Heritage Financial Corporation (HFWA) Q3 2020 Earnings Call Transcript

Heritage Financial Corporation (HFWA) Q3 2020 Earnings Call Transcript

  • October 23, 2020
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Heritage Financial Corporation (NASDAQ:HFWA)
Q3 2020 Earnings Call
Oct 22, 2020, 2:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you standing by and welcome to the Heritage Financial Quarterly Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. Replay information will be given at the conclusion of the conference.

I’ll turn the conference over to your host, President and CEO, Jeff Deuel. Please go ahead, sir.

Jeffrey J. DeuelChief Executive Officer

Thank you, Kevin. Welcome to all who called in and those who may listen later. This is Jeff Deuel, CEO of Heritage. Attending with me are Don Hinson, our Chief Financial Officer; and Bryan McDonald, our Chief Operating Officer. Our earnings release went out this morning pre-market, and hopefully you have had an opportunity to review it prior to the call. We have also posted a third quarter investor presentation on the Investor Relations portion of our website. Please refer to the forward-looking statements in the press release.

We are pleased with our performance in the third quarter. We continue to operate the Bank effectively with the majority of our branch lobbies open by appointment only, and about 40% of our workforce working remotely. Despite the challenging circumstances, we have adapted, and this operating model has worked for us — has worked well for us and actually has helped us identify some new areas for efficiencies and increased productivity. We have reached something of a plateau, with regard to reopening the economy in the two states where we operate. The major metro areas are still generally operating in a more limited fashion than the less populated rural parts of our footprint. The downtown areas of Seattle and Portland feel pretty empty, but there is a lot more movement outside the core metro areas.

We expect to remain in the current level of activity, until we have some relief from a vaccine. We announced the consolidation and closure of nine branches, or 15% of our locations. This move is in response to our ongoing efforts to improve efficiencies, and at the same time, respond to the evolution of the industry overall. We continue to focus on digital enhancements in the back office, to continue to improve the customer experience. Our goal is to optimize operations by integrating systems, with process automation, which will allow us to do more with the same workforce, and also better serve our customers.

We’ll now move on to Don Hinson, who will take a few minutes to cover our financial results, including color on our core operating metrics, with some specific comments about credit quality and CECL.

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Thank you, Jeff. As reported in our earnings release, we’ve recognized earnings of $0.46 per share in Q3, and an ROA of 1%. We also showed improvement in our efficiency ratio from the prior quarter, in spite of a lower margin.

Moving on to the balance sheet; net loan balances were relatively flat, compared to Q2 levels. We had an increase in CRE loans and commercial construction loans, this being offset by decreases in C&I and consumer loans. Impacting C&I, was a continued decline in utilization rates for operating lines of credit to 23.3% at September 30 from 26.2% at June 30. Consumer loan balances are decreasing due to indirect auto loans, which we ceased originating earlier this year. Bryan McDonald will discuss loan production in a few minutes.

Deposits increased $121 million in Q3, due primarily to a combination of new deposit relationships obtained, in conjunction with the SBA PPP lending process, and existing customers, maintaining higher cash balances. We continue to have very strong balance sheet liquidity. At quarter end, we maintained combined credit facilities at the Federal Home Loan Bank, Federal Reserve Bank and Fed Fund lines at other banks of over $1 billion. In addition, we have unpledged investment securities and overnight cash balances totaling over $1 billion, and brokered deposits currently make up less than 5 basis points of total deposits. Our loan-to-deposit ratio was 82%. We continue our long-standing strategy of operating a balance sheet with low leverage, which we believe will serve us well in our current economic situation.

Regarding credit quality, our net charge-offs for Q3 were $481,000. The bulk of these charge-offs were due to two C&I borrowers impacted by COVID-19. We also experienced an increase in non-accrual and potential problem loans, due to the continued impacts of COVID-19. The increase in non-accrual loans was due primarily to three commercial lending relationships totaling $17.4 million related to COVID impacted high risk industries. The increase in potential problem loans was due mostly to loans that have been modified under the CARES Act provisions, that showed signs of credit weakness.

