Earnings Call Transcript
SouthState Bank Corp (SSB)
Earnings Call Transcript - SSB Q3 2020
Operator, Operator
Good day and welcome to the South State Corporation Third Quarter Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions, please note this event is being recorded. I would now like to turn the conference over to Will Matthews. Please go ahead.
Will Matthews, CEO
Good morning and welcome to South State's third quarter earnings call. This is Will Matthews. And joining me on this call are Robert Hill, John Corbett, Steve Young, and Dan Bockhorst. The format for this call will be that we will provide prepared remarks and then we will open it up for questions. Yesterday evening, we issued a press release to announce earnings for Q3 of 2020. We've also posted presentation slides that we will refer to on today's call, on our investor relations website. Before we begin our remarks, I want to remind you that the comments we make may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements we may make are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in the press release and presentation for more information about risks and uncertainties which may affect us. Now I will turn the call over to Robert Hill, Executive Chairman.
Robert Hill, Executive Chairman
Good morning and thank you for being with us. I'm excited to be with you today and excited for you to hear from John and Will about the progress the team is making in building South State. This CenterState - South State partnership was about the long-term but you can clearly see the progress being made in the short-term. Progress with technology, products, efficiency, all of which have us uniquely positioned for the long-term. But most importantly, it's about having a great team, which we are fortunate to have and are continuing to build. Our board and our management team are united around the opportunities that are ahead of us and our culture is growing in a healthy way that will only make us stronger in years to come. John Corbett's leadership along this journey has been excellent and I will now turn the call over to John for more insight into the quarter.
John Corbett, CEO
Thanks, Robert. Good morning, everyone. I hope you and your families are doing well. In light of the challenging environment, I couldn't be happier with the progress our team is making and the financial results that we're producing. It was a solid quarter. Adjusting for merger costs, the company produced diluted earnings per share of $1.58 for a 17% return on tangible equity. Our pre-provision net revenue grew to $170 million for a pre-provision return on assets of 1.8%, and tangible book value per share grew at an annualized rate over 15%. The highlights for the quarter were clearly the profitability of our mortgage and correspondent banking units. We heavily invested in these fee-based businesses when treasury rates fell after the 2016 Brexit vote. And now, four years later, these non-interest income lines of businesses are producing a healthy return on investment. Two weeks ago, we announced another investment into our correspondent banking division with the acquisition of a broker dealer based in Memphis, Tennessee. Duncan Williams is a 51-year-old family firm led by the son of the founder, and it's the perfect complement to the fixed income line of business that we've been building for over a decade. South State currently serves nearly 700 community banks nationwide, and Duncan Williams adds an additional 250 financial institutions to our coverage universe. This was a negotiated transaction that Steve Young and Brad Jones have been pursuing for a year and a half, and we're very excited to welcome Duncan and his team to South State. While fee income has been remarkably strong, we continue to be faced with industry-wide loan growth and margin headwinds as we navigate through the pandemic. The good news is that our loan pipeline bottomed out in August and is steadily rising every week. The pipeline is now 24% higher than the low in August, and it continues to grow as our clients become more confident in the future. Asset quality metrics improved considerably during the quarter, with loan deferrals declining to just 2% of loans. Of the 2% of loans currently on deferral, half of those are actually making their interest payments, so really only 1% of loans are full principal and interest deferral. This is the second quarter in a row that we recorded only one basis point in charge offs. As for the merger integration, it's proceeding on time and on budget, and the encouraging thing to me is that the merger integration isn't slowing our forward momentum in the rest of the bank. I can definitely feel the South State team leaning forward and eager to go on offense to prove what this new franchise is capable of. One area where we continue to improve is the South State digital experience. This month, under the leadership of Renee Brooks, we rolled out our new website and next month, we roll out a new mobile banking app that has been in the works for over a year. Our team is excited to offer a mobile app that rivals the largest banks in the country for customer functionality and convenience. To pay for these digital investments, we will be downsizing our branch network by 20 branches this quarter, reducing our branch footprint from 305 branches currently to 285 by year end. This also increases our average deposits per branch to over $100 million, up from $40 million a decade ago. We are also excited about the huge opportunities that are presenting themselves to recruit the very best relationship managers from the largest banks to the Southeast. South State now has the scale, technology, and capital markets platform to be the logical alternative for middle market bankers looking to make a change away from the turmoil at the largest banks. So when I step back and I think about our positioning and the environment that we're operating in, there are things that we can control and there are things that we cannot control. We can't control the path or duration of the COVID virus and we can't control the shape of the yield curve. What we can control is the $80 million of cost savings to be achieved through a merger and branch consolidation initiatives. We can also control our investments into the future, including investments in technology and our mortgage and correspondent banking teams that are not dependent on the interest spread. Finally, we can make investments in top-notch relationship managers in the best growth markets in the country. As I think about where this franchise is headed, I'm confident we're making the right strategic moves to create value for our owners, our team, and our communities over the next decade. Along those lines, I'm happy to share the news that South State has created a new executive level position of Director of Corporate Stewardship. LaDon Jones, a 21-year veteran of our company, has accepted the invitation to lead our company's diversity initiatives, college recruiting, management training, as well as our ESG community development and employee assistance programs. Everyone at South State is excited for LaDon and his new role and eager to support his leadership as we create a company culture that will be a source of pride for all of us in the years ahead. With that, I'll turn the call over to Will to provide more color on the numbers.
