Enterprise Financial Services Corp (EFSC) 2020 Q3 法說會逐字稿

Good day, and welcome to the EFSC Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Jim Lally, President and CEO. Please go ahead.

Well, thank you, Ryan, and thank you all very much for joining us this morning, and welcome to our 2020 third quarter earnings call. Joining me this morning is Keene Turner, EFSC's Chief Financial and Chief Operating Officer; Scott Goodman, President of Enterprise Bank & Trust; and Doug Bauche, our company's Chief Credit Officer.

Before we begin, I would like to remind everybody on the call that a copy of the release and accompanying presentation can be found on our website. The presentation and earnings release were furnished on SEC Form 8-K yesterday. Please refer to Slide 2 of the presentation titled Forward-Looking Statements and our most recent 10-K and 10-Q for reasons why actual results may vary from any forward-looking statements that we make today.

Overall, the third quarter represented another solid quarter for our company. On a fully diluted basis, EFSC earned $0.68 per share and reported a net income for the quarter of $18 million. On a pretax pre-provision basis, net income was $38 million, yielding a pretax provision ROA of 1.81%, which is relatively consistent with what we reported in the second quarter.

These strong earnings allowed us to continue to build our capital position even with the elevated provision for credit losses. At 9/30, the ratio of tangible common equity to tangible assets stood at 7.99%, and when adjusted for PPP, this increased to 8.89%.

We will get into the details around margin and our rationale for the provision expense, but I just wanted to comment that we are preparing the company for a prolonged low and flat interest rate environment. Scale and maximizing our returns, our investment in people and technology will be key.

Furthermore, we believe that we are still in the early stages of this current credit cycle and we will use our strong earnings profile to appropriately build our allowance for credit losses in light of this. This does not mean that growth is not a focus for us because it is. It means that more than ever, we have to be consistent in our credit process in order to take advantage of others who will not be.

We ended the quarter with 3 primary focuses: first, we wanted to continue working diligently on the loan portfolio to ensure that we focused on the high-risk industries and customers to mitigate the impact of further deterioration while identifying other potential issues on specific credits, not within these industries. As you will hear from Doug and evidenced by our asset quality statistics, we feel very good about the current state of the portfolio.

Secondly, we wanted to attend to the needs of our clients who are thriving and make sure that they have all the tools and capital to maximize the opportunities that lay ahead of them. This included working closely with the several hundred new clients acquired through PPP. Scott was going to spend some time in his comments on our process and successes that we are seeing.

And finally, we wanted to heighten our focus on growth and reloading the loan pipeline. Obviously, the balance between credit quality and pricing needs to be struck with this desire to grow. But this is something we have been -- we have managed well in our company over the years. So I feel very confident in our efforts. And you'll hear some encouraging trends from Scott regarding this.

In addition to all of this, we announced the acquisition of Seacoast Commerce Banc Holdings back in early August. As we discussed back then, this combination considerably improves both sides of our balance sheet, is better than 10% accretive to earnings in 2022 and further derisks our company in a myriad of ways.

We have received FDIC approval, a waiver from the Federal Reserve and anticipate other necessary approvals shortly and plan to proceed towards a close later in the fourth quarter. Having now worked more closely with the Seacoast team over the last 1.5 months preparing for our integration, I can tell you that the quality of the business and the upside of this combination is exactly what we thought it was, and we last spoke to you about this.

Before I hand the call off to Scott, I would like to call your attention to our areas of focus on Slide 4. Looks a little bit like more of the same, but the flawless execution of these areas will put us on solid footing to accomplish both our near and long-term goals. Furthermore, all of these areas play to the strength of our company which gives me further confidence in our ability to succeed.

I would now like to call the turn over -- I'd like to now turn the call over to Scott Goodman. Scott?

Thank you, Jim, and good morning, everybody. The loan portfolio, which is highlighted on Slide #6, was relatively stable in Q3, with balances posting a minor decline of less than 1% from the prior quarter. In general, relatively solid production was offset by continued declines in line of credit usage and some commercial real estate-related payoffs.

While loan demand from private business is somewhat soft given economic uncertainties, our team continues to drive consistent organic activity through stable demand in our specialized businesses and proactive calling on new relationships. Production in Q3 was roughly 85% of historical averages, with an upward trend which saw September production above monthly averages.