Moving on to loan modifications; of the expiring first round of modifications, 21% have received second modifications. At the end of Q3, we had 260 loans, that were in payment deferral modification status, totaling approximately $117 million, which represents 3.1% of the loan portfolio, ex-PPP loans. At September 30, approximately 42% of these current deferrals were interest-only payments and 58% were full payment deferrals. 81% of the loans and payment deferral status are on their second modification. Of the $117 million of loans and modification status at the end of Q3, approximately 41% are loans related to either the hotel or restaurant industry, which are two high risk industries in our portfolio, most significantly impacted by the COVID shutdown.

Provision for credit losses for Q3 was $2.7 million compared to $28.6 million in Q2. The provision for Q3, included a provision for increased unfunded commitments in the amount of $410,000 due to a combination of an increase in forecasted loss rates on C&I loans, and the lower utilization rates I previously mentioned. At the end of Q3, the allowance for credit losses on loans increased to 1.57% of total loans or 1.53% at the end of Q2. Excluding PPP loans, which are guaranteed and not provided for, the allowance for credit losses on loans was at 1.93% at September 30, an increase from 1.88% at June 30. This higher allowance was due to an increase in the number of individually evaluated loans moving to non-accrual status during the quarter, offset partially by a decrease in the allowance for loans collectively evaluated. The decrease in the allowance for loans collectively evaluated, was due to a marginally improved economic forecast.

The magnitude of future provisions will be dependent on a combination of factors, including economic forecast, charge-off experience and loan growth. Our net interest margin decreased 26 basis points in Q3. This occurred due to a combination of new loans and investments having a lower than current portfolio rates, due to the low yield curve, a repricing of existing variable rate loans and investments, a higher percentage of lower yielding overnight cash balances, and the PPP loans, which have a much lower yield, than the rest of the loan portfolio. Partially offsetting the lower loan investment yields, was a decrease in the cost of deposits. Deposit costs decreased in all categories, with the total cost of deposits decreasing 7 basis points in Q3.

Non-interest expense decreased $1 million in the prior quarter, due primarily to a decrease in professional services. Professional services decreased due to approximately $1.1 million in Q2 costs associated with the implementation of Heritage Direct, our new online and mobile commercial banking platform.

Compensation expense decreased in Q3, due mostly to reduced FTE, lower incentive compensation accruals, and a decrease in COVID and PPP related compensation costs. Offset partially by a reduction in deferred compensation costs, resulting from higher PPP loan originations in Q2. FDIC premium expense increased, due to a combination of higher assessment rates and it being the first quarter over the past four quarters, where we did not have any small bank credit remaining to offset the assessment.

And finally, moving on to capital. We remain well capitalized for all regulatory capital ratios. Although our TCE ratio was 8.5% at September 30, the ratio was 9.9, when you remove the impact of the PPP loans, which is unchanged from the prior quarter. Yesterday, the Board declared a $0.20 dividend, which is consistent with the prior quarter. Based on our capital position and long-term outlook, we believe the continuation of the regular dividend is appropriate.

Bryan McDonald will now have an update on loan production and SBA PPP.

Bryan D. McDonaldExecutive Vice President

Thanks Don. I’m going to provide detail on our third quarter production results, starting with our commercial lending group. For the quarter, our commercial teams closed $181 million in new loan commitments, down from $200 million last quarter, and down from $305 million closed in the third quarter of 2019. The commercial loan pipeline ended the third quarter at $386 million, down 8% from $421 million last quarter, and down 12% from $440 million at the end of the third quarter of 2019. New loan demand has been negatively impacted by COVID-19, with many customers putting capital projects, expansion plans and bank transitions on hold. Consumer production was $19 million for the third quarter, up from $18 million last quarter and down from $59 million in the third quarter of 2019. The decline versus 2019 was due to the discontinuation of our consumer indirect lending business during the first quarter of 2020.