Will Matthews, CEO
Thanks, John. Our net interest margin was 3.22% on a taxable equivalent basis, down 2 basis points from Q2. Given the June merger closing date and associated purchase accounting marks and pre-closing securities sales on the legacy CenterState side, the second-quarter NIM is not entirely an apples-to-apples comparison, nor is the combined business basis margin of 3.38% from Q2, as it includes the unmarked CenterState balance sheet and income statement for the 68 days of the second quarter prior to closing. Our margin continues to be negatively impacted by the significant liquidity we're carrying, $4.4 billion on average for the third quarter. If you were to reduce our balance sheet cash and fed funds sold to $1 billion, reducing deposit funding accordingly, our NIM would be approximately 24 basis points higher. Loan yields of 4.35% were up 10 basis points from Q2, reflecting a full quarter of the CenterState loan portfolio in the company. Accretion was $22 million for the quarter, and core NIM excluding loan accretion was 2.95%. As noted on Page 6 of the release, we had some measurement period adjustments as we finalized purchase accounting marks, including a reduction in the loan discount of $29 million. While this improved capital, I'll remind you that it will reduce future accretion accordingly. Our loan repricing mix is 55% fixed, 25% floating, and 20% adjustable. Our total cost of deposits continues to improve, down to 20 basis points for the quarter. Our CDs are relatively short, with 19% coming due in Q4, another 32% in the first half of 2021, and 26% in the second half of 2021. On non-interest income, we had a record $115 million in quarterly non-interest income led by our mortgage and correspondent banking capital markets. Our mortgage team has done an outstanding job in the midst of a merger of two mortgage teams, as well as a pandemic, with record volume of $1.57 billion, 60% of which was purchased and strong margins resulting in $48 million in revenue. Our correspondent banking division continues to show strong results with a $26 million quarter. On that note, I'd like to echo John's welcome to the Duncan Williams team. We're not disclosing transaction terms due to the size of this acquisition, but we are excited about Duncan and his group joining Brad Jones and his team and helping us grow this business, as well as the help it should provide in a very low interest rate environment. Steve has responsibility for these non-interest income businesses and is available to answer questions on them during the Q&A session. On expenses, our NIE for the quarter was $237 million, including $22 million in merger-related expenses for an operating NIE of $215 million. Our efficiency ratio was 55.8%, excluding the merger-related expenses. Our expenses for the quarter came in a little better than we expected, in part because we have begun to realize some of the merger cost savings faster than expected through normal employee turnover and some departures of employees who will not be retained, as well as certain vendor savings. We expect that this cost savings realization number will continue to increase each quarter, with the bulk of the savings coming in 2021, particularly Q3 after system conversion. Additionally, our expenses for a number of items were down in Q3 due to COVID. Business development, loan-related expenses, travel expenses, and to some extent health insurance costs are all down due to COVID. But we would expect many of these to normalize once we are beyond the health crisis. The Q3 run rate for several areas is lower than we would expect in a normal non-COVID environment. On merger-related expenses, we've recognized approximately half of the estimated $205 million to date, some of which occurred on the CenterState side pre-closing. Turning to credit, our net charge-offs remain very low at $594,000 for the quarter, or 1 basis point annualized. Ending NPAs were 33 basis points of assets, down 5 basis points from Q2 due to a combination of payoffs and upgrades. Our provision for credit losses was $29.8 million for the quarter, $22.1 million of which was for the reserve for unfunded commitments