Seacoast Banking Corporation of Florida (SBCF) Q3 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the Seacoast Third Quarter Earnings Conference Call. My name is Anna, and I'll be the operator for today's call. [Operator Instructions] Before we begin, I have been asked to direct your attention to the statement contained at the end of the press release regarding forward-looking statements. Seacoast will be discussing issues that constitute forward-looking statements within the meaning of the Securities and Exchange Act and their comments today are intended to be covered within the meaning of that act. Please note that this conference is being recorded. I will now turn the call over to Mr. Dennis Hudson, Chairman and CEO, Seacoast Bank. Mr. Hudson, you may begin.

Thank you all for joining us this morning. As we provide our comments, we will reference the third quarter 2020 earnings slide deck, which can be found at seacoastbanking.com. With me this morning is Chuck Shaffer, President and Chief Operating Officer; Tracey Dexter, Chief Financial Officer; Jeff Lee, Chief Digital Officer; David Houdeshell, Director of Credit Analytics and Policy; and Richard Raiford, our Chief Credit Officer. As you'll hear in a few minutes, despite the unprecedented operating environment for banks, we reported a strong Q3 with adjusted earnings per share of $0.50. Tangible common equity per share rose 12% on an annualized basis in the quarter to $15.57. Our tangible common equity per share has grown at a compounded 12% annual rate over the past 3 years. During the quarter, we closed on the Freedom Bank acquisition, began the process of PPP forgiveness and continue to operate the business safely and successfully for our associates and customers. I would like -- again, like to express my sincere appreciation to the entire Seacoast team for their hard work this quarter. They were able to onboard new customers and associates, all while operating remotely, and yet continued to achieve significant performance milestones as Chuck and Tracey will cover in a minute. Chuck, I'll turn the call over to you to share a few thoughts on the quarter.

Thank You, Denny. I will also open by expressing my sincere appreciation for the Seacoast team for producing another solid quarter of impressive results despite the challenge of operating in a pandemic environment. The company generated earnings per share on an adjusted basis of $0.50 and tangible book value per share grew 12% on an annualized basis to $15.57. Asset quality, liquidity and capital are all strong, and we continue to generate meaningful capital growth, bolstering our fortress balance sheet. Our capital ratios are more substantial than most of our peers, which provides strategic flexibility as we move through the coming period and ultimately, an economic recovery. During the quarter, Florida's Governor moved to Phase 3 of the state's recovery plan, fully opening up Florida's businesses with no restrictions. We have seen our business customers return to full operations. We are encouraged by the state's economic recovery, but are maintaining a conservative stance in the face of COVID's uncertain path. Our ACL coverage increased modestly from the prior quarter, and we continue to model our ACL in line with a more severe downturn. Tracey will have more details on the ACL modeling in her prepared comments. We continue to be vigilant in maintaining our disciplined, conservative credit culture. Additionally, we are passing on deals that are not pricing to an appropriate risk-adjusted return. Given our conservative position on both pricing and credit, weaker borrower demand and increasing payoffs as anticipated, we saw our loan outstandings decline quarter-over-quarter when you remove the Freedom Bank acquisition contribution. We are comfortable with this dynamic and continue to manage the balance sheet holistically, carefully balancing the interest rate and credit environment, while protecting and prudently growing capital. Loans on deferral status, as of last Friday, have fallen to $290 million or 5.6% of total non-PPP loans compared to a peak back in June of over 20%. Overall, we are pleased with the deferred portfolio's performance to date, and expect deferrals to continue to decline into the fourth quarter. Given the significant amount of loans returning to payment status in October, we will provide an updated disclosure in mid-November. We focused on building fee-based revenues during the quarter with mortgage banking, wealth management and interchange income, all having record-breaking quarters. The mortgage banking business had the best quarter in its history, taking share from larger competitors. The team consistently hit service level standards while prioritizing purchase money volume supporting our local realtors. The group generated over $5 million in fees in the third quarter and is positioned for an outstanding fourth quarter. This increased performance contributed to the increase in expenses in part quarter-over-quarter, as much of the expense base is variable, albeit more than offset by higher revenue production. We also completed the successful acquisition of Freedom Bank, headquartered in St. Petersburg, one of Florida's fastest-growing markets. We are excited to have the Freedom Bank team join Seacoast and believe this combination will generate meaningful momentum looking forward. To conclude, given the full reopening of Florida economy this quarter, the continued positive momentum of loans on deferral returning to payment status and increasingly positive conversations with our customers, we are cautiously optimistic that the outlook may be improving. However, given the pandemic's unpredictable path and its broader impact on the economy, we will continue to maintain our conservative posture. Our goal remains to continue increasing market share in a disciplined manner, while delivering consistent growth in tangible book value per share and positioning the company post pandemic to acquire weakened players across the State of Florida, should those opportunities develop. I will now turn the call over to Tracey, who will walk through our financial results.