Moving on to interest rates; our average third quarter interest rate for new commercial loans, excluding PPP loans, was 3.55%, an increase of 10 basis points from 3.45% last quarter. In addition, the average third quarter rate for all new loans, excluding PPP loans, was 3.64%, up 6 basis points from 3.58% last quarter. The mortgage department closed $49 million of new loans in the third quarter of 2020, compared to $53 million closed in the second quarter, and $48 million in the third quarter of 2019. The mortgage pipeline ended the quarter at $52 million versus $51 million in Q2, and $39 million in the third quarter of 2019. The strong pipeline, is due to a spike in refinance activity caused by the drop in long-term rates. Refinances made up 77% of the pipeline at quarter end.

And finally, moving on to PPP; we started taking forgiveness applications in waves from our 4,600 plus SBA PPP customers in late September, and as of this morning, have 424 applications in some stage of the process. We have one loan that has progressed all the way through SBA approval, but have not yet received any payments of forgiveness proceeds. We anticipate inviting all customers to submit for forgiveness by the end of 2020, and the process to continue into late 2021.

I’ll now turn the call back to Jeff.

Jeffrey J. DeuelChief Executive Officer

Thank you, Brian. As I mentioned earlier, we are pleased with our performance to-date. Our ACL is at a healthy 1.93% ex PPP, and we are in a better position now, with a clear view of our portfolio’s expected performance over the next several quarters. Our conservative risk profile and our much discussed concentration management system have positioned us well for the impact of the pandemic. Our primary concerns remain with the high risk categories of restaurants, hotels and recreation entertainment, which is not new news. We are working closely with the business owners, and these businesses make up the vast majority of the increases in non-accrual and potential problem loan categories. Generally, we are approaching round three deferral requests by downgrading ratings, and moving loans to TDR and/or non-accrual status.

Of course, there are many better variables to consider in the near term, including the elections, additional government stimulus, and how long we remain in the current state of reopening the economy. But for now, we are comfortable with where we sit, and believe the damage to our loan portfolio, may be much more subdued than we originally anticipated, when the pandemic started.

As Don mentioned earlier, we believe our current capital levels are adequate, and our robust liquidity provides us with a solid foundation, to address challenges and to take advantage of opportunities.

That is the conclusion of our prepared comments. So Kevin, we’re ready to open up the call now and welcome any questions from anybody on the call.

Questions and Answers:

Operator

Thank you. [Operator Instructions]. We go to the line of David Feaster of Raymond James. Please go ahead.

David FeasterRaymond James — Analyst

Hey good morning everybody.

Jeffrey J. DeuelChief Executive Officer

Good morning, David.

David FeasterRaymond James — Analyst

I just wanted to start on the branch rationalization. You guys have done a great job on the expense front. But just — could you talk a bit about the decision to close these branches? How you identified the ones that you are closing? And then maybe just expectations for attrition? I mean, just given the use of technology, would you expect the attrition to be lower? And then just finally, just maybe the timing of some of the cost saves, and where it comes out, whether it’s occupancy or salaries?

Jeffrey J. DeuelChief Executive Officer

Yeah. I’m happy to start and Don may want to chime in. We started this process several months ago and went through a pretty rigorous analysis of each of the locations in our overall footprint. Up till now, you know, we have closed, I think 22 branches over the last seven to 10 years, we’ve done them in ones and twos. And we have some experience with it. So when I get back — when I go back to your comment about what we expect in the form of attrition. Historically, we have estimated between 20% and 50%, depending on how extreme the distances from one of our branches. In most cases, all of the ones we’re talking about, are relatively close to another branch, so we would expect a relatively moderate run off, maybe in that 10% to 20% range.