liability. After running two separate legacy bank CECL models and combining the results in Q2, we consolidated onto one model in the third quarter, and this consolidation of the legacy South State loans onto a different model resulted in the increase in the reserve for unfunded commitments. For economic assumptions, we used the Moody's Baseline forecast. That forecast has the unemployment rate for the South Atlantic region holding at 8.2% for Q3 and Q4 of this year before starting to decrease in 2021, with a forecast of 7.4% at year-end 2021 and 5.4% at year-end 2022. With a provision expense of almost $30 million and net charge-offs of less than $1 million, our reserve coverage excluding PPP loans grew to 211 basis points, including the reserve for unfunded commitments, or 192 basis points just including the reserve for funded loans. This brings the allowance to NPLs to just under four times. Our loss absorption capacity ratio, which ended the quarter at 258 basis points. As John said, our deferrals reduced significantly since our last update dropping below 2% as of October 23rd. Additionally, our full P&I deferrals were only 1% at that date, as almost half of the deferrals are paying interest. For the effective tax rate, our return to profitability in Q3 after the impact of the double count provision and other merger expenses in Q2 caused our effective tax rate to decline in the third quarter to 19.6% from the second quarter's 22.6%. Turning to capital, with good profitability and a flat, though still somewhat inflated balance sheet, our capital ratios grew during the quarter. Our TCE ratio grew 27 basis points ending at 7.83%. Our CET 1 and total risk-based ratios grew by approximately 80 and 100 basis points, respectively, ending at 11.5 and 13.9%. Our ending tangible book value per share was just shy of $40 at $39.83, up $1.50 from Q2 and up $1.63 from the year-ago quarter. I'll turn it back to you, John.
John Corbett, CEO
All right, as a reminder, we are conducting this call from different locations, so it's going to be helpful if you direct your questions to the person that you'd like to respond. This concludes our prepared remarks, and I'd like to ask the operator to open the call for questions.
Operator, Operator
Our first question comes from Michael Rose with Raymond James. Please go ahead.
Michael Rose, Analyst
Good morning, everyone, and thanks for taking my questions. I wanted to just circle back to expenses, Will. You guys had obviously some really good revenue generation this quarter and the expenses were down. I understand some of it is COVID-related. But can you just help us from a run rate perspective as the economy continues to reopen? What are some of the specific addbacks we should think about? And if you can just remind us how much of the cost savings you've actually realized? Thanks.
Will Matthews, CEO
Sure, Michael. We would on the latter part of the question estimate that thus far we have recognized on an annualized basis about 12% to 13% of the $80 million cost savings goal. So call that $2.5 million for a quarter. In the quarter, as I said, we don't have people out there doing business development efforts, there's a lot less travel going on, there's not much real estate foreclosure activity, and those related expenses and professional expenses associated with that. Those areas are all down. I'd say for a lot of us, not going to the doctor as often as we used to has led to a little bit of a decline in health insurance costs. I’d estimate that combined relative to a normal quarter might be around $5 million, give or take. I just want to be clear that while we're pleased that it came in at $215 million, this is an unusual environment and I don't want people to overinterpret that as they look forward.
Michael Rose, Analyst
That's very helpful. Then maybe just switching to the core margin at 2.95. I noticed some moving parts in their first full quarter post-integration. As we think about going forward, I mean, are there other areas that you guys are working on to optimize the balance sheet? And then how does that relate to the ability to prevent or limit NIM compression from here? Thanks.
