nearly 700 community banks nationwide, and Duncan-Williams, Inc. adds 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, and we're very excited to welcome Duncan and his team to SouthState. 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, 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. Of the 2% of loans currently on deferral, half of those are in fact making their interest payments. Really, only 1% of loans are at full principal and interest deferral. This is the second quarter in a row that we recorded only one basis point in charge-offs. As for the merger integration, it's proceeding on time and on budget. 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 SouthState team leaning forward and eager to go on offense to prove what this new franchise is capable of. One area where we continue to improve is the SouthState digital experience. This month, under the leadership of Renee Brooks, we rolled out our new website, 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 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. SouthState 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. 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 there are things that we cannot control. We can't control the path or duration of the COVID, 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 our 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. Finally, we can make investments in top-notch relationship managers in the best growth markets in the country. 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. Finally, along those lines, I'm happy to share the news that SouthState has created a new executive level position of Director of Corporate Stewardship. LeDon 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 LeDon 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.
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 pre-closing security sales on the legacy CenterState side, 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 CenterState 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, $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 in the company. Accretion was $22 million for the quarter, and core NIM excluding loan accretion was 295. 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. 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. Our total cost of deposits continues to improve down to 20 basis points for the quarter. Our CDs are relatively short, with 19% coming due in Q4, another 32% in the first half of 2021, and 26% in the second half of 2021.
On non-interest income, we had a record $115 million in 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 teams, as well as a pandemic with record volume of $1.57 billion, 60% 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 quarter. 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.
Steve has responsibility for these non-interest income businesses and is available to answer questions on them during the Q&A session. On expenses, our NIE for the quarter was $237 million, including $22 million in merger related expenses for an operating NIE of $215 million. 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 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.
Our expenses for a number of items were down in Q3 due to COVID. Business development, loan related and ORE expenses, travel expenses, and to some extent, health insurance costs were all down due to COVID. We would expect many of these to normalize once we are beyond the health crisis. The Q3 run rate for several areas is lower than we would expect in a normal non-COVID environment. On merger-related expenses, we've recognized approximately half of the estimated $205 million to date, some of which occurred on the CenterState side pre-closing. Turning to credit. Our net charge-offs remained very low at $594,000 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 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 CECL models and combining the results in Q2, we consolidated onto one model in the third quarter. This consolidation of the legacy SouthState 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 and Q4 of this year, before starting to decrease in 2021 with a forecast of 7.4% at year-end 2021 and 5.4% at year-end 2022.
With a provision expense of almost $30 million and net charge-offs of less than $1 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 4x . 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 2% at October 23rd. Additionally, our full P&I deferrals were only 1% at that date, as almost half of the deferrals are paying interest. For the effective tax rate, our return to profitability in Q3, after the impacts of the double-count provision and other merger expenses in Q2, caused our effective tax rate to decline in the third quarter to 19.6% from the second quarter's 22.6%.
Turning to capital. With good profitability and a flat, though still somewhat inflated balance sheet, our capital ratios grew during the quarter. Our TCE ratio grew 27 basis points, ending at 783. Our CET1 and total risk-based ratios grew by approximately 80 and 100 basis points respectively, ending at 11.5% 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'll turn it back to you, John.
All right. As a reminder, we are conducting this call 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. To ask a question you may press star then one on your touchtone phone. If you are using a speakerphone please switch off your handset before pressing the key. To withdaw you question, please press star then two. At this time we will pause momentarily to assemble our roster. 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 just circle back to expenses, Will. You guys had obviously some really good revenue generation this quarter and the expenses were down. I understand some of it is COVID related, but can you just help us from a run rate perspective as the economy continues to reopen hopefully, what are some of the specific add backs we should think about? If you can just remind us how much of the cost saves, I'm sorry if I missed it, how much of the cost saves so far you've actually realized? Thanks.