Payoffs in general are at levels below historical norms and are mainly concentrated in the CRE category relating to refinancing into long-term secondary market fixed rate structures. Behavior we witnessed during Q2, which resulted in a steep reduction into line of credit usage continued into Q3 with paydowns outpacing advances, as businesses continue to deleverage and build cash balances.

Looking at the loan categories which are outlined on Slide 7 and 8, the change in the book, net of PPP, represents loan activity, most prevalent in the C&I, investor CRE and tax credit businesses. However, the aforementioned payoff activity stifled net growth in CRE for the quarter.

As we discussed last quarter, our sales activities in 2020 have been focused on leveraging our outstanding results with the PPP program, which is illustrated on Slide #9. Through an internally-led process, we were able to fund over 3,800 companies across all of our markets, including all of our existing clients who fully applied, as well as over 700 non-clients.

Contributing to our success in C&I this quarter, we have since developed a robust sales and marketing campaign which has, to date, converted 2/3 of these new businesses to clients, including new loans, operating accounts and 6 figures of new annuitized fee income. This same process also places higher focus on deepening relationships with existing clients in value-added areas such as treasury management, card programs, private banking and wealth.

And as we now progress into the forgiveness phase for PPP, we continue to take an advisory-based approach to these conversations, arming our sales teams with continually updated program information which enables them to build trust and provide value-added consultation to our clients. Doug will touch further on the forgiveness process in his comments.

The loan portfolio is further broken out by business unit, industry and product type on Slides 10 and 11, and generally reflect my prior comments. The decline in specialized lending follows from seasonally slower activity in EVL originations and life insurance premium finance as well as some additional line paydowns in the EVL sector.

The Arizona portfolio posted a strong quarter, rising by 5% and reflecting higher levels of economic activity in this market, including new CRE development and acquisitions. This market has also been responsible for adding the most PPP-based new relationships to the company.

Looking ahead, the current loan pipeline is encouraging and provides some reason for optimism that barring further deterioration of external headwinds, growth is possible near term. High level, the current pipeline shows opportunities which can provide net growth in nearly all of our major business units. The largest unknown around this outlook, however, is timing as we have seen loan requests and planned investment taking longer to close or being pushed out.

Our approach to credit will continue to be consistent in supporting existing clients, opportunistic for new relationships, but disciplined relative to credit structure despite growing competitive pressures. Our portfolio is performing well today, and you'll hear more on this from Doug in his comments.

Overall, deposits remain in a healthy position, and our focus continues to be on building core relationship-based accounts and reducing cost. Portfolio changes are highlighted on Slide #12, and show a slight dip in the quarter, mainly reflecting continued proactive management to reduce higher cost brokered and nonrelationship-based balances, as we discussed in detail last quarter.

The reduction also reflects the deployment by our client base of some of their PPP-related funds. Sales efforts around PPP and the ongoing focus on new relationships is resulting in new average account balances that are trending larger and at a lower cost than those that are closing.

And now I'd like to turn it over to our Chief Credit Officer, Doug Bauche, for further color on credit. Doug?

Thanks. Third quarter asset quality results were solid. Nonperforming loans declined modestly to $39.6 million. Classified assets were reduced to $85 million. Net charge-offs totaled just over $1 million for the quarter, now $2.5 million year-to-date. And 30-plus day delinquencies were approximately $5 million or 9 basis points on total loans, excluding PPP.

Furthermore, as shown on Slide 13, loans and deferral or payment modification due to COVID-19 declined substantially to $139 million or 3% of total loans, excluding PPP. This includes 40 loans totaling $86 million that are still in a deferral status due to the granting of a second round of 90-day principal and/or full contractual payment relief. The hospitality sector represents approximately $58 million or 68% of loans with multiple deferrals that are still in a deferral status.

I would note that while we are pleased with the results, we continue to monitor the portfolio very closely, and I meet weekly with our senior credit management team to evaluate and implement strategies to remedy our largest troubled credits. The return to payment performance alone is not an indication that a borrower is out of the woods. We are taking prudent steps to downgrade credit where appropriate, build reserves in light of continued uncertainty and stress and to work with our borrowers in a manner that both protects bank capital and maintains our reputation as one of the best relationship lenders in the market.

Slide 14 provides detail on loan accommodations by loan type, changes in risk ratings assigned to loans granted payment modifications and the scheduled expiration of payment deferrals between now and January 2021.