Thanks, Chuck. Good morning, everyone. Directing your attention to third quarter results. Let's start with Slide 5. For the third quarter on a GAAP basis, earnings per share was $0.42. On an adjusted basis, which excludes M&A and isolated branch consolidation charges, earnings per share was $0.50 compared to $0.48 in the second quarter. Tangible book value per share increased to $15.57, up 3% from last quarter and 12% annualized. Excluding the variable impact of PPP and accretion of purchase discount on acquired loans, net interest margin contracted only 4 basis points from 3.46% last quarter to 3.42% this quarter. Lower cost of deposits had a positive impact on our margins, with a decline of 7 basis points from 31 basis points last quarter to 24 this quarter. Our mortgage banking business generated record revenue this quarter, with a 48% increase to $5.3 million. This is the result not only of higher inbound volume due to market conditions, but also due to our team's ability to keep service levels high. And our digital and omnichannel mortgage specialists supported with leads from our marketing analytics tools have represented an increasingly high proportion of total volume. The wealth management team continues to build on AUM growth and reported $2 million in revenue this quarter. Loans with deferred payments declined 35% from $1.1 billion last quarter to just over $700 million at September 30, with another $528 million due to return to contractual payments through October. And simultaneous with the Freedom Bank acquisition in August, which added 2 branches in St. Petersburg, we consolidated a legacy St. Petersburg branch, which we expect will result in an ongoing annual expense reduction of $0.5 million. Further branch consolidation is expected in 2021. Turning to Slide 6. Net interest income decreased $3.8 million sequentially. This was the direct result of the change in timing of recognition of PPP fees. For the duration of the PPP program, for originations from April through early August, we earned $17.2 million in origination fees from the SBA, net of relevant costs. We expect to recognize the entire $17.2 million as these loans are forgiven over time. In the second quarter, we recognized $4 million of the total, based on our expectation that forgiveness would start in the third quarter and that applications would be submitted and processed at a rapid pace. However, the SBA only began processing forgiveness applications in October, and with what we feel is less certainty this quarter about the timing of early forgiveness, we've extended our recognition schedule to the loan's full contractual period and recognized only $200,000 in PPP fees in the third quarter. We expect to recognize $2.1 million in each of the next 6 quarters, if no early forgiveness occurs, although actual early forgiveness events may create variability in timing. The net interest margin, excluding PPP and accretion of purchase discounts, decreased by only 4 basis points from 3.46% to 3.42%. That decrease results from lower loan and securities yields, partially offset by lower cost of deposits and utilization of some excess liquidity. The effect on net interest margin from accretion of purchase discounts on acquired loans was 17 basis points in the third quarter of 2020 compared to 16 basis points in the second quarter. The effect on net interest margin of PPP loans was a reduction of 19 basis points in the third quarter compared to an increase of 8 basis points in the second quarter. Quarter-over-quarter, the yield on loans excluding PPP and accretion of purchase discounts decreased 9 basis points, reflecting higher pay downs and refinancings. The yield on securities decreased 56 basis points affected by rate resets and faster prepayments as well as additional investments of excess liquidity into securities this quarter. The cost of deposits decreased 7 basis points from 31 in the second quarter to 24 basis points in the third quarter. This reflects a favorable product mix, including an increase in the proportion of noninterest-bearing demand deposits to total deposits. We expect the cost of deposits to continue to decline in the coming quarters. Moving to Slide 7. Again, this quarter, we're pleased to report record levels of noninterest income in key categories. On an adjusted basis, which excludes realized gains on security sales, noninterest income was $16.9 million, an increase of $3.2 million or 23% from the previous quarter and an increase of $3.1 million or 22% from the prior year quarter. Our mortgage banking business continues to capitalize on a vibrant residential refinance market and strength in the Florida housing market, with revenues increasing 48% to $5.3 million in the third quarter. As a reminder, we sell in the secondary market the large majority of residential mortgages that we originate and use rate locks with investors at the time of application to eliminate exposure to interest rate risk. This quarter, we were able to generate substantial growth in this area. The omnichannel approach is supported by analytics-based marketing and tools and the success of our digital channel team has been a tremendous contributor, generating 20% of our third quarter mortgage production and 20% of the quarter end mortgage pipeline. The third quarter was also a record quarter for our wealth management team, with $2 million in revenue and additions of $43 million in new assets under management, bringing total AUM to $793 million. Interchange revenue increased 16% to $3.7 million with notable increases in business card utilization, resulting from recent growth in business customers and our marketing focused on driving spend behavior. Moving to Slide 8. Adjusted noninterest expense totaled $45.4 million, an increase of $4.8 million from the prior quarter and an increase of $8.5 million compared to the prior year quarter. On an adjusted basis, salaries and benefits increased by $3 million compared to the second quarter of 2020. Back in the second quarter, we originated nearly $600 million in PPP loans. And as discussed on last quarter's earnings call, higher loan production driven by the PPP program resulted in higher deferrals of related salary costs, which lowered second quarter expenses by $2.9 million, driving the variance quarter-over-quarter. This quarter, the provision for credit losses on unfunded commitments was higher by approximately $0.6 million, primarily associated with lending-related commitments acquired from Freedom Bank. Other expenses were higher in the third quarter by $1.4 million, including higher FDIC assessment expense, executive recruiting fees and processing cost associated with higher mortgage production. Much of the cost base for our mortgage business is variable in nature and the strong revenue performance, therefore, resulted in higher expenses. Overall, expenses