Steve Young, CFO
Sure, Michael, it's Steve. Let me put this in the broader context around revenue. We talked about on Page 18 that we have a slide in the deck discussing our revenue composition over the past four quarters. What you see there is that revenue composition has changed. A year ago, we were about 77% from net interest margin (NIM) and 23% from fees. Now we're at 30% from NIM and 70% from fees. Our reported margin, as Will mentioned, was 3.22 and our core margin at 2.95. A couple of things on that. We are a core deposit funded bank in great markets. Our checking accounts make up 54% of deposits, and our total cost of deposits this quarter was actually 20 basis points. We continue to grow low-cost deposits on retail, our small business, and our treasury platform. From a margin perspective, we don't have much room to reduce costs, but we will go as low as we can without cutting at the core. On the loan portfolio, X accretion this quarter was 4.16 with new loan production yields this quarter coming in at 3.53, which will continue to be a headwind. As it relates to excess liquidity, we have about $4.4 billion of average Fed funds sold, probably about $3 billion over a target. This weighed on our margin by about 24 basis points this quarter. Right prior to close, we sold a $1 billion to the CenterState portfolio because it was going to mark-to-market in the quarter. As we think about the future of that excess liquidity, we invested about $500 million in this quarter. We're likely on a path to get it closer to a $4 billion target by year-end. Our target for investment portfolios is around 12% of assets. That will depend upon liquidity and the yield curve, but we also want to ensure that we're not investing capital in a low-rate environment. So we will be cautious regarding that, particularly as the non-interest income businesses are performing. One last comment on the securities portfolio. It was at 1.63% this quarter, and we're adding purchases at about one in a quarter. So that would be the core margin commentary.
Will Matthews, CEO
Yes, I think I just would reiterate a couple of things to make sure that we emphasize. One is just a reminder Steve gave about the marking of the CenterState portfolio in Q2 and the impact we had. You essentially had a $2 billion bond portfolio, half of what you sold turned into cash at 10 basis points, while the remaining half had to be marked down to a yield about half of what it was earning before. This is the impact. What I think is more important is that our long-term focus attempts to ensure the decisions we make are ones we will stand by for the long term. We could easily boost earnings a bit if we took that excess cash of $3 billion and invested it to pick up 110 to 120 basis points over the rate we're earning today at the Fed. However, we want to be thoughtful about that process, avoid getting aggressive, and regretting it nine months or a year down the road if rates move back up. Therefore, we will be prudent about pulling that lever, although it does exist.
Michael Rose, Analyst
Okay, all that color is helpful. So I think the way to read that is that maybe the core margin will face pressure here. But you guys are making some investments, and the loan portfolio and pipelines you mentioned will continue to grow. So maybe we reach a point where NII actually troughs on a core basis, excluding PPP and accretion, sometime next year and then starts to build from there. Is that the right way to think about it?
Steve Young, CFO
Yes, Michael, that's a fair way to look at it. The tailwind will be any of our investment purchases. The headwind is the loan book until it gets closer to par. With the elections and COVID and all the uncertainty, the yields are going to be volatile. But that is how we are approaching it.
Operator, Operator
Our next question comes from Stephen Scouten with Piper Sandler. Please go ahead.
Stephen Scouten, Analyst
Good morning, everyone.
John Corbett, CEO
Good morning.
Stephen Scouten, Analyst
I want to get some clarification on the expenses. I want to make sure I heard correctly on the branch reductions. It sounds as though that's incremental to the cost savings related to the deal, but that, more or less, it's going to get us to a point where we won't see net savings due to investments in digital and other technology initiatives. Is that correct?
Will Matthews, CEO
Yes, Steve, and I think John can elaborate further. It's hard to separate out between the merger cost savings we have as well as the additional investments we're making in digital initiatives and the branch reduction. Our $80 million goal includes all three of those areas. Both the expense reductions from the branch reductions, and the extra investments we're making in improving our technology. It is more of a reallocation of the branch rationalization into the digital funding way I would describe it. John, you may have some better comments.
John Corbett, CEO
I think you nailed it, Will. I don't have anything to add.
Stephen Scouten, Analyst
Perfect. How would we think about a variable comp percentage on mortgage? With mortgage being so elevated, how do we think about how that's represented in salaries in this quarter and the quarters to come, assuming that does kind of trickle down with the MBA forecasts next year? How should we think about the impact on salaries or maybe an efficiency ratio in that business on a variable basis?