Sure, Michael. On the latter part of the question, we would estimate that thus far, we have recognized on an annualized basis run rate about 12%-13% of the $80 million cost saves. Call that $2.5 million for a quarter. In the quarter, like I said, we don't have people out there doing business development efforts. There's a lot less travel going on. There's not much real estate foreclosure activity and 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 as often as we had, so we're seeing a little bit of decline in health insurance. I'd say all of those items combined, relative to a more normalized quarter, might be $5 million or so in a quarter, roughly.
That's why we just wanted to be clear that while we're pleased that NIE was down to $215 million, this is an unusual environment and didn't want to have people overinterpret that as they look forward.
That's very helpful. Then maybe just switching to the core margin, 295. I know there's some moving parts in there, first full quarter post-integration. As we think about going forward, 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 prevent or limit NIM compression from here? Thanks.
Sure, Michael, it's Steve. Let me just 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. What you see in there is the revenue composition has changed. A year ago, we were about 77% NIM, 23% fees. Now we're 30% fees, 70% NIM. Just wanted to draw your attention to that. Our reported margin, as Will mentioned, was 322, our core margin at 295. Just a couple of things on that. We are a core deposit-funded bank in great markets. Our checking accounts make up 54% of deposits, and our total cost of deposits this quarter was actually 20 basis points. We continue to grow low-cost deposits on our retail, our small business, and our treasury platform.
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 speak through the components of margin. First, on the yield on the loan portfolio, ex-PPP and accretion this quarter was 416. We're putting new loan production yields this quarter in at 353. That continues to be a headwind. As it relates to Will's comment on the excess liquidity, we have about $4.4 billion of average Fed funds sold, probably about $3 billion over a target. It weighed on our margin about 24 basis points this quarter. 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 $1 billion of the CenterState portfolio because it was going to be mark-to-market around 1.25. As we think about the future of that excess liquidity, we invested about a $0.5 Billion this quarter to get us to around $3.5 billion. We're likely on a path to get it closer to $4 billion by the end of the year. In the medium term, our target for the investment portfolio is around 12% of assets. That'll depend upon liquidity, it'll depend on 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. We are cautious on that, particularly as the non-interest income businesses have been performing. One last comment on the securities portfolio.
It was at 1.63% this quarter, and we're adding purchases somewhere around 1.25%. That would be the core margin comments. 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 there's about $110 million of discount left on the acquired loans. With that, why don't I turn it over to Will if you have any other comments there?
I think I just would reiterate a couple of things to make sure that we emphasize them. One is just the reminder Steve gave about the marking of the CenterState portfolio in Q2 and the impact we had. You basically had a $2 billion bond portfolio, half of which 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. That's the impact. The second is probably more important, and that is just our long-term focus and trying to make sure the decisions we make are ones that we're going to like for the long term.
It would certainly be easy to boost earnings a bit if we took that excess cash of $3 billion and invested it to pick up 110, 120 basis points over where we are earning today at the Fed. We want to be thoughtful and do that over time and not get aggressive and then regret that nine months or a year down the road if rates have moved back up. We'll be thoughtful about pulling that lever, although it does exist.
Okay. All that color is helpful. I think the way to read that is maybe core margin ex PPP and ex accretion income. 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. Maybe we get to a point where NII actually troughs on a core basis, ex PPP and accretion sometime next year and then starts to build from there. Is that the kind of the messaging and the way to think about it?
Yeah, Michael, it's Steve. I think that's a fair way. I think the tailwind will be any of our investment purchases. The headwind is the loan book until it gets closer to par. With elections and COVID and all those, the yield curve is going to move around a lot, but that's how we're thinking about it.
Completely understood. Thanks for taking my questions.
Our next question comes from Stephen Scouten with Piper Sandler. Please go ahead.
Hey, good morning, everyone.
Hi, Stephen.
Morning.
I 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 we won't see net savings due to investments in digital and other technology investments. Is that correct? Did I kind of interpret that right?
Yes, Stephen, I think John can elaborate further, but it's hard to separate out between the merger cost saves we have, as well as the additional investments we're making in digital and the branch reduction. Our $80 million goal includes all three of those, both the reduction in expenses from the branch reductions as well as the additional investments we're making in improving our technology. 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.