were higher than our guided range from last quarter's call resulting from better-than-expected performance in mortgage banking, an increase in the reserve for unused commitments and also higher expenses associated with our self-funded health insurance program with outsized medical claims in the third quarter, likely the results of routine medical appointments having been postponed in the second quarter due to COVID-19 lockdowns. Outside of mortgage expenses, which we expect to continue to track higher revenue production, we do not expect these to repeat in the coming quarter. As such, we're guiding to a lower noninterest expense range of $42 million to $44 million on an adjusted basis, excluding the amortization of intangible assets. Moving to Slide 9. The adjusted efficiency ratio in the third quarter increased to 54.8%. That increase results from the PPP fee accretion timing issue and higher expenses discussed on the prior slide, partially offset by higher noninterest income. Notwithstanding the unpredictable PPP forgiveness process, we expect the efficiency ratio to decline in the fourth quarter as we continue proactive, disciplined management of our cost structure. We've demonstrated over the past several years, our commitment to efficiency, and we will continue to apply that discipline as we look ahead. Turning to Slide 10. Loans outstanding increased to $5.9 billion, reflecting the addition of $309 million from Freedom Bank and $176 million in organic portfolio production this quarter, offset by portfolio runoff and lower demand from business customers. Given the pandemic environment, we continue to take a conservative posture to new loan originations. In commercial, the pipeline at period end was $256 million. We continue, though, to maintain the discipline of our established credit culture, focusing only on relationships with strong balance sheets that can support significant stress. The consumer pipeline fell to $17 million from $31 million last quarter, reflecting lower demand for home equity lines as consumers favor first mortgage refinancing options. In the residential category, pipelines have continued to increase, now up 70% from the prior quarter to $183 million. The refinance market has remained strong, and our markets have benefited from high levels of purchase activity. A significant majority of our residential mortgage volume is sold in the secondary market on a best efforts basis promptly after origination, thereby incurring no interest rate risk associated with the pipeline. Looking forward to the fourth quarter, we expect loans outstanding to continue to be carefully managed, modestly lower as a result of our disciplined posture, given the pandemic environment. Additionally, we expect PPP balances to continue declining at an accelerated rate as the forgiveness process begins. Turning to Slide 11. Further highlighting our vigilant credit culture, we intend to continue to manage our credit exposures and robust capital position prudently. We are confident that our established conservative posture entering this environment will serve us well. Our portfolio is broadly distributed across various asset classes. Stabilized income-producing commercial real estate represents 24% of loans outstanding, owner-occupied commercial real estate represents 19% of the portfolio and residential real estate comprises 24% of the portfolio. Approximately 80% of our commercial portfolio is secured by real estate with borrowers that have meaningful equity in their investments and lower loan-to-value. The average LTV of the commercial portfolio secured by real estate is 48%. Fortunately, for years, we have managed our portfolio to keep construction and land development loans and commercial real estate loans well below regulatory guidance. At September 30, that represented 28% and 165% of risk-based capital, respectively. Those levels have continued to decline and are lower than most in our peer group. Our loan portfolio is diverse and broadly distributed across categories with an average commercial loan size, excluding PPP, of $386,000. Turning to Slide 12 for a look at loans on deferred payment status. We supported our customers when the pandemic hit with short-term payment deferral programs. What remains at September 30 is largely loans with original 6-month deferrals that started in April and are expiring in October. Of the $703 million in loans on deferred payment status at quarter end, the majority is in commercial real estate, and we'll see the detail of those on a later slide. But first, moving to Slide 13. Presented in the graphs are loans on deferral as of September 30, and the large majority of those deferrals expire and are due to return to making contractual payments in the month of October. As of last Friday, with over a week left in the month, we had already received payments on over 70% of the October expirations. It's helpful to consider our experience with loans that came off of deferral in the third quarter, which is identified on the right. Of the loans that were put on payment deferral earlier in the year and those deferrals expired in the third quarter, 83% have returned to making contractual payments or have paid off the loan balance; 13% had deferrals expiring in September, so their first payment is due in October; 1% are 30 days past due; and the remaining 3% of loans with deferrals expiring in the third quarter were offered additional accommodation, so they remain in our deferral balances at period end. We have data available through October 23, and at that date, our total loans on deferral were down to $290 million or approximately 5.6% of total non-PPP loans down from $703 million or 13% at September 30. We expect this will have declined meaningfully by the end of the year. Deferrals or additional accommodations extending beyond 6 months have been rare. Turning to Slide 14 for a more detailed look at our CRE and construction portfolios, including deferrals in those categories. Diversification across the industries and collateral types has been a critical tenet of our strategy, which we believe positions us well in this environment. The largest exposure in our aggregated owner-occupied CRE, CRE and construction portfolios is office buildings, which represents only 13% of the portfolio. 18% of these loans were on payment deferral as of September 30, down from 27% last quarter. The average loan size in our office portfolio is $578,000. The average LTV is 53%. 