John Corbett, CEO
I'll start and then Steve can comment on the efficiency ratio side. There are two components to compensation expense. Obviously, one is the staff needed to process all of the loans through the system. The requirement for support staff in an environment like this is greater than in a lower volume environment. As for variable compensation with mortgages, accounting guidance dictates that you offset against revenue. So FAS 91 states that the cost of raising that loan, i.e., the commission is a revenue offset, and again, it goes against margin. Not every company handles it the exact same way, but this is the methodology we adhere to as it's guided from the multiple accounting entities we engaged with. It may lack some comparability when you review other companies.
Steve Young, CFO
And Stephen, just to your point, mortgage for the industry had a great quarter. We're very proud of our group. The integration of those teams, led by Tom Brett and Steve, is performing excellently. The production was substantial, and the gain on sale is significant. Considering the efficiency ratios, I would anticipate that over time, that margin, which is currently at a record across firms, will revert to about 3%. That said, even though production may normalize and reduce by 20% to 25% over time, we expect to maintain strong performance.
Stephen Scouten, Analyst
Got it. Okay, one last question for me is about growth, which could be a John question. It looks like there was a big migration from the acquired book into the non-acquired book, or maybe not. If you could comment on that, the large reduction in acquired non-credit impaired, combined with the pipeline building, how do you view net growth in this environment, which is still a little tenuous?
John Corbett, CEO
I'll comment on the first question and then Will can jump in for some numbers. You talked about a decline in the acquired book and a rise in the non-acquired book. The acquired book only runs off; you never add to it. All of the CenterState loans came in under fair market value accounting, so they only decline. The loans generated by South State and Legacy CenterState contribute to the non-acquired book. So you can expect a continued decline in the acquired book and growth in the non-acquired portfolio as a result of doubled production. Our recent two quarters were volatile, making it challenging to forecast. However, to unpack the components a little: in residential, our book experienced a $150 million decline, which annualized to around 10%. Yet we had a record residential production of $1.6 billion. This leads to capacity issues, from an Alco perspective, in continuing to add long-term loans to the books in this economic climate. In the commercial segment, the loan pipeline typically processes in a 90-day window. The volume of loans closed in Q3 would have been those initiated in Q2, which was relatively inactive due to COVID impacts. Despite that, our CNI portfolio was up during the quarter, and owner-occupied commercial real estate increased as well. I think the pipeline is currently climbing around $100 million to $200 million weekly. Our pre-COVID pipeline ended at $3.4 billion but fell to $2.4 billion in August. The pipeline is now back up to $3 billion - a 24% increase since that low, and I expect that to translate into increased production in Q4 and Q1 of next year, resulting in modest growth.
Stephen Scouten, Analyst
Great, thanks for all the color and congrats on a very good quarter and a lot of progress already.
John Corbett, CEO
Thank you.
Operator, Operator
Our next question comes from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.
Kevin Fitzsimmons, Analyst
Good morning, everyone.
John Corbett, CEO
Good morning.
Kevin Fitzsimmons, Analyst
Just wondering, on correspondent banking, given the strength, the full quarter's impact of that coming in and the business doing well, as well as the acquisition you announced, how sustainable do you view that pace of revenues going forward? Are there any seasonal or cyclical forces we should be aware of, additionally with the deal? Are there other bolt-on deals in that area you're looking at?
Steve Young, CFO
Thank you. Kevin, one thing I'll just emphasize is that we really like the diversification of these fee-income businesses. Our mortgage, correspondent, capital markets, and wealth services do not make up more than 12% of our total revenue. So we settle in with that diversification. If you look back over the last twelve months under Brad's leadership, our correspondent division has generated roughly $105 million in revenue. Broken down, about $20 million was generated from fixed income, around $80 million came from our capital markets product, and about $5 million from payments. Expecting the record year of $80 million in our capital markets business to see some pullback, likely around 20% to 25%, similar to mortgage operations. With Duncan Williams, whose clients amount to about 250 financial institutions, combined with our 700 clients, gives us around 1,000 financial institutions total. Last year, Duncan reported about $27 million in revenue. In modeling the deal, we typically run these non-capital-intensive businesses at a 75% efficiency ratio. This should help in your modeling. You'll probably notice capital markets activity likely decline a little. The synergy between these two teams is promising and we foresee gradual progress there.
Kevin Fitzsimmons, Analyst
That's great, Steve. Thanks for the color. Moving on to a broader question about reserve build. I appreciate all the detail regarding your current reserve ratio and your loss absorption assessments. Given that charge offs have remained low, should we assume that reserve build is mostly in the rearview for you guys? Or do you perceive that there are still losses incoming that aren't observed yet?