I think historically, even when we estimated 20% for example, we typically didn’t get past 10%, and I think, that we’ll probably see maybe the same results, or may be better, because people have more digital access to us, than maybe they did, when we were closing branches in the past.

Don, do you want to add anything about the expenses and the timing?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Sure. I think it would spread over the next two quarters, depending on that we — some of the facilities are leased and so it depends on the timing of our settlement with the lessors and then also the severance packages. So that will — it will just be spread out over the next two quarters. This should all be done by — again, Q1 of next year. And going back on just about the run off; historically, we have, on average, been around 15% run off. And so with technology, we are hoping to keep it within 10% to 15%.

David FeasterRaymond James — Analyst

And then how much of that $2.3 million do you — what do you think of the breakdown between occupancy versus salaries and benefits?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

I think it’s [Indecipherable] trying, right now. I think, mostly occupancy and — as opposed to salary and benefits. But its spread out. Again we didn’t run our branches — we didn’t run expenses branches as it was. As you see, it’s about $250,000 [Phonetic] per branch, so they weren’t expensive branches.

David FeasterRaymond James — Analyst

Yeah, that’s helpful. And then just on loan production, how has the loan production trended? Where are you seeing opportunities for new demand? What’s the pulse [Phonetic] of your clients? And I guess just, what’s your, your appetite for new loans?

Jeffrey J. DeuelChief Executive Officer

Bryan, you want to take that one?

Bryan D. McDonaldExecutive Vice President

Yeah, sure. It’s — our appetite is still there, where obviously we have a heightened emphasis on credit quality, and we’ve asked our bankers to pay additional attention to management of the portfolio for obvious reasons. So we’ve really been highlighting that. At the same time, encouraged our bankers to remain active with the clients, and looking for new opportunities. And we’re still actively looking at both refinances, as well as — new opportunities, as well as kind of a separate group that came to us through PPP. So if you look at the numbers, the closings were down versus last year by about a third, but the pipeline was down about 12%. So I would consider that pretty good, and we’re still seeing new opportunities on a regular basis.

Jeff talked about the — kind of what’s going on in the communities and although the metro markets, people are working remotely, so they’re pretty quiet. The businesses are still active and business is still being conducted. So, our customers are being a little bit more cautious, which we appreciate and think that’s reasonable. But there is still loan demand there.

Jeffrey J. DeuelChief Executive Officer

And you know, David. We see it directly. Brian and I get involved, when exposure and approval hits a certain level and we’ve seen pretty much the same flow of deals that we were seeing before. It’s nice to see that there is activity out there.

David FeasterRaymond James — Analyst

Okay. Okay, that’s helpful. And then, I mean deposit growth has been tremendous. And maybe this is a wrong way to think of it, but maybe some attrition would be a good way to deploy some excess liquidity. But I guess, how do you just think about deploying excess liquidity going forward, and maybe expectations assuming the yield curve doesn’t steepen a ton, what do you think — how do you think about the mid and near-term and where do you think we should — where and when should we trough?

Jeffrey J. DeuelChief Executive Officer

Well, with regard to deposits, David, we’re still seeing the benefits of that 20% of the PPP loans we did were for new customers, and we continue to work with those customers. We’ve talked about that for two quarters now, and it’s taking time, because everyone’s remote and the new prospective customers are slow to move, partly because they’re remote and we can’t get together as easily as normal. But we can see evidence of those deals closing, and business coming across, and that is embedded in the growth on the deposit side. We also, up till now, have seen the phenomenon of businesses that were operating, who got PPP money, let it sit. I think now, we’re starting to see some of that PPP money get used. And Bryan, you probably have some comments on deposits, that you want to add. But I think we would expect deposits to be flat or start trending down. And Bryan after you comment, maybe, Don, you want to pick up on the NIM question.

Bryan D. McDonaldExecutive Vice President

Yeah. As Jeff said, we are still adding new accounts and then just generally, third quarter tends to be our highest growth month historically, and on top of that, we’ve seen a lot of existing customers continue to build liquidity. So. Don, I will turn it to you on the NIM.