57% of this portfolio is classified as owner-occupied, comprised primarily of independent professional practices, including medical, accounting, engineering, health care and other like type professional. The remainder of the office portfolio is stabilized income-producing investment properties. And as an update on deferral status, through last Friday, loans on deferral in the office building category have dropped from the $135 million presented on the slide to only $56 million. Our second largest segment is retail real estate, representing only 8% of total loans, with 32% of these on deferred payment status, down from 38% last quarter. These are typically multi-bay shopping centers, and many were provided with an initial 6-month deferral period when the shutdown began, so will be expected to return to payment status in October. As we progress through October, as of last Friday, loans on deferral in this category have declined from the $147 million presented on the slide to only $75 million. The average loan size in our retail portfolio is $1.3 million, and the average LTV is 46%. The portfolio does not include regional mall complexes, outlet malls, movie theaters or entertainment venues. Our exposure is low in some of the most seriously affected industries. Our hotel portfolio is $135 million and restaurants are $48 million. The restaurant and hotel portfolios are primarily secured with real estate, with an average loan-to-value of only 52%. To date, both portfolios have performed better than we expected at the outset of the pandemic. Our hotel exposure is well diversified. The majority of our exposure is beach side or along the interstate and major arteries, both of which have benefited from weekend travel, and there are no occupancy restrictions. We have little exposure in theme park locations and do not finance resort or conference center facilities. Turning to Slide 15 for a more detailed look at our commercial and financial loans. The largest exposure is in holding companies owned by high networth individuals for aircraft and marine vessels, and this represents a modest 3% of total loans. 22% of this segment had payment deferrals earlier in the year and only 3% remain on deferral at September 30. The remainder of commercial and financial loans is spread across multiple industries with no concentration above 2%. Turning to Slides 16 and 17 for the securities portfolio. With the decline in rates and faster prepayments on mortgage-backed securities, yields are down this quarter by 56 basis points. We made additional purchases of primarily agency-grade MBS at an average add-on yield of 1.31% and an average duration of 4.6 years. We're carefully investing in bonds that have little extension risk and will roll down the curve over a 3- to 4-year period. Overall, the portfolio is in a net unrealized gain position of $33.6 million. Turning to slides 18 and 19. Deposits outstanding increased $248 million or 4% sequentially. The change includes the addition of $330 million in deposits from Freedom Bank, partially offset by lower brokered balances. The cost of deposits is lower by 7 basis points this quarter to 24 basis points, and we expect it to drop further in the fourth quarter. Transaction accounts represent 55% of total deposits. Our analysis of PPP loan proceeds shows that approximately 60% of those funds remain in the bank. Turning to Slide 20, we present the changes in the allowance for credit losses in the chart. During the quarter, the addition of loans from Freedom Bank increased the allowance and that was offset by the impact of declines in other loan balances. We ended the quarter with a slight increase in coverage from 1.76% at June 30 to 1.80% at September 30, excluding PPP. On the right, you can see the impact on the income statement during the quarter of provisioning for credit-related items, which totals less than $100,000. Moving to Slide 21. The allowance for credit losses under CECL reflects our estimate of lifetime expected credit losses, which includes our expectation that some loans will migrate into loss through the cycle. In addition to what we feel is a prudent level of allowance, note that we also have $34.6 million in purchase discount that will be earned over the life of those loans as an adjustment to yield. Also of note, our obligations under unfunded loan commitments have a separate reserve of $3 million. Turning to Slide 22 on asset quality. Note that the trends were in part influenced by the closing of the Freedom Bank acquisition during the quarter. We're confident that our credit mark associated with the transaction adequately reflects the expected performance of this portfolio. Turning to specifics. Charge-offs were flat this quarter at $1.7 million. The level of nonperforming loans increased by $7.2 million to $37.2 million and now represents 0.64% of total loans. The changes include additions of $3 million from the Freedom Bank acquisition and a net increase of $4 million in portfolio loans, including 1 borrower for $3.3 million that paid off in early October. Criticized loans were 18% of total risk-based capital at September 30. The increase from prior quarter is primarily in the special mentioned category, which came from 10 loans totaling $54 million this quarter. We're taking an appropriately conservative approach to grading, given the pandemic environment, and the majority of loans moving into special mention are from our hotel exposure. The overall allowance for credit losses at September 30 is $94 million, increasing from prior quarter with loans added from Freedom Bank, partially offset by the decline in balances in the remainder of the portfolio. Excluding PPP loans, our coverage of allowance to total loans is 1.80%, up slightly from 1.76% in the prior quarter. We continue to have a cautious view of the economic outlook, so our allowance estimate gives significant weight to the Moody's S3 Moderate Recession Scenario, where the characteristics of the downturn might be more unfavorable and could be sustained over a more extended period. Turning to Slide 23. Our capital position continues to be strong, and our long-standing commitment to maintaining a fortress balance sheet has positioned us for resilience. Tangible book value per share is $15.57, an increase of 3% over prior quarter. The tangible common equity to tangible asset ratio was 10.7% at quarter end and has ranked amongst the highest in our peer group. The Tier 1 capital ratio was 16.8%, and the total risk-based capital ratio was 17.9% at September 30, each increasing over the prior quarter. In measuring return on tangible common equity, the ratio on an adjusted basis was flat compared to prior quarter, reflecting the impact on equity of the Freedom acquisition. To wrap up on Slide 24. Since 2017, we've achieved a compounded annual growth rate in tangible book value per share of 12%, driving shareholder value creation. We're confident that our established conservative posture and efficient operating model will serve us well as the recovery progresses. Seacoast is well positioned to take advantage of opportunities as they ultimately arise. We look forward to your questions. I'll turn the call back over to Chuck and Denny.