Slide 15 reflects the allocation of our $123 million allowance by loan type and further highlights the factors contributing to the build in the reserve from the prior quarter. Higher levels of reserve are held against the construction real estate portfolio, approximately 3.99%, due to lower risk ratings, inclusion of some hospitality-related construction exposure and prior loss history during the prior financial crisis.

During our Q1 and Q2 earnings call, I provided in-depth commentary on certain portions of our loan portfolio that were viewed as most susceptible to the changing economic environment. Overall, our portfolio mix remains largely unchanged from the prior quarters. The details of these portfolios will be included in our investor deck that will be filed in the next couple of weeks. But I'll provide an update on some of the highlights.

While many of the portions of the portfolio have seen revenues return and operating performance somewhat stabilized, the hospitality sector has continued to suffer due to the extended impact of COVID-19. Our $375 million hospitality portfolio consists of approximately $230 million in hotel or lodging loans. The top 5 hotel borrowing relationships represent nearly $100 million or 45% of the lodging exposure, and we remain highly confident in their ability to withstand the downturn due to strong balance sheets, liquidity, personal sponsorships and low loan to values.

We have, however, applied additional qualitative reserves against the hospitality portfolio and special reserves against individual credits that have defaulted or remain in payment deferral status. As noted in the release, an $8.7 million in-market hotel loan was put on nonaccrual in the third quarter. This specific lodging loan had been watch rated prior to the impact of COVID-19, and it is not representative of a trend in the overall portfolio.

Other industries previously highlighted, including aircraft, Ag, EVL and life insurance premium finance have demonstrated stable performance that is consistent with our overall strong asset quality results for the third quarter. As a reminder, we had engaged an independent third-party consultant to conduct a thorough review of our EVL exposure and to stress test the portfolio under various economic recovery scenarios. That report exam, which achieved 78% penetration, was completed in July. The findings of the exam supported and confirmed our risk assessment with stress losses that were well within our internally identified stressed ranges.

Before turning it over to Keene Turner, I'd like to comment on our PPP loan portfolio. As you saw back on Slide 9, we have 3,849 PPP loans, totaling roughly $819 million that we originated and that we are servicing today. We did not purchase nor have we sold any PPP loans. We are making final preparations to begin accepting forgiveness applications from our clients, and we are pleased to report that 50% of our PPP loans are less than $50,000 and therefore, qualify for the streamlined 3508S application that provides significant administrative and financial relief to both small business owners and lenders alike.

And with that, I'll turn it over to Keene Turner.

Thanks, Doug. My comments reflect Slide 16 of the presentation. Our operating fundamentals continue to produce organic earnings that further supported our capital and reserve levels. In the third quarter, we generated $76 million of operating revenue, net income of $18 million and earnings per share of $0.68. The combined effect of operating revenue on EPS in the quarter was essentially flat, with the changes in fee income and net interest income offsetting one another.

While we continued to build our reserves during the third quarter, the provision for credit losses of $14 million decreased from $19.6 million in the second quarter and reflects an improvement in the macroeconomic forecast. We also recognized $1.6 million of merger-related expenses that impacted EPS by $0.05 per share.

On Slide 17, net interest income was $63.4 million in the third quarter, a decrease of $2.4 million in the linked second quarter. Net interest margin was 3.29%, a decrease of 24 basis points from the second quarter. Just to note and Doug hinted at this, the PPP forgiveness process was not kicked off in the third quarter and we did not realize any acceleration of PPP loan fees.

We do expect the fourth quarter to resume PPP forgiveness. And just to note, loans under $50,000 that will qualify for the simplified forgiveness process, we have about 2,000 loans totaling $39 million with $1.6 million of unamortized fees at the end of September.

What we expected in the third quarter were full quarter impacts from continued erosion of loan yields from the early 2020 decline in LIBOR, which was around 15 basis points. Full quarter average of PPP balance and the sub-debt at 5 basis points combined. What we didn't anticipate was the additional liquidity which pulled 5 basis points from net interest margin and accelerated investment premium amortization which was another 3 basis points.

Based on the initial comments on the quarter, apparently, the margin trend was unexpected, and so I'll try to crosswalk to my second quarter comments and give you some perspective as to what transpired. Average loan balances declined approximately $100 million in the quarter, and while yields on those loans declined 21 basis points compared to the second quarter, in the quarter, we realized the full impact of decreases in the short-term LIBOR rates, which occurred in the first and second quarter, the impact on the third quarter was approximately 15 basis points of net interest margin.