I think you nailed it, Will. I don't have anything to add.
Perfect. How would 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's represented in salaries kind of in this quarter, in the quarters to come, assuming that does kind of trickle down maybe with MBA forecast next year, how we can think about the impact on salaries or maybe an efficiency ratio that you think about in that business on a variable basis?
Yeah. Why don't I start and then Steve, maybe you can comment on the efficiency ratio side. Two components to compensation expense in mortgage. Obviously, one is the staff to get all of the loans through the system, and obviously 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, accounting guidance dictates that you offset against the revenue. It's FAS 91. The cost of originating that loan, i.e. the commission, is a revenue offset and the gain on sale margin.
I will admit to you that we've looked at all our peers, not everyone does it the exact same way, but we do it that way, and that's the way we understand the accounting guidance from the time we've spent discussing with a number of accounting firms. That's a component that probably lacks some comparability when you look at other companies. Some other companies, I should say.
Steve, to your point, mortgage for the industry had a great quarter. We are really super proud of our group. The integration of those teams, Tom Britt and Stephen's leadership, they're just doing a great job at integrating those teams. The production was very large, but the gain on sale is very large. If you think about efficiency ratios, I would expect that over time, that margin, which are record at every company right now, would move back toward 3%, even though the production, as we think about these historical levels, may move back 20%, 25% over time. Hopefully, that kind of helps guide you through. The efficiency obviously is really good right now because the margins are so large. The margins will come in, but 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 else. It looks like there was maybe a big migration from the acquired book into the non-acquired book. Maybe not. Maybe if you can comment on that, the big reduction in acquired non-credit impaired, and then just kind of with the pipelines building, how you think about net growth in this environment, which obviously is a little tenuous still at best, I guess I should say. 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. I think, Stephen, you talked about a decline in the acquired book and a rise in the non-acquired book. You remember how this works. The acquired book only runs off. You never add to it. All of the CenterState loans that came in under the fair market value accounting, they only decline. All of the loans that are being generated by both SouthState and Legacy CenterState, all of that goes into non-acquired. I think you'll continue to see that mix where one portfolio is going down, the other one has the outsized growth because now it's got double the production.
From a growth standpoint, we've had 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. 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 book at the end of the second quarter, we saw a $150 million decline. It annualized out at, like, 10%. On the same token, we had a record residential production of $1.6 billion. We had $150 million run off, but yet we produced $1.6 billion. The economics, as Steve mentioned, of this gain on sale being at 4% is just unprecedented.
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 from an ALCO standpoint, the right thing to do for our clients is to move those loans to the secondary market. 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 recognize that a commercial loan pipeline is a 90-day pipeline. Loans you close in the third quarter are typically loans where they enter the pipeline in the second quarter. What was the pipeline in the second quarter was dead. It doesn't surprise us that total commercial portfolio would be down in the third quarter.
Having said that, within the commercial portfolio, we were encouraged that we were up. The C&I portfolio was up during the quarter, and owner-occupied commercial real estate was up in the quarter. It's important to think about those components, but as you think forward about the pipeline, the pipeline is climbing now between $100 million and $200 million a week. Let me step back and put it in perspective for you. Pre-COVID, 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 low in August, the pipeline's 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 and 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.
Great. Thanks for all the color, and congrats on a very good quarter and a lot of progress already. Congrats.
Thank you.
Thank you.
Our next question comes from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.
Hey, good morning, everyone.
Hey, Kevin.
Morning.
Just wondering on correspondent banking, given the strength, the full quarter impact of that coming in and the business doing well, but also the acquisition that you guys announced. Just curious how sustainable you view that pace of revenues going forward, just any kind of seasonal or cyclical forces we should be aware of. Also, with the deal, are there other bolt-on deals like this you guys are looking at in that area? Thanks.