Thanks, Tracey. And thank you, operator. We'd be pleased to take a few questions.

[Operator Instructions] And our first question comes from Michael Young from SunTrust.

First of all, just wanted to offer my congratulations to Denny. Certainly, we'll miss hearing your voice on future calls as frequently, et cetera, but I just wanted to pass along those -- my -- kind of pay my respects there. In terms of questions, I guess, just on capital, I'm trying to get the interplay between capital and growth correct. So capital levels are obviously very high and you have plenty of excess capital. So it would seem like you could begin to return some of that, assuming regulators kind of bless that move, but is there something either in the M&A pipeline out there that you see where you want to maintain these higher levels? Or do you see growth kind of returning in a more material way that would eat into some of this capital on a go-forward basis?

Well, I'll kick off here, Michael, and thanks for your comments. As you know, our Board and the management team do take a look at that very seriously, uses of capital on a fairly regular basis. We think right now, where we are, given the unpredictable nature of the environment we're in, with the pandemic, as of right now, we're comfortable with our current robust capital levels, which, along with, I think Tracey's very detailed comments around our credit discipline, support our commitment to maintaining a fortress balance sheet. And as she said, that gives us a heck of a lot of resiliency and a heck of a lot of opportunity to use that capital as we look ahead. Our primary goal has been to build, consistently over time, shareholder value. And I think that's best evidenced by the 12% CAGR that we produced in tangible book value per share since 2017. That said, we do recognize, our capital continues to build, and we think as the full impact of the pandemic is further revealed in the coming months, we'll want to reevaluate the full range of capital management alternative, and we're going to seek to deploy our capital carefully and prudently based on circumstances. As we look out over the medium to long run, we have a lot of option. In fact, we have multiple options for the use of capital, as you've said, including buybacks, dividends, organic growth and M&A. And we're going to carefully weigh these options as we look ahead while ensuring that our capital position does remain robust and supports what we see as potential acquisition opportunities that we think could develop later in 2021.

Okay. That's helpful. And then maybe just moving to the net interest margin, 3.4% on kind of a core basis this quarter. Looks like, maybe there's a little bit of room for the cost of deposits and funding to come down from here, but not a tremendous amount. So should we think kind of gradual downward pressure, absent more material loan growth, and then as loan growth comes back, maybe we hold the line or expand slightly. Is that kind of the right way to think about that?

Yes. Thanks, Michael. This is Tracey. Maybe going through the pieces. Assuming a similar rate environment in the fourth quarter, we expect continued pressure on security yield, the dilutive effect of lower new add-on yields there. Loan yield will also drift down, but at a slower pace, as you said. Partially offsetting, we expect lower funding costs. Though, we do still expect some continuing effect from higher levels of liquidity. With all that, core NIM, excluding PPP and purchase loan accretion, will likely see slight compression in Q4 from the low 3.40s percent, we reported in Q3.

Out anything beyond Q4, it's very difficult to provide any guidance, Michael, given all the variable issues that are ahead of us, including election and pandemic and everything else. And so, redeployment of that liquidity into loans and other things could be very supportive of the NIM in 2021, but that will be very dependent upon how things play out with the current environment.

Right. That makes sense. Maybe NII dollars is a better way to think about it. So ex kind of PPP, which will be volatile, but kind of starting from $63 million, $64 million, we would expect that to kind of move higher as you deploy some of that liquidity, maybe some loan growth returns, et cetera, even though the margin may come down?