As expected, portfolio loan yields were basically flat during the months within the quarter, consistent with our expectations at the end of the second quarter. We believe this trend will continue and limit further margin compression in upcoming quarters, absent material shifts in the balance sheet composition.

Investment yields also declined 16 basis points from the linked quarter as cash flows were reinvested at slightly lower coupons and premium amortization increased as a result of higher prepayment speed and mortgage-backed securities. As noted, that's around 5 basis points.

Also of note, the remaining unamortized premium on mortgage-backed securities is around $8 million. Growth in funding, particularly noninterest-bearing balances, resulted in $120 million of additional interest-bearing cash balances, which further eroded net interest margin by 5 basis points.

Our cost of liabilities was relatively unchanged, declining 1 basis point in the linked quarter. The total cost of interest-bearing deposits declined 6 basis points due to lower balances and rates on brokered CDs and customer time deposits, but it was offset by additional expenses from the full period of our most recent sub-debt issuance and reset on some hedges we used to control borrowing costs.

As noted by Scott, we remain focused on growing the earnings power of the company, and we do have some elevated expectations regarding loan growth in the upcoming quarters. That should help us to slow the sequential decrease in net interest income dollars as ultimately, that is our focus, and it remains growth -- for growth in the upcoming quarters.

Turning to Slide 18. Let's review our credit metrics and asset quality changes during the quarter. Net charge-offs in the quarter remained relatively low at 7 basis points and average loans of approximately $1 million. These credit losses were mainly attributable to 1 EVL relationship that had been previously identified and reserved in the prior period. We also incurred a charge-off on this loan in the second quarter, and we believe that we have now worked through this particular credit. We have remaining book balance on this loan of $3.7 million with a specific reserve of $2.4 million. Overall, asset quality metrics improved with both nonperforming loans and classified assets declining, but we have experienced a slight uptick in our watch category.

Looking at Slide 19, we provided some additional color on the changes in the allowance this quarter as there are a number of moving pieces. We increased our allowance for credit losses to $123 million at the end of September. This was the result of an increase to specific reserves, qualitative reserves allocated to certain loan categories and the previously mentioned increase in watch loans.

The qualitative reserve allocation was based on a review of certain loan portfolios, primarily those that have received multiple deferrals, including hospitality loans that make up a large portion of loans with multiple deferrals.

The increase in specific reserves was mainly from the addition of the noted hotel loan that we placed on nonaccrual status this quarter. It's important to note that while we put this loan on nonaccrual, we have not seen a trend in this industry segment. It's also worth noting that this loan could have received a deferral. However, our relationship with this borrower was already stressed.

These increased reserves were offset by an improvement in the macroeconomic forecast, variables that are significant drivers in the allowance on the CECL model. The primary variables driving the forecast are unemployment and changes in the GDP. The combination of these factors resulted in a provision for credit losses of $14 million, down from nearly $20 million in the second quarter. Excluding PPP, the allowance of total loans was increased to 2.32% from 2.01% at the end of June. We believe it's prudent to build and maintain a reserve that reflects the uncertainty in the economy and the risk it poses to our customers and the potential for lifetime credit losses within the portfolio.

With that said, we'll move on to fee income which is outlined on Slide 20, and that came in at $12.6 million for the third quarter, which was an increase from $10 million we saw in the second quarter. Deal flow returned in the tax credit space during the third quarter and we experienced positive impact on card services, cash management, service charges and wealth, which we experienced rebounding activity in revenues from second quarter levels.

Mortgage expanded again in the third quarter as volumes increased from the prior quarter as the interest rate and real estate environment continue to support refinance and purchase activity. We strategically sold some lower yielding securities in the investment portfolio during the quarter and posted about a $0.5 million gain as a result.

Expenses on Slide 21 continue to be well controlled, coming in at $38 million before merger charges. The third quarter saw $1.6 million of merger-related expenses, primarily consisting of legal and professional costs as we work towards closing Seacoast. As we have in previous quarters, we continue to support the community and employee families affected by current economic conditions and social unrest.

We continue to work hard to ensure that we're spending prudently in this environment. And we're extremely pleased that we have kept expenses in check despite challenging revenue headwinds. We also continue to operate effectively across all of our markets with a large part of our workforce working remotely. With regard to the Seacoast acquisition, our internal integration team has been working hard with our Seacoast partners and using our established playbook and procedures to make progress along our expected time line.