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Okay. And just as a reminder, Q3 is our is our largest growth quarter usually. So on the NIM, again our cost of deposits — first, we’ll talk of costs, you kind of have to break the NIM into many pieces here. The cost of deposits, we expect to continue to drop down, we may end up hitting bottom around 15 basis points total costs. We are at 19 basis points now. So it’s not a whole lot to go there. But we are looking to work it down further.

On the overall NIM, we are still putting on loans at 3.64% last quarter, and the kind of the core rate yield is 4.12%, so there is still some room to come down. Although when you factor in loan, fees and stuff like that, it doesn’t necessarily always equate. But I think we are going to see a little bit of drop again next quarter, in both loan yield and in NIM, not to the extent we would have this past quarter. Unless, you know, our non-accruals go up, because that does start — when you start getting in these cycles of how much you put on non-accruals, it will impact the NIM.

David FeasterRaymond James — Analyst

Okay, that’s helpful. Thanks everybody.

Jeffrey J. DeuelChief Executive Officer

Thanks David.

Operator

Okay. Next we’ll go to the line of Jeff Rulis, DA Davidson. Please go ahead.

Jeffrey RulisDA Davidson — Analyst

Thanks. Good morning.

Jeffrey J. DeuelChief Executive Officer

Good morning, Jeff. Go ahead.

Jeffrey RulisDA Davidson — Analyst

I guess the branch rationalization right. How do you — does that alter your thoughts, and we’re probably not at the doorstep of this just yet, but if you think about future M&A, does it alter kind of the appetite or what you had traditionally sought after, if we are sort of pivoted to a little more efficient base? I know that well — I guess we’ll take it from there, just do you think it adjusts the M&A approach?

Jeffrey J. DeuelChief Executive Officer

I would say probably not, because of the way we look at M&A, is it’s either additive, taking us to new areas or it’s — maybe it’s a financial play, where we enter into an arrangement and we consolidate branches, as a result of the undertaking. We’ve done both of those in the past. They have contributed to the 22 closures that I talked about before. So no, I don’t think it necessarily would have an impact on the go forward.

Jeffrey RulisDA Davidson — Analyst

Okay. Got it. And maybe a question for Bryan, you mentioned — certainly demand impacted by COVID. I thought of — and this is — everything is COVID related, but the utilization rate decline, taking that by pieces, you think that’s somewhat stunted by the PPP usage as far as that could be better? I know that overall, demand may be impacted by COVID, but that specifically — is that something that you think is a factor?

Bryan D. McDonaldExecutive Vice President

Definitely the liquidity, Jeff. We saw a big drop in utilization in Q2, something around $100 million on the lines. So that was a lot of excess liquidity and a portion of that was PPP dollars that came in, where maybe the company had ended up having relatively normal revenues. So it fell through into higher liquidity. So I think it is liquidity, and then also augmented by all the PPP money in both cases, as we watch the financial statements come through, how much of it is due to maybe a decline in receivables or inventory, more cash than investment in those assets. So we’re watching that, but nothing notable, I would say yet. It’s — a lot of the businesses are performing — continue to perform reasonably well. But it is really low, relative to anything we’ve seen in many years.

Jeffrey RulisDA Davidson — Analyst

All right. Last one, the non-accruals added — I think you have ring-fenced the additions there. I guess, are there — any kind of spread to other areas that you think are related, that you didn’t or was it kind of a pretty aggressive effort to — anything that looked and felt like certain credits, those were added?