Yes. And I think, it will all depend on how the economic recovery continues and the strength of that and how the environment improves.

Our next question comes from David Feaster from Raymond James.

I just wanted to start on the loan side. Just curious, some of the -- what's driving the runoff? How much is the competition? Whether that be pricing or structure? And then -- or just client conservatively paying off debt? And then maybe how much is just even strategic, where it's just credits from major acquisitions of Freedom that you may not want to hold on to and just they're strategically running off just -- and then maybe like kind of -- should we expect the pace of runoff to keep pace with what we've seen in the past few quarters?

Yes. I think there's a few components around that, David, to think through. One, obviously, in the quarter, we didn't have the level of originations we normally would have had, particularly in the commercial side, and that's 100% because of our prudency around making sure we take an appropriate approach to credit taking in the current environment, something we're comfortable with. Secondly, when you look at loan growth, we did have a portfolio of residential mortgages that are generally being refinanced in this environment. We are -- the originations we are handling here at Seacoast of our portfolio, we are selling in the secondary market, given the better economic return of doing that activity, and I think that played into it. And then thirdly, I would just say, we've seen some deals trade at very, very low cap rates and some things be sold out of our portfolio that we didn't have an interest in reoriginating, primarily not necessarily structure of credit, but just where those cap rates were and the pricing on those deals. And so we continue to take a very conservative approach that led to a little bit higher runoff. Looking forward in the next quarter, just on loan outstandings, I would expect loan outstandings to be down slightly, but not at the pace that we saw this quarter. And probably we'll see some improvement on originations quarter-over-quarter.

Okay. Okay. That's helpful. And then just digging into the commercial pipeline more broadly, glad to see that recover. But within the commercial pipeline, just in light of what we were just talking about, where are you seeing opportunities, both by market and segment? And how are new yields on new originations in the pipeline?

Yes. We're holding the line on yields as best we can. I would say the bulk of that portfolio is current customers that we already know that we do business with that are looking for further opportunities with expanding their businesses and the like or looking for opportunities in the marketplace. Those are, for the most part, going to be and for the significant most part, going to be customers that are well understood, that can demonstrate clear projections on cash flow, can support strain, regardless of the environment ahead. So we're being very picky, I would describe it as, around what kind of credits we're willing to take, and being very selective. It's coming from all parts of the state. We're not seeing one area over the other, but we are being very careful and very cautious in the environment we're in. And it's -- we're trying to be thoughtful, given where we're at. And if you just step back more broadly, look at our sort of approach to credit in this environment, we've been very conservative and what I think is a positive in the quarter as we continue to grow tangible book value per share, driving it through fee-based categories versus extending our credit profile. Removing the impact of the Freedom Bank acquisitions, our overall credit risk exposure actually declined quarter-over-quarter, while tangible book value per share increased, something I see positive and any further loan growth type or origination type of philosophical approach will be highly dependent upon the outlook for the pandemic and how more clarity comes into the marketplace. But for now, we think a conservative prudent approach is appropriate, and we'll continue to be positioned there.

Okay. That's helpful. And then on technology, I mean, kind of staying on that defensive topic, you guys have had a tremendous amount of success using data analytics on the offensive front, right? Just curious how that can play into your defensive posture? What are you doing to maybe anticipate potential credit issues and address those early? And then maybe just walk us through some of the other initiatives that you have on the -- in using your technology to play some defense?

David, do you want to kick us off there? And then Jeff, maybe a follow-up?

Yes. David, this is David Houdeshell. So yes, if you think back to our call for first quarter results, we talked about some real early action. We've built and leveraged some of our tools we use for our CECL models. We focused on looking at industry sectors, customer characteristics, depository transaction information and built our own models. So we've been running those models every month, trying to bring in new data as it's materialized. We've used this data for outbound calling to look at maybe suspected distressed customers, to do a health check, see how they're doing, gather some additional information. A good example would be, of course, I think we all know by this time, but back in April, we started pretty assertively, going after the hotel portfolio. Asked some questions at that time, started looking at deferral programs, loan modifications. And I think that very early, quick action has turned into some very positive results for the company. We've also used those models that we've been building to look and to basically provide a challenger model for allowance. So we're pretty much running 2 models with some fundamental differences in some of the assumptions in the economic scenarios to stress test the portfolio, to really give us some assurance that when we do produce an allowance for credit loss that we're comfortable with the risk that's in the portfolio. So a couple of examples there and how we have used the credit information, and we're taking some of that model results and pushing it into our proprietary Connections tool. Our Connections tool is useful for outbound calling, tracking, next call action. And maybe, Jeff, you could speak about some of the activities and the benefits we're getting from marrying those 2 systems?