I'll conclude my remarks with our final Slide #22. Our strong organic earnings profile continued to drive our capital levels with tangible common equity to tangible assets ratio at 8.89%, an increase of 22 basis points in the quarter when excluding PPP loans.

Our tangible book value per common share increased to $24.80, an 8% increase over the prior year, while building the allowance for credit losses by 151 basis points. We maintained our dividend at $0.18 per share in the fourth quarter to provide an ongoing return to shareholders while providing flexibility in our capital structure.

I want to conclude by saying that we are pleased with our financial results in the quarter. In particular, we believe we have been proactive in bolstering capital and reserves, which will allow us to focus more intently on business development and maintaining and expanding our earnings over the coming quarters.

We're also excited about the pending acquisition of Seacoast and the addition of their SBA loan generation and low-cost deposit specialties. We discussed the financial merits of the transaction when we announced the deal in August, but it's worth repeating that we expect double-digit EPS accretion in 2022 and an earnback under 3 years at an IRR around 20%.

I appreciate those who have taken the time to listen today, and we'll now open the line for analyst questions.

(Operator Instructions) We will take our first question today, and that is from Andrew Liesch with Piper Sandler.

Just wanted to kind of circle back to the provision here, and you referenced some of the hotel loans and setting aside specific reserves. I'm just curious on the hotel, one that did go to nonaccrual, can you tell us what the LTV on that property is?

Andrew, it's Doug Bauche. So we have LTVs prior to, of course, the impact of COVID. And the LTV would have been around 75% to 80% prior to the impact of COVID. As I mentioned, this was a particular credit acquired that was on our watch list and relatively considering higher risk credit due to the higher loan-to-value and nonrecourse nature of the loan. And the fact that, as Keene pointed out, our relationship with the borrowers already stressed, we've taken the loan into a nonaccrual status and established some special reserves.

Okay. And then just overall, in the hospitality book, you referenced low LTVs. Did you have the blended average of that entire portfolio?

Sorry, Andrew, I had you on mute there. Yes, the hospitality portfolio -- yes, the hospitality portfolio on average was around 60% to 65% loan-to-value, well sponsored by the owner developers of those hotels with good liquidity. And again, I mentioned the top 5 relationships have multiple hotel properties that total about $100 million. The balance of that lodging portfolio is really represented through about 20 various and independent relationships.

Okay. And that LTV seems pretty reasonable. And I understand the wanting to add to the allowance and build the reserve. But these LTVs do seem pretty manageable, just given what's currently going on. I mean if you look at that portfolio, I mean where do you see loss content coming in? It seems like with that underwriting, it should be pretty modest.

And really just trying to get to provisioning going forward. It seems like you've already built a lot of the allowance that you'll need to with the LTVs here and with some of the higher -- with these being some of the higher risk loans, that the provisioning may not need to be as high as it has been in recent quarters.

Yes, Andrew, I would say, under the CECL model, at any given point in time, I think we need to make sure that we've got what we think is a life of loan result. I think the first 2 quarters, you had the economic forecast driving a lot of that reserve. And we had some time, as Doug noted, to gather a lot of information about what the potential for losses could be. And so to your point, I think that we feel like sitting here today, barring material changes and information, deterioration or underlying trends, I think you're probably right. We're probably pretty well reserved. And I think our posture is to reflect more of the uncertainty than less of it, and we just -- we want to be proactive and get that reserve where it needs to be.

I would say when you think about what we did on the qualitative, maybe think more about the second round deferrals as the starting point, which typically included some loans in some categories that were maybe more stressed than the hospitality space that we're referring to, and I think there's some breakouts on the slides as well as select EVL loans. So from that perspective, I think that that's more qualitative in terms of the EVL and the hotel piece, but more quantitative in terms of loans ahead of second round deferral. I think we're looking at that and saying, overall, those are probably higher loss given default, given the commercial nature of the portfolio and some of those chunks that's there.

So that's the way we're thinking about it. But again, I think absent further deterioration, I think we would expect certainly that we've gotten the reserve to a point where we can feel comfortable, and we've got a really strong balance sheet to move forward.

We'll move on to our next question. That is from Jeff Rulis with D.A. Davidson.

On the Seacoast, wanted to kind of get an update. I think, Jim, you mentioned expecting a later Q4 close. How does that impact integration timing? I mean I think this was initially a late '20 or early '21 close. So thinking about integration and then thinking about, ultimately, cost savings, timing possible to get all of that by the end of next year?