John Corbett, CEO
Yes. Kevin, I'll kick this off, and anyone can jump in as well. It’s important to note that CECL implemented a life-of-loan model shortly before the pandemic. The theory established is to reserve fully for the economic forecast in which you'd anticipate losses driven by economic forecasts over that forecast period, meaning that we should currently contain all necessary reserves if the economic forecasts remain stable. However, with the recent COVID trends, there is substantial uncertainty, so despite current reserves being adequate, the variability of forecasting remains.
Dan Bockhorst, CFO
Yes, from a future loss perspective, the last two quarters have shown very low charge-off rates, and I don't foresee material changes in Q4. However, it may vary in Q1, Q2, or further quarters, based on how the pandemic unfolds and its implications on credit. For now, NPAs and charge-offs look strong.
Kevin Fitzsimmons, Analyst
Okay, thank you, guys.
Operator, Operator
Our next question comes from Catherine Mealor with KBW. Please go ahead.
Catherine Mealor, Analyst
Thanks. Good morning.
John Corbett, CEO
Good morning.
Catherine Mealor, Analyst
I have a follow-up question on asset quality. You highlighted an increase in classified assets this quarter. Could you provide a little context regarding which specific categories drove that increase?
Dan Bockhorst, CFO
Yes, Dan Bockhorst here. The pandemic created economic headwinds that placed many loans in deferral during Q2 and Q3. Because we are good risk managers, we partnered with credit administrators and market presidents in August to review all loans over $1 million, particularly those in high-risk categories or on deferral. This review led to changes in risk rating grades to ensure adequate allowance levels and to acknowledge the economic headwinds impacting some borrowers. The severity of any potential loss is mitigated significantly in the hotel portfolio across the industry, of which there is more stress, particularly in our own portfolio. This primarily accounts for the classified and criticized numbers we are currently experiencing, especially considering the approximately 5% PCD mark on legacy CenterState bank loans and the overall 55% LTV in the hotel portfolio. Given our current trajectory, we don't anticipate any material changes in criticized or classified assets in the immediate future.
Catherine Mealor, Analyst
Great, very helpful. One last question regards big-picture capital thoughts. As many banks discuss upcoming buybacks, and while I might not expect many banks of your size to re-engage in those activities this year, I’d be curious on your outlook for when re-engaging in buybacks might be thought of next year.
John Corbett, CEO
Catherine, it's John. With all the uncertainty in the summer, combining two large balance sheets, we wanted to see how our capital ratios settled. In the second quarter, we did raise subordinated debt to bolster our capital position. Evaluating our peers on CET1, we are doing quite well in that regard. Our total risk-based capital also looks solid; the one ratio currently marginally lower is tangible common equity at around 7.8%. If we maintain profitability where it is, we should exceed 8% as we head into 2021. If credit remains benign in 2021, that enables us to have extra capital moving forward, giving us optionality for buybacks. Our policy currently yields about 3%, paying out about one-third of our earnings while feeling comfortable with dividends. However, I believe growing the capital base will create options into 2021.
Catherine Mealor, Analyst
Great, thank you. Congrats on a great quarter.
John Corbett, CEO
Thank you.
Operator, Operator
Our next question comes from Brody Preston with Stephens. Please go ahead.
Brody Preston, Analyst
Good morning, everyone.
John Corbett, CEO
Good morning.
Brody Preston, Analyst
I just wanted to circle back on expenses real quick. I appreciate the $5 million or so in business development not being in the quarterly run rate right now. Correct me if I'm wrong, but that should have also been somewhat missing from the Q2 pro forma run rate of 225 just given the world was still locked down at that point. Was that indeed the case? And what else might have driven the larger reductions in expenses this quarter?
Will Matthews, CEO
Brody, it's Will. So that $5 million I mentioned included more than just business development; it also included ORE and loan-related foreclosure expenses, plus reductions in professional fees not all directly linked to lower activity levels. If you look back at Q2, because there might have been more expenses carried over from Q1, that could explain some of the noise. In terms of Q2, we also had elevated expenses from COVID-19 urgency. So that makes the comparison to Q3 a bit challenging because expenses might have been higher as we geared up for that response.