Jeffrey J. DeuelChief Executive Officer

Yeah, I think that we talked about this in prior quarters, Jeff, that we may be slightly more conservative than may be some of our counterparts. But in this case, these were relationships that were large enough, that we were receiving a good amount of information over the past several months, and kind of running alongside these customers, understanding what they were facing into. And I think that when it comes to the third round of modifications, we tend to view that as more of a TDR status than anything else. And then, the next step is, if it’s a TDR, is it a — it’s typically a substandard and then we make a decision, whether it’s nonaccrual or not. We do have circumstances where we have maybe a TDR, substandard rating, but we can see — support that maybe is outside of the contractual arrangement, around the payments and we might call that an accruing loan. Whereas the ones that we called out, are the ones that are TDR substandard, and we don’t necessarily see a lot of support around the contractual payment stream that’s beyond the entity, that is the borrower. So there is room for interpretation at this point in time, and I think we’re all little bit in a gray area, we have up through the end of the year to consider TDRs, but we don’t think that calling it that now, is going to be vastly different at the end of the year, so we’re approaching it as calling it that now and just moving forward. We don’t see a deterioration widespread that goes beyond the high risk categories that we mentioned, and any additional activity in this area, we think will come from those industries.

Jeffrey RulisDA Davidson — Analyst

Appreciate it. I’ll step back. Thanks.

Jeffrey J. DeuelChief Executive Officer

Thanks Jeff.

Operator

Next we’ll go to the line of Matthew Clark of Piper Sandler. Please go ahead.

Matthew ClarkPiper Sandler — Analyst

Hey, good morning.

Jeffrey J. DeuelChief Executive Officer

Good morning, Matt.

Matthew ClarkPiper Sandler — Analyst

If we can start with the margin outlook. I know it was touched on a little bit earlier, but you take the yield on new business of 3.64%, you consider securities around 1.5%, and you’ve got deposit cost basically bottoming out about 15 basis points. It suggests you’re going toward a 3.05% kind of core margin. Question is, how quickly do you get there? But are there — is there something about the mix in the production this quarter or last quarter, is there anything you can do to kind of improve pricing? I know it’s competitive, but just want to get a sense for whether or not you agree or disagree on that 3.05%?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Well, maybe I’ll start, and maybe Bryan you can talk to the margin on the loan. I do think we’re probably headed, based on our current portfolio in the low threes. It could hit could hit 3.05%. I think it will bottom out next year. I think that, if we can get to, again some steepening of the yield curve, which — a little bit this week, that obviously helps us a lot on pricing both loans and investments. We did put in actually new investments on this last quarter — like over two, it’s just that we didn’t buy that many of them, because they were — we are being pretty selective and you are right, a lot of the new investments are around the 1.50% range. But yeah, we will head down in the low 2s again, as PPP runs off and we’ll have to redeploy that, that will also be challenging for use of those funds. But I think next year will be the bottom, and then we’ll be increasing from there. But as I said on the loan yields, just because we’re putting them on 3.64% doesn’t mean they will yield 3.64% when you factor in other things like lower fees, stuff and things. Bryan, you want to talk about…

Bryan D. McDonaldExecutive Vice President

Sure. If you look at the change from last quarter, the 3.58% to the 3.64%, there was a couple of categories where we ended up with a little higher rate than what we had last quarter. But generally, it’s the overall mix that caused that 6 basis point increase. The composition and the underlying categories, the relative dollars. We are raising spreads and negotiating wherever we can. But at the same time, we’re booking into the — what I would call the top of our portfolio, given the environment. So it’s the higher quality, highest quality portions of our portfolio. And so we always have potential for competition in those groups. But we are working both the loan pricing and the deposit pricing hard, just for — also to meet the market.

Matthew ClarkPiper Sandler — Analyst

Okay. And then on the branch rationalization plan, it’s about 15% of your branch network, and I think 25% of your branches are within two miles of one another. So why not do more. Can you do more, the cost saves being less than 2% of the last 12 months’ operating expenses. Just wondering if there is, again an opportunity to do more there?