Yes, I -- this is Keene, Jeff. I would say the integration is pretty well set for middle of first quarter. Unless something materially goes away from us at this point or even as we were planning, I think that's fairly well set. From our closing perspective, I think we're on -- we set an aggressive time line and I think we're hitting it. I think you can see that based on some of the dates that are out there. So I think we feel good about it.

And then I think that you might see a clean fourth quarter next year, maybe third quarter, depending on the timing and the environment a little bit. But yes, I think everything is essentially on track as we had communicated. And again, on a fairly aggressive time line.

Got it. It sounds on track or maybe even better than the kind of the delayed or worse case outcome -- not worse case, but just -- got it. Okay.

That's fair. Yes.

I guess on the margin, Keene, you alluded to kind of limiting further pressure here. Just to follow-up on that and thinking about the core ex-PPP, it sounds like we're kind of nearing a trough here and some of the things you've done on. On the deposit side, just firm up that outlook. That's kind of what you had indicated that this is sort of settling in on a go-forward basis.

Yes. I would say, I think we're entering the fourth quarter here. And I think the big wildcard is that we typically have strong growth in the fourth quarter, both in deposits and loans. And so I think you're going to probably just see some margin drift given I think there's going to be some liquidity coming in. I don't know how much that is because we've seen so much liquidity build already. And so we're really trying to get some insight into that.

So I think just mathematically, excess deposits coming in are going to erode margin. But I think from where we sit today, same balance sheet, we've seen loan pricing -- repricing stabilize from the June through September time frame, and it's drifting down a little bit, 1 basis point or 2 here and there. But I think we feel like that should -- that has firmed up. And really, we should have, I think, been more articulate about what the impact of May -- April, May and June versus July, August and September was going to be on margins.

So I think we probably set a higher expectation than we should have given what we knew at the time because my comments were not as clear. But I think we feel like it's going to firm up, it might be a few basis points of drift down from here. But I think we feel like this is probably a pretty good baseline ex some of the noise on liquidity and PPP. And ideally, we'll get some loan growth that will help drive growth in net interest income dollars on a core basis for end of 2020 and 2021.

Yes. Certainly not alone on the liquidity front, I think, as an industry, that's been maybe a surprising number. Last one, just a housekeeping. On the miscellaneous income, that line item up a little over $1 million linked quarter. Did you mention that was gains in there? What explained the sequential lift in the miscellaneous?

Yes. So I think that some of the private equity activity that we have, that happens sort of periodically. As part of what we do in the EVL space, we have a small investment in certain funds. And so I think there was an exit there that is really driving that. And then there's just kind of some little things that nickel and dime into that line item, international fees and just some things like that, that depressed kind of going into the second quarter based on activity and you just had a couple of things additionally hit there.

So probably not exactly repeatable to that level in the fourth quarter, but we do expect the tax credit line to continue to gain strength moving forward there. So something that probably hits 2 out of 4 quarters a year from that perspective in the $0.01 to $0.02 a share.

We'll take our next question, and that is from Michael Schiavone with KBW.

On the hotel loan that was moved to nonaccrual, is there a large balance of acquired hotel loans remaining? And then also, can you just provide how much of the total hotel book is on deferral still?

Yes. So there's not a large acquired portfolio, Michael. I can tell you that hotel loans that have received second round deferrals, but still be on deferral, second round deferrals were $58 million as reported. And there are a few others that are scheduled to roll-off of deferral status in October and November. So I would tell you this, that I don't have the exact number of acquired portfolio in the lodging sector but of the $220 million, it's probably less than 20% of the overall portfolio.

Okay. And just to clarify, when you say acquired, is it acquired through acquisition as opposed to...

Acquired through acquisitions, correct.

Understood. Understood. Okay. And then on fee income, you had a good quarter, grew about 30% linked quarter. And mortgage income was a big contributor. Can you just talk about the mortgage pipeline and the outlook for overall fee income growth from here?

Yes. This is Keene. I think mortgage has been a bright spot for us this year. Prior to Trinity, we didn't really have a meaningful contribution from mortgage, and I think it was something that post-acquisition late last year, we made an investment in to really take advantage of the producers that Trinity had and improve the processing shop here in the organization. So I expect that mortgage will continue to be a regular contributor.