Yes, David. And -- yes, as you know, Connections has been a big platform for us, right? And what it's really done is, it's just enabled us to operate a lot more quickly in terms of taking advantage of the insights that we see. We pipe those insights to retail bankers, to other business bankers and to other folks across the bank, and it's really enabled us to move quickly. We think that will serve us very well in this period of time. We're already seeing it play out. We think it will serve us very well when we get back to a rapid growth mode as well. The other aspects we're pushing on, David, as you know, well, we're pushing very hard on digital servicing. We're pleased with the way customers continue to migrate to those low-cost channels to manage the day-to-day banking. That's been a boon for us, and we think that's going to continue. And the last piece that I'll talk about is, it's really this notion of banker efficiency, which has come about by focusing on nCino. We're still making refinements and tweaks into that system with the overall goal of being on the other side of this, with a very efficient commercial banker workforce. And so I think combining the speed and power of connections and analytics, the push to digital servicing and banker efficiency driven by nCino and our own internal platforms, that bundles kind of how we're thinking about using technology to unlock further value.

Okay. That's helpful. And Denny, congrats on the well-deserved retirement.

Thank you.

Our next question comes from Steve Moss from FBR.

I want to start off on the expense guidance. Just nice leg down here in the upcoming quarter. Kind of curious, how that incorporates the potential impact of another strong mortgage banking quarter? Or just what your assumption maybe around mortgage and expenses?

Yes, our expenses were in line with the guidance we provided last quarter and one of the unusual items that you'd consider in adjusting that is the higher mortgage production-related expenses. This quarter, they were higher than our forecast by about $0.5 million, given the outsized production results there. So with that, we'll be back in the middle of the range that we guided to for this quarter. Also, remember that the second quarter had the benefit of PPP originations that were deferred. And so when we look ahead to the fourth quarter, we're expecting expenses to come lower to a more normal range, $42 million to $44 million, although, certainly, those higher mortgage production-related costs will continue to some extent.

Steve, let me just jump in there real quick. So I think if you're thinking about mortgage banking, I think we'll have another very strong quarter. It likely won't be quite as strong as this quarter. And so revenues will still be very good, but maybe down modestly as well on the expense side. And so I think that's all baked into the $42 million to $44 million guide that Tracey provided.

Okay. That's helpful. And then on PPP forgiveness, just wondering if you could give us some color as to what are the applications you're seeing -- level of applications you're seeing for forgiveness here?

Did you get all that?

Yes. He's just asking, what we've seen for PPP forgiveness in the level of applications today?

Yes. Actually, the applications flow has been fairly light. I think there's still a lot of uncertainty out there in the marketplace. As you know, the SBA has produced a third application for forgiveness processing. All of them, I think they will be like, very complicated. So our customers are waiting to really gather the data and get some additional guidance we are providing. And we are processing a few applications that come through, but the flow is very light. I think there's also still some hope with the next stimulus program, there could be a bigger waiver forgiveness for some of the smaller balanced loans, the SBA, the government is talking about maybe less than $100,000. So I think we're seeing a lot of wait-and-see customers from that position. Some of them are still gathering information. And we're working with customers as they raise their hands, and we're also working on the outbound program to help them get prepared and gather documents and help guide them through the process, and we're standing by and ready to assist when needed.

Tracey, are you going to add anything to that?

Yes. No, just that, my data is from about a week ago, and we had reviewed and submitted around 70 loans to the SBA. The SBA has 90 days to decision those submissions. And so we'll continue to kind of build that pipeline and wait for notification from the SBA that those forgiveness applications were successful.

And I know we've had a few that were approved. I checked a couple of days ago. We've had a few that have been approved. They've all been typically smaller loans under $100,000.

Okay. That's helpful. And then just 1 more on the hotel loans. Just following up on that. I know the bulk of your downgrades here, to criticize or special mention were from hotels. Just as we think about longer-term plans, just kind of how are you guys thinking about working out? Or what's the level of, should I say, borrow liquidity goals in terms of just trying to get people to the other side here?

Yes. In this hotel portfolio, we've had some very good results, as Chuck mentioned. We've been very conservative in our risk rating. We moved a few of our hotels to special mention, based on what we thought were more tenuous type situations. In this month of October, their first deferral period did come up, and they have made payments. So we're very pleased to see them continue to be able to perform. I think our outreach have been very close to them throughout the summer. We've been working with additional options, if a restructure is needed, but they are basically telling us that they're very comfortable. We do have a couple of smaller loans, though, that may not be great story based on occupancy levels. We'll work with those customers as very reasonable. But the ones that we did downgrade that we're very more nervous about based on tenancy or occupancy levels, the ADR rates, they seem to be performing very well, and they're really having much better business activity on the weekends than they are -- none of them are really targeted toward the business traveler. So they're dependent on transient people, people going on vacation or just trying to get out of their houses into a different location for an extended weekend. So we feel pretty good about that portfolio, and we'll be prepared to help hotels and any other customers and our re-deferral rate, as Tracey mentioned, has been very few. It's been a very nominal need.

Okay. And Denny, I'm sure -- congratulations on your last earnings con. I'm sure, we'll be in touch in the future.