John Corbett, CEO
I'd just add, as we presented in the deck, there was an increase in normal services from a combined basis of expenses; in Q2 expenses were relatively stable despite those impacts. So, Brody, I hope that adds clarity.
Brody Preston, Analyst
Okay, understood. Thank you for that. On the PPP updates, I believe you mentioned that you still have $2.4 billion on the balance sheet. I was hoping to get a sense of the timing of that, and I'm unsure if you have any ideas for how much of those deposits are still resting with you.
Dan Bockhorst, CFO
I'll start off by saying, Brody. With respect to our vision, it is rather cloudy, but here's what we can confirm: About 20% of our loans are currently in the forgiveness process. During this quarter, we recorded a net PPP fee of about $8.5 million, leaving a balance of approximately $53 million remaining at the end of the quarter. We cannot say when the forgiveness process will pick up its pace, nor how quickly the SBA will respond. Further, whether there will be new legislation affecting forgiveness post-election is also uncertain. But our working expectation is that this will trend towards Q1 and Q2 concentrations.
Steve Young, CFO
Yes, Brody, to add to that, we do not have an exact figure, but I believe our deposit levels have remained relatively flat since that initial peak in Q2 when the PPP funds flowed out. So in summation, we have a large amount of excess liquidity together with PPP funds, all part of what may be creating the uncertainty around future deployment into earning assets.
Brody Preston, Analyst
Okay, understood. And on Duncan Williams, thanks for clarifying their revenue of $27 million last year. Can you provide context on their business being negatively affected this year due to COVID or their performance year-to-date?
Steve Young, CFO
We won't provide specific figures, but regarding our fixed income business, it has outperformed this year. This is likely attributed to the excess liquidity within the financial sector, with our clients looking to invest that float. Hence, our focus remains strong in this area moving forward.
Brody Preston, Analyst
Thank you for that clarity. Regarding the $110 million in loan discounts, is that the total discount or is there additional amounts beyond that?
Steve Young, CFO
That's the total discount.
Brody Preston, Analyst
Great. So the $22.4 million in PAA loan accretion income this quarter, what should the quarterly run rate for PAA look like moving into Q4, and when might we expect the loan discounts to be fully accreted into income?
Will Matthews, CEO
Brody, that’s a hard number to predict based on payoffs and pay downs. Ideally, I would not have guessed $22 million three months out. It can decline over time. The best approach to modeling that is to evaluate the weighted average life for that portfolio and use that to guide your calculations. Generally, from my experience, the weighted average life is often shorter than projected. So I can't provide a specific estimate.
Steve Young, CFO
For your reference, prior to the merger, CenterState's weighted average life was about 3.3 years, which gives you a good reference for projections.
Brody Preston, Analyst
Got it. Thank you for the thorough responses, everyone.
Operator, Operator
Our next question comes from Christopher Marinac with Janney Montgomery Scott. Please go ahead.
Christopher Marinac, Analyst
Thanks. Good morning. I appreciate the information regarding problem assets from prior calls. I want to delve deeper into the classified and criticized trends. Do you envision a situation where those loans get upgraded in the coming quarters, or do you think it will face stagnation until there's greater visibility on the recession or COVID etc.?
Dan Bockhorst, CFO
There may be a combination of both situations here. Some loans in classified status may see quicker upgrades whereas those in criticized status might take a bit longer, likely six to nine months as we gain economic visibility. However, I don't project any additional downgrades.
Christopher Marinac, Analyst
That's helpful, thank you. One follow-up regarding the PPP. Are there concerns related to fraud? Should that be an area of worry, and do you need to reserve for that even if it is immaterial at this time?
Steve Young, CFO
Since there hasn't been significant discussion surrounding fraud in our risk meetings, I'm inclined to say it's not currently a major factor for us. We've taken measures to ensure vigilance and implemented solid processes during PPP. So we are less susceptible to fraud risks than others may be.
John Corbett, CEO
I have also asked that question. As of now, the feedback has assured me that fraud trends have not emerged, so we're hopeful.
Christopher Marinac, Analyst
Thank you for that information. Best of luck moving forward.
John Corbett, CEO
Thank you.
Operator, Operator
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.