Jeffrey J. DeuelChief Executive Officer

Matt, we’re always looking at that as an effort to — in an effort to maintain or improve our efficiency. Doing nine is pretty dramatic for our organization. So right now, I think we’ll be focused on that, and if you add that nine to the 22 we’ve done over the last several years, we haven’t been sitting on our hands. Yeah, there may be some that are close in proximity, but oftentimes, there is a play between the two branches that make it difficult to close one over the other. But I guess suffice it to say, that we’re always looking at our branch footprint and how we can improve on it and still maintain our customer base, as best we can.

Matthew ClarkPiper Sandler — Analyst

Okay. Understood. And then just…

Bryan D. McDonaldExecutive Vice President

Matt, I want to follow up on something that I said earlier, kind of a correction, when David asked about the closures. When I mentioned it, most of it was occupancy costs. Most of the exit costs or occupancy costs, about 60% of the ongoing saves are actually salary and so it’s about 60-40 salary and occupancy on the go forward saves. Just wanted to clarify that.

Matthew ClarkPiper Sandler — Analyst

Got it. Thank you. And then on the PPP, I guess how much of your customers that you funded have started to seek forgiveness, maybe in 3Q or 4Q?

Jeffrey RulisDA Davidson — Analyst

Yeah. So right, now we opened roughly three weeks ago. We’ve got 424 apps in process and only one of those has gone all the way through the SBA and has SBA approval, but we don’t have — we haven’t been paid the forgiveness on that loan yet. Although, we’re likely to receive it shortly. So we’re bringing the customers through in waves. We’ve got a system set up internally, and having the various individuals that are working with the customers on forgiveness, doing groups at a time, when they’re ready to apply. And our goal is to get everybody invited by the end of this year. That’s our goal. Looking at the waves, and obviously our teams are on a learning curve currently and so we’re taking a little bit slow, just to allow everybody to become experts. But yeah, we’ve got 424 of the 4,600 plus total that had been invited in so far Matt.

Matthew ClarkPiper Sandler — Analyst

Okay, great. And then just on the tax rate, I think going into the quarter, we thought it would be 15%, came up around 13%. Is 13% kind of the expectation, or should we put it back to 15% going forward?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

I think 13% is the expectation. I don’t remember communicating 15%, but 13% is kind of what I’m expecting for kind of the year, and therefore fourth quarter.

Matthew ClarkPiper Sandler — Analyst

Okay, thank you.

Jeffrey J. DeuelChief Executive Officer

Thank you, Matt.

Operator

And next we’ll go to the line of Jackie Bohlen of KBW. Please go ahead.

Jacquelynne BohlenKBW — Analyst

Hi, everyone. Good morning. Just one quick follow-up on the discussions surrounding deferrals. Am I interpreting your comments correctly that, there is no real round three, at that point, you’re just moving it into a TDR?

Jeffrey J. DeuelChief Executive Officer

Yeah, you could look at it that way Jackie. We were given — the CARES Act has one set of rules and the regulators had given us leeway to go out six months. And if you think in terms of the fact that most of our modifications, first and second round were generally 90 days in duration. More we get to the third round and it’s time to maybe call it what it is and move forward based on our analysis of them at the time, and what the prospects are for them going forward.

Jacquelynne BohlenKBW — Analyst

Okay. So does that way of thinking play into Don’s comments related to the margin, where the kind of unknown factor is the impact of non-accruals, and what could play out there? Just as in some of those second round of deferrals and impacted industries, and completely understandably given the environment, are not ready to return to payment status yet. So you’ll have downgrades that may not necessarily result in losses, given the security you have, but could be non-accruals that does impact the margin?

Jeffrey J. DeuelChief Executive Officer

I think definitely that’s a possibility and Don may want to jump in. But what we’re seeing is, a lot of the — or many of the relationships that we have that are requesting quote to third round, are in those high-risk industries, so you can understand why they are asking for it. But what we can do is, is obviously take the time to analyze the situation, and many of them have extenuating circumstances, where they have support from beyond the entity itself for the borrower itself. So I don’t think, just because they go to TDR, they have to automatically go on non-accrual, and I think many of them will not.