Sure. Thank you, Kevin. This is Steve. One of the things I just remind us, we really like the diversification of these fee income businesses. If you think about mortgage, correspondent, capital markets and wealth, none of those businesses make up more than 12% of our total revenue. We like the diversification within each line. As it relates to the correspondent group, if you look at the trailing 12 months under Brad's leadership, 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, and about $5 million in payments.
As you think about the future, I would think that, the record year of $80 million in our capital markets business, likely with loan volume in the industry being where it probably will be next year, we'd expect that to come off a little bit, call it 20%-25%, just like mortgage probably will. Just to go into Duncan-Williams, Inc., as we talked about already, Duncan-Williams, Inc. has about 250 financial institution clients. You put that with our 700, that's about 1,000 financial institutions. Last year, in 2019, Duncan reported about $27 million in revenue. Just from a modeling perspective, as we model the deal, we typically try to run these non-capital intensive businesses around a 75% efficiency ratio business. Hopefully that's helpful in your modeling.
As you think about the pluses and minuses going into next year, I think you're going to see some of the capital markets activity likely decline a little bit. With the opportunity to increase relative to our fixed income opportunity with our own group as well as Duncan-Williams, Inc. and the replacement of revenue there. I think long term, I think we're just excited to see the synergies between the two teams as we have products and services from both groups that eventually we can cross-sell into. Clearly, that's not going to happen in the next six months, but that's the long-term approach. Hopefully that's helpful for you.
That's great, Steve. Thanks. Appreciate that color. Just one other broader question about reserve build. I appreciate all the detail, the level you've taken the reserve ratio to, more broadly when you look at loss absorption as you guys are describing it. That being said, if net charge offs are staying low as they are, and we don't get any real big change in some of the economic indicators for your CECL models, should we assume reserve build is 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, maybe it will be later next year. It still may make sense for you all to incrementally build in the next few quarters. Thanks.
Yeah. Kevin, I'll start, and if Dan or anybody else wants to jump in they can certainly do so. The thing about CECL, of course, and it's interesting that we all implemented this new life of loan model shortly before hitting this pandemic. The theory behind it is that we reserve fully for the economic forecast, the losses that would be driven by these economic forecasts and loss drivers in your 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 CECL, absent a change in that forecast. Forecasting from there, if the economic forecasts don't worsen, then our reserves should be adequate.
There's a lot of cloudiness to the crystal ball right now with what appears to be increases in COVID cases, and who knows what that's going to do to some of the forecasts of unemployment and other loss drivers going forward. Sitting here today, the way the CECL model is supposed to work, we should be fine. I mentioned in my comments the model change. 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. 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 for unfunded commitments.
Absent that, the quarter's provision expense would've been $6 million or $7 million. In terms of loss realization, Dan, you might want to comment on Kevin's question about where we think losses in the industry are heading in the future.
Yeah. Just from a future loss perspective, the last two quarters have been very good from a charge-off perspective, and I don't anticipate any material change in that here in the fourth quarter. It's more first, second, third quarter, depending upon how the pandemic plays out and what impact that may have in the future on credit. Right now, NPAs, charge-offs, et cetera, credit looks strong.
Okay. Thank you, guys.
Our next question comes from Catherine Mealor with KBW. Please go ahead.
Thanks. Good morning.
Good morning.
Morning.
One follow-up on the asset quality. You mentioned in your slide deck that classifieds increased this quarter. Can you just give us a little bit of color around the categories that drove that increase this quarter?
Dan, you want to take that?
Dan Bockhorst. I'll take that question. 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 presidents in August of all of our loans over $1 million that were either in high-risk categories or 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. Clearly, there is more stress in the hotel book across the entire industry, and so that's what's driving these numbers primarily that make up the majority of the classified and criticized, recognizing the headwinds there.
The severity of any loss is mitigated by the approximate 5% PCD mark on the legacy CS CenterState bank loans, plus the overall 55% LTV in the hotel portfolio. From where we are today, if the economy continues this rate of recovery, we don't anticipate any material change in the level of criticized or classified assets in the immediate future quarters.