I'll be on -- the last one will be in January, and we'll be talking about the year-end, and then I'll turn everything over to Chuck. But I'll still be in the room, keeping an eye on Chuck.

Our next question comes from Christopher Marinac from FIG.

Chuck and Denny and Tracey and team, I wanted to ask about the sort of adjusted efficiency and expense numbers. I mean as we get to whatever the new normal is going to be in future quarters, do you think we can get back to that kind of sub-50 level that was there pre-pandemic? I mean is that realistic? Or is it too early to tell?

Yes. I think we want to be careful providing any guidance out beyond the quarter, giving all the variability in the marketplace. There's just too many variables to provide guidance beyond that, given interest rate selections, pandemics, so there's so much happening here, any guidance beyond that. But I do expect in the coming quarter, the efficiency ratio to decline in line with Tracey's guidance and be somewhere between 50 and 55 as we move through the coming quarter. But I do expect the efficiency ratio to come down quarter-over-quarter. And I'll just reiterate, we're very disciplined in our approach to expense. We're also very focused on efficiency. I expect further branch consolidation in the coming year. Our plan has about 4 branches that we are considering for consolidation. And as we continue to drive digital transactions -- drive transactions over to digital, we expect to continue to take cost out of the franchise. And we'll maintain our very keenly focused approach to expense management and efficiency.

Great. I appreciate that, given the circumstances. And just a quick one for Jeff. Jeff, you talked about the digital servicing and the progress there. Where is Seacoast relative to the beginning? I mean you're still kind of in the second or third inning of this process? Or do you think you're more advanced than that? I mean you have accomplished a lot in the last 4-plus years. I'm just kind of curious how much more remains?

Yes. I had a hard time hearing, but just to confirm your question is kind of where are we, kind of what inning are we in, in terms of digitizing parts of the business. Is that correct?

Correct. Exactly.

Yes. I think if you look on the consumer side, I think we're probably middle innings in terms of where we've gone. The numbers are really good. If you look at the business side, that's really picked up of late. The pandemic kind of shot that up. I'd say we're probably closer to the early innings on the business side than we are on the consumer side. But I think there's a bigger picture of what processes of the bank can we digitize? What processes of the bank can we further automate? And that's an area that we're going to continue to look into as well, just trying to streamline as much as we can, not just for the customer, but also for the way the whole bank operates. And in terms of that, I still think we're early innings. So consumer, I think, we're mid-innings; business, I think we're probably coming out of the early innings and starting to mature a little bit better. But I'm thinking more broadly about the entire business. How do we streamline everything that we do, make it more efficient and also make it more scalable, kind of where our heads are right now.

Yes. We've made incredible progress in the residential business. And it served us well in the pandemic, the full end-to-end process in the mortgage business as digital. And we've moved to some remote notary processes. And so there's a lot that's going on in the mortgage business. That's probably out ahead of most of our other businesses, but the commercial side of our company has a lot of work ahead of us, and we are very much in the early innings there, and there's great efficiency gains to be put together here over the next couple of years.

And I would just say -- add that the pandemic kind of opened up an opportunity for us to move more quickly in some of the process automation that has been very helpful. And as you heard a little bit, a few minutes ago around risk. And we've really kind of leaned into that as a result of our perception of things to be concerned about with work-from-home environment and other things, it's been quite helpful. So hopefully, we'll continue to move a little faster as a result of the pandemic.

I have another question from Michael Young.

Just wanted to touch base on kind of the caution around new lending opportunities, obviously, very well understood. But in general, are there certain things that would give you greater confidence to be more, I guess, aggressive or more active in the market with new relationships, new originations, et cetera, on a go-forward basis? Just anything you're kind of watching would be helpful.

The challenge right now is nobody can predict where the pandemic is headed. And so when you look at the pandemic's impact, it's wide and through almost all industries in some respects. There's obviously, in some industries that have been more severely impacted than others, I think we all can see those hotels, restaurants, et cetera. And so we're avoiding anything that's the obvious impacted-industry-type vertical. But I would say, there's going to be a lot more clarity emerge over the next 2 quarters. You're going to have the election happen. We're going to hopefully be moving closer to a vaccine. And that all will provide more clarity on what 2021 will look like. And as that clarity emerges, that will give us more confidence as to how we react. But for now, given the unpredictable nature, I think a very conservative approach is appropriate and a focus on growing tangible book value through fee-based revenue and other means of driving shareholder return are more appropriate. And when more information comes to light, we'll lean back into loan growth and kind of the good news about that is we'll have a lot of liquidity. We're in the process of investing in the company, both in terms of process development and being very opportunistic around talent, and we'll be ready to perform when the time comes. But for now, a conservative approach is what we think is appropriate.

And I'm not showing any further questions at this time. I'd like to turn the call back over to the hosts.

Thank you all very much for attending today, and I think we all look forward to speaking with you in January as we wrap up the year. Thank you.

Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.