Fourth quarter activity is hard to predict. I think, typically, activity falls off 60 or so percent from the third quarter, but I also think we're not necessarily at our limit in terms of market share, certainly, the high water mark.

So I would say that it's going to continue to be $0.01 to $0.03 a quarter moving forward given continued low rates and a lot of housing activity in our markets. And then I think from an overall perspective, I think you're starting to see some return to activity in charges in areas that are behavior-dependent. And so if the second quarter was low in terms of volumes and activity, I think we're building off of there, and I think we're holding our own in a lot of categories versus last year. And then I do expect that fourth quarter will provide some good tax credit income as it does -- as it has historically for -- to round out the year.

Okay. Great. And final question, just your reserve and capital levels are looking pretty healthy at this point. How much economic improvement or continued capital availability will it take for the Board to resume share buyback?

Well, so we still have our -- we still have about 100,000 shares in our existing buyback. So we just -- we stopped buying shares in the first quarter. And I think post Seacoast closing and looking at -- out at the future, I think we need to replenish that as an ordinary course. But I think given the reserve build that we've done, I think it's pretty clear that we believe that we haven't really even entered the credit cycle yet. We have 1 loan that we're talking about that's gone bad or had some stress. We haven't taken a charge-off on it yet.

And so I think we're just trying to be really cautious about making sure that the balance sheet is as strong as it can possibly be. And from my perspective, as much as it's attractive at these prices with the debt markets and the stock market for banks where it is, I still think it's a little bit too early. And I think our provision this quarter and allowance build reflects that posture.

(Operator Instructions) We'll move on to our next question, and that is from Brian Martin with Janney Montgomery.

I think, Scott, maybe you touched on just -- Keene, both of you guys, just a little bit on the outlook for loan growth going forward. Can you just give a little color on where you're optimistic? And kind of is it most of the new PPP relationships? I know you said that things may continue to take longer to finalize, but just some outlook on the loan growth outlook would be helpful, just demand -- among your current customers.

Yes, Brian, this is Scott. I'll start, and certainly, Keene can add. I think what we saw in Q3 was just continually liquidity building by clients and some paydowns. But also, as Keene had mentioned, there's some seasonality to the specialty businesses. So we saw typical seasonal lags in LIPF, maybe a little bit in EVL.

So I think looking forward to Q4, we do expect the seasonal -- or the specialty businesses to perform. So you're going to see a seasonal uptick there as well as just continued growth in the tax credit, the low-income housing tax credit businesses.

I think maybe at a high level with existing clients across the market, in general, there's optimism. I would characterize it as optimism. And if you look at pipelines, there's a lot of near-term planning for opportunistic investment, some M&A, some recapitalization relating to either succession or just repositioning of the balance sheet. And so all those deals are developing, but slowly, right? They're staying in the pipeline a little longer. So I think the additional activity is really a result of ramping up our proactive calling really, as you mentioned, to leverage PPP.

And if you look at that, each market may be a little different. But in Arizona, you've got some good industrial development, clients that are in the storage business, owner-occupied real estate that's being acquired opportunistically. And then we're getting some new looks because there's disruption in that market from competition.

Kansas City, a little bit of the same, some disruption from the changes that have occurred over the last couple of years, expanding existing C&I. And then in St. Louis, we've got good activity in the pipeline from existing clients that are in the tax credit business that we do fund -- leverage fund financing for some new CRE relationships.

So that all, to me, is encouraging, but I think it's a little bit of the wait and see. I think if you talk to clients, they know they're going to do it, but what does stimulus look like, maybe looking a little bit at seasonal COVID trends, how much is that going to impact us as we hit the winter, maybe some political. So just that uncertainty, I think, is just affecting timing. But I think what's optimistic is all of the stuff is staying on the pipeline and even looking out further opportunities for new business, those discussions are developing as well. So hopefully, that's the color you're looking for.

Yes. No, that's helpful. I appreciate it, Scott. And how about just the last couple of easy ones for me. The PPP forgiveness, any thought as far as how you guys are thinking about timing? Is that a 1Q, 2Q event? I know you talked about the smaller-sized credits that get streamlined. But just big picture, how are you thinking about that today versus what was out there last quarter?

Yes, that's a comment for...

That's the last quarter, Brian. Scott?

Go ahead, Keene.