Great. On the hotel book, any kind of update on what you're seeing at some of your properties in terms of occupancy rates? Maybe kind of the difference between what you saw this past quarter in your coastal properties versus even some of your metro markets?
The hotel book is performing better than we anticipated. About two-thirds of the portfolio is in leisure segment, vacation areas, coastal waterways that are destinations within driving distance of a large segment of the Southeast population. The summer was fairly good. Occupancy levels in those categories exceeded 60%. In some cases were greater than 80%. You combine that with deferrals and the PPP funds. With this improvement in performance allowed a lot of these borrowers to stabilize and build some liquidity, as well as they've adjusted expenses to better operate in this environment. The business segment which makes up about one-third, seeing occupancy levels typically in the low to mid 50% range. Some might be a little bit lower. Those are the ones that are struggling a little bit more and have a little bit more headwinds.
Great, very helpful. Then maybe one other question on just big picture capital thoughts. A lot of banks are starting to talk about buybacks. I don't think many banks of your size will start buybacks this year. How are you thinking about what you're looking for to be able to start to think about reengaging in the buyback activity as we move into next year? Thanks.
Catherine, it's John. Maybe I can comment and Will, feel free to chime in. A lot of uncertainty this summer, plus in our situation, we were putting two large balance sheets together, wanted to see where these capital ratios shook out. We did raise some sub-debt in the second quarter of the year to bolster the capital position. If you look at us, we look pretty good relative to our peers on CET1 and total risk-based capital. The one ratio that's a little bit lower is 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.
If credit is as benign in 2021 as we're feeling like it might be now, having that extra capital, getting TCE back above 8%, I feel like it gives us some optionality to look at a buyback. Right now, the dividend, I think it's yielding about 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.
Thank you.
Thank you.
Our next question comes from Brody Preston with Stephens. Please go ahead.
Hey, good morning, everyone.
Good morning.
Morning.
I just wanted to circle back on the expenses real quick. Appreciate the $5 million or so in business development that's sort of not in the quarterly run rate right now. Correct me if I'm wrong, theoretically, that should have also been somewhat missing from the Q2 sort of pro forma run rate of $225 million, just given the world was still locked down at that point or just coming out of a lockdown. I guess, it's still really good cost savings, and you mentioned the $2.5 million or so from the SSB/CSFL sort of cost savings. I guess, was there anything else that you all sort of did that drove the larger sort of reduction in expenses this quarter?
Brody, it's Will. Let me clean up a little bit just to make sure. That $5 million I mentioned, that was more than just business development. It included ORE, loan related, foreclosure related, all those kind of expenses. It included professional fee reductions all related to sort of activity levels being lighter. I looked on the business development, this is Q2 versus Q3. I think part of it is in, while Q2 you probably have some Q1 expenses, i.e., employee credit card and stuff like that, those bills are received and paid in Q2. That's probably a little bit of noise there. The full $5 million was not business development, just to be clear on that.
I would say Q2 had probably a little higher expenses associated with our COVID reaction, just getting things geared up in terms of responding with our facilities and things like that. That was a little bit of a, I would think that would be the climb from Q2 to Q3. My comments were just to try to give you a little more clarity on. It feels to me like 215 is not a permanent run rate given the unusual environment in which we're operating. If we move back to a more normalized environment, we're going to be out calling on customers. Greg will appoint his team. We're going to be hitting the road and spending some money on the business development side. Foreclosure activity is going to come back in the industry to some extent. We'll spend a little more money on that.
I kind of wanted to just make sure that that idea was out there.
Will, I'd just add to that. We showed in the deck the combined business basis, the expenses there. If you think about, sometimes our fee revenue businesses move these expenses up and down on the variable side. Our revenue is up on the fee income by about, I think $6 million, $6.5 million. A lot of that related to an MSR adjustment. If you think about the variability of the fee income, there really wasn't from a commission perspective much difference in quarter two and quarter three. The quarter two expenses would be on a combined basis outside of our cost saves would be pretty reflective of the run rate where we're at. Sometimes the fee income businesses move that around a little bit, but really in the third quarter, it did not. Hopefully that's helpful commentary, too.