Jacquelynne BohlenKBW — Analyst

Okay.

Jeffrey J. DeuelChief Executive Officer

Don, anything you want to add on that?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

No. I would agree with you. It didn’t necessarily happen this last quarter. But I think most of what — we had those three big credits that kind of went directly to non-accrual, because they were obviously struggling and we felt that’s where they needed to go, but I would say of all of them, like the modifications of $117 million that we have left there, I wouldn’t say that — just because we hit a third modification, doesn’t mean they’re going to non-accrual. It could just again be strong enough, just to go on a TDR, for continued extend payments.

Jeffrey J. DeuelChief Executive Officer

And Jacky from a timing standpoint, they came they came to the surface or caused us to take action at the very end of the quarter. They very easily could have slid into fourth quarter. But we’re just like let’s just — let’s just take it and go.

Jacquelynne BohlenKBW — Analyst

Okay. No, I understood and I am obviously very familiar with your credit profile. So I just wanted to make sure I was understanding the process. And then one last topic for me, I just want to make sure that I’m looking at the expense base properly, when I start layering in some of the consolidation savings. Was there anything unusual on the run rate in 3Q ’20? I know you’ve got some moving parts there with the new treasury management system last quarter, and it looks like — at least optically, the other expense line was a little bit lower than it has been in past quarters. So I just want to make sure I’m starting with a good base rate?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Yeah, I think if you don’t — if you take out the exit costs, I don’t think it’s going to change significantly quarter-over-quarter. I think toward that $36 million rate, with some exit costs, and maybe just some general increases items. But I don’t think some of these increases will be offset by that. I think we’ll have lower FDIC premium, so I think the $36 million run rate without the exit costs are probably not fairly reasonable.

Jacquelynne BohlenKBW — Analyst

Okay. And Don, how much of that linked quarter increase in the FDIC line item was related to the normalization versus the impact of the leverage ratio?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Say that one more time?

Jacquelynne BohlenKBW — Analyst

It said in the press release text, that there was some impact to that line item based on the leverage ratio. And so I know that, the credits were expiring, that you’ve been getting the benefit from. And so I couldn’t tell, what the trend of each of those items was?

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Yeah, I think the high is — I think our kind of baseline is in the high 3s, like maybe 3.85% or something like that. And then, so — I think in the like — if I look forward to Q4, I think it’s kind of probably more in the $600,000 range, and then gradually work down as we — as some of these assets decrease. And so the — we hope the leverage ratio improves and that will help the overall assessment. But I think it will be, probably about maybe 2.50% lower next quarter.

Jacquelynne BohlenKBW — Analyst

Okay. Thank you.

Jeffrey J. DeuelChief Executive Officer

Thank you, Jackie.

Operator

[Operator Instructions]. At this time we have no further questions in queue.

Jeffrey J. DeuelChief Executive Officer

Well, thank you, Kevin. If there is not any more questions. We’re ready to wrap up this quarter’s earnings call, and we thank you all for your time, your support and your interest in our ongoing performance, and we look forward to talking with many of you over the coming weeks. Thank you and goodbye.

Operator

Thank you. Ladies and gentlemen this conference will be available for replay and that will be available 1:00 PM Pacific Time today, will run through November 5th midnight. You may now the AT&T replay system at any time, by dialing 1-866-207-1041 with the access code of 4372884. International callers may dial area code 402-970-0847 access code 4372884.

[Operator Closing Remarks].

Duration: 44 minutes

Call participants:

Jeffrey J. DeuelChief Executive Officer

Donald J. HinsonExecutive Vice President, Chief Financial Officer

Bryan D. McDonaldExecutive Vice President

David FeasterRaymond James — Analyst

Jeffrey RulisDA Davidson — Analyst

Matthew ClarkPiper Sandler — Analyst

Jacquelynne BohlenKBW — Analyst

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