I was just going to say, I think we continue to get delays here. And if you look back first quarter, you look back last quarter, it continues to delay. So we know those fees are sort of embedded gains in tangible book value. And I'm not sure the liquidity is going away, even if you get forgiveness. So from our perspective, we'll just see where it falls. But Doug or Scott might have more comments on specific borrowers. But from an organizational perspective, we're looking at the results without it knowing that, that unrecognized gain could come in at some point in time, but between now and the end of next year.

Okay. All right. I think that's helpful. At least gives me an idea of how you're thinking about it Keene. So how about -- I guess, maybe, Doug, I guess you guys mentioned that the special mention loans or the watch list credits were up a touch. And I guess, what was driving that? Was there any certain -- I mean how much of an increase? Is it pretty minor or is it -- was it more material?

Yes. No, Brian, I'd tell you what, we effectively manage the portfolio closely and review for any additional credit deterioration or stress. And while we're very pleased with classified levels remaining flat to actually somewhat improved, we have seen a migration of what we'll consider average 5 rated credit to the monitor status, which is risk rated 6, or to watch, risk rated 7.

I believe that the preponderance of those changes, we've seen already occur in the second and third quarter. And now the portfolio looks to be quite stable. But again, we're just going to have to continue to monitor performance, operating results as we head into the fourth quarter and the fiscal year-end. And we'll evaluate changes in risk ratings as need be. But I think right now, we feel pretty solid about the performance of the portfolio.

Okay. And just to be clear, the watch list was up a touch this quarter, just nothing significant. That's what I was trying to get at. It was up unlike classified that were down, right?

That's correct.

Okay. And then just going back, Keene, just for the 1 question on the margin, just kind of the liquidity outlook. And then just kind of -- if you remind us, I mean the loans that are at their floors today and just -- and I know that you look at the variable rate portfolio and kind of what's going on with the loan book, how much of the loans today are protected at their floors versus, I guess, or not?

Yes. So we've got about $3 billion of variable rate, 1 point -- a little over $1.3 billion of those has a floor and $1.2 billion of that is on the floor. And then they're pretty evenly distributed of 0 to 25 basis points -- at 0 to 25 basis points, 25 to 50 basis points, et cetera, and those increments to where the floor is. So not a whole lot more that will -- that can step down the floor. So that will help and has helped keep the loan yields fairly stable here in the third quarter from where they were at the end of the second quarter.

Okay. And then the liquidity, I guess, your sense is that the level that we see out there right now is probably sticks around for a little bit. Is that kind of how you're thinking about that?

Yes. We haven't seen it deploying. I mean I think what we've seen is there are businesses who've gotten PPP loans that are deploying it, but there's other businesses that are accumulating -- that are doing well and accumulating cash and typically, we'll see that accumulation be more aggressive towards the end of the year. So I don't know if that -- it's been more steady throughout 2020, and I don't know if that will affect what would ordinarily be a several hundred million dollar swing of liquidity accumulation, if that gets cut by a fraction.

We typically don't have that information until after October and into November. So I think the way I think about it is it doesn't impact net interest income, it just impacts margin. And I think that the underlying earnings of sort of where you are here at the end of September, regardless of what happens with that coming in, will pretty much be able to be fairly reasonably estimated. And then really the only other delta is if we decide we want to do anything with some of the locked in funding that we have, which would come at a cost. But if we think that liquidity is going to stick around, that may be a good trade to trade down, especially if some of that comes in at low interest-bearing and noninterest-bearing deposits. So to me, those are really the only big levers you get from it.

Got you. Okay. All right. And just 1 last one, just on the hotel. The occupancies within the hotel book today, how are the occupancies trending in that book? I mean have they gotten better? Are they just kind of flat lined now?

Yes. I think we reported before, right, occupancy rates were starting to trend up and then were really impacted again by some regional shutdowns and travel restrictions. And I think as we look at it today, we're seeing those occupancy rates slowly start to tick back up, so we might be getting back up into the mid 40%, maybe low 50% range. But of course, there's some room for improvement there yet as we head into 2021. But maybe that 55% range is kind of the necessary occupancy rate to start breaking even from a cash flow perspective. And I think we would still see the preponderance of that portfolio still falling short of that.

(Operator Instructions) And at this time, there are no further questions. I will turn the call back over to Jim Lally for closing remarks.

Brian, thank you, and thank all of you for joining us this morning. I appreciate your interest in our company. We look forward to speaking with you at the end of the next quarter, if not sooner. Have a great day.

Thank you, ladies and gentlemen. This concludes today's conference. All participants may now disconnect.