Okay. All right. Understood. Thank you for that. On PPP, I think you'd mentioned that you have $2.4 billion still on the balance sheet. Wanted to get a sense for the timing of that. 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?
I'll start by saying, Brody, that with respect to PPP, our crystal ball is probably more cloudy than some of the other commentary I've heard folks give. What I'll tell you what we know, we have about 20% of our loans in the forgiveness process, have entered the forgiveness process. During the quarter, we recognized about $8.5 million of the net PPP fee, leaving us about $53 million, $53.3 million, I think, remaining at the end of the quarter. It is really hard to tell 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?
I would say our rough 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 you on how much of those deposits are still on the balance sheet. That's a good question, but John or Steve may have a feel for that.
Brody, this is Steve. We don't know the exact answer, but it's pretty obvious when you looked at the picture on page 19 of the deck, which shows the deposits from the first quarter to the second quarter. What you see is $4.2 billion in deposits are there, and that's when all the PPP money was going out, and we're flat from there. The way I would characterize it is, the deposits from those companies, although we don't have a specific answer, really haven't spent out yet. 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. You've got $3 billion in excess liquidity, like you said, on the balance sheet. I guess just thinking about the deployment of that, either into loans or securities throughout 2021. I guess as those PPP deposits flow out, I guess that would sort of flow out with it. 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 PPP deposits?
Yeah, Brody, I think the answer is we don't know. I think what our target, if you looked at our companies as separate companies, we ran our investment portfolio as 12% of assets. That's how we've traditionally done it. When we had a lot of excess liquidity in the financial crisis, we probably ran it closer to 15%. I think right now we're in the wait-and-see mode. We need to build the securities book back up to that medium-term 12% number. Then see where the landscape is and see how those PPP funds because I do think it's uncertain, and we just want to be thoughtful as we do it.
Okay.
I would say, Steve, I would also just add to that, while certainly a portion of the excess liquidity is PPP, it's also just the liquidity that the Fed has pumped into the economy. Some of those PPP loan fundings have been used to pay payroll and things like that. I think there is just an excess amount of liquidity that's with us right now based on the actions the Fed has taken over and above the PPP.
Okay. Understood. On Duncan-Williams, Inc., thanks for giving the $27 million in revenue last year. Just want to get a sense for if their business has, I guess, been negatively impacted this year as a result of COVID or how they've been faring year- to- date.
Yeah, we won't give those public numbers, but just, 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. As you think about all the excess liquidity we're talking about, it needs to be invested at some point. Do our clients. I think, even though financial institutions like ours have been pretty hesitant to go too fast on this, at some point next year or the year after, you'll start seeing that deployed. I think this is another good business to be hedging with because I think the fixed income revenue will probably be a little stronger than that. It's probably too early to tell.
Okay. 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. just wanted to ask, it was $22.4 million in PAA loan accretion income this quarter. I guess just thinking about the quarterly run rate moving forward, understood that it's supposed to step down, but what should the quarterly run rate on PAA look like perhaps for Q4? when do you sort of expect those loan discounts to be fully accreted into income?
Will, you want to take that?
Well, I was hoping you would, Steve, because, I'm chuckling, Brody. I hope you understand why. If you'd asked me three months ago, I would not have guessed $22 million. It's just a hard number to predict based upon when payoffs occur, pay downs occur, and things like that. It should decline from here, and you model it 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 had modeled. If I were to throw out a number for you, I would worry that I would be imbuing that number with more precision than would be appropriate given the difficulty.
The best way to do it is just to model up whatever you think a weighted average life would be for that acquired portfolio, and that would sort of guide you to a number. I wish I could give you a better number, but I really don't feel comfortable doing so.
Okay. Do you know the weighted average life off the top of your head?
I do not, actually. I don't. The type of lending we do, and again, this would be from origination date. The type of lending we do, you generally think about it being in that three or five- year range.
Yeah. This is Will. I'd say for the CenterState book, prior to merger, it was around 3.3 years was the average life. I think that is probably a decent 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 to 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, get more visibility on the recession, COVID, et cetera, and then those will migrate back later?
Dan?
Yeah, this is Dan Bockhorst. I think a little bit of combination of both. I do think there's an opportunity for some of those classified loans to get upgraded sooner than later. The ones that are in the criticized category, probably a little bit maybe longer path of six months to nine months to see those start to get upgraded as we get a little bit more visibility. I don't anticipate those to migrate and get downgraded.
Got it. That's helpful. Again, the reserve build really kind of counts all that into effect now as of these downgrades?
Correct.
Got it. Okay, thanks for that, Dan. Just a follow-up for whomever. On the PPP, what are you seeing on fraud? 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?
The fact that it hasn't really been a conversation at any of our various risk meetings and whatnot would lead me to answer, Chris, that it's really not a factor for us, and I'll knock on some wood as I say that. I think we built some pretty good processes and had involvement of local teams which is a strength of our company throughout that process. Hopefully, we would be less subject to that than others. I don't think we've seen much of that. John or Steve, and Dan, do y'all have a better answer?
Will, this is John. I think I've asked that question, and so far, I'm receiving confidence back that they're not seeing trends of fraud. It's still early, but that's what we're hearing now.
Great. I appreciate that. Thanks again for all the time this morning.
You bet.
Thank you, Chris.
Okay, If you'd like to ask question press star then one. Our next question comes from Jennifer Demba with Truist. Please go ahead.
Thank you. Good morning.
Good morning.
I think all the 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 reduce more branches or corporate real estate that's not currently planned right now in order to offset revenue challenges, should there be any?
Yeah, Jennifer, it's John. With our merger, there really wasn't branch overlap. I think both companies in the past have acquired a lot of banks with branch overlap, and we've put branches together. Setting that aside, there is this secular trend, and I think you're seeing this history with both companies that each year looking to rationalize the 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. We've consolidated about half of everything that we've purchased. 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 opened 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?" They said remarkably slow. Customers have become accustomed to doing business in the drive-through, doing business digitally, and 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%. A year ago, this is people taking a picture of their check on their telephone. We were doing about 15% of our deposits that way. Now it's 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, now it's 27% of our accounts. Consumer loans opening up online is up 90% year-over-year. A year ago, it was about 10% of our consumer loans, now it's 19%. 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 operations centers, one in Charleston with a few hundred people, and one in Winter Haven, Florida, with a few hundred people. In actuality, we have 17 total operations centers. There's 15 smaller ones.
Those support teams have been working from home for six months, and it's been working fine. 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 operations centers. These are secular trends you're hearing from others, and definitely there's a lever for us to continue to pull 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 working from the office?
Yeah, good question. Our two quarters here, our loan production's down. 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? I'd like to believe that they're as productive. Let me answer a different way. Go back to the PPP process, okay? The economy was shut down there. They were working from home. We did 20,000 loans in a period of about, I want to say it was like three weeks. I think that's the case study, PPP, that the ability to be productive is there, at least in that kind of crisis moment. I think our relationship managers love to get in front of their clients. I think that's slowly starting to open up.
In the long term, you're probably going to see a mix of in-person and also more digital contacts. Good news is, on the RM front, we're having a lot of success now recruiting, and there's a lot of turmoil in the biggest banks. It's a new world. We're all trying to figure out how much time to spend in front of a Zoom call and how much time to spend in person.
Jennifer, I'd just add just anecdotally on some of these lines of business, whether it be mortgage, fixed income, capital markets, they're all working remotely and having record production. I think the ability to get in front of the clients is a little harder. At the same time, I think we're all figuring out that you can do some of this more remotely. I think there's pluses and minuses out of both of them.
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 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. 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.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.