Good morning, welcome to the SouthState Corporation quarterly earnings conference call. Today's call is being recorded, and all participants will be in listen-only mode for the first part of the call. Later, we will open the line for questions with the research analyst community. I will now turn the call over to Jim Mabry, SouthState Corporation Executive Vice President in charge of Investor Relations and M&A.
Thank you for calling in today to the SouthState Corporation earnings conference call. Before beginning, I want to remind listeners that the discussion contains forward-looking statements regarding our financial condition and results. Please refer to slide number two for cautions regarding forward-looking statements and discussion regarding the use of non-GAAP measures. I would now like to introduce Robert Hill, our Chief Executive Officer, who will begin the call.
Good morning, thank you for joining us. Before discussing the financial results for the second quarter of 2018, I would like to comment on our recently announced organizational changes. The greatest strength we have at SouthState is our tremendous depth of leadership. We have seen substantial growth over the past decade and achieved strong financial performance and shareholder returns during this period. These leadership changes come as we focus on the next chapter for SouthState. The management moves we recently made position us well for the long term by realigning parts of the reporting structure and transitioning critical leadership roles to our next generation of leaders. We focus considerable attention on maintaining and improving our culture. A part of that effort seeks to emphasize the development of talent.
The strength and depth of our team was evident with these recent leadership changes, coming from very experienced individuals and all within the company. People drive the numbers in our company, we are fortunate to have great people. Turning to the financial results, net income for the second quarter was $40.5 million or $1.09 per diluted share. This represents a return on average assets and a return on average tangible equity of 1.12% and 13.79%, respectively. Adjusted for merger-related expenses, earnings were $52.7 million, or $1.43 per share. This represents a return on average assets of 1.45% and a return on average tangible equity of 17.68%. As we continue with the integration of Park Sterling, the company was able to generate annualized net loan growth for the quarter of over 7%.
The legacy Park Sterling markets were among the most productive markets in the bank, and customer retention in these markets has been very high. Additionally, during the quarter, we added strength to the team with a number of key hires in commercial, wealth, private banking, and mortgage. The quality we are seeing in our loan growth is also strong. Commercial banking and consumer banking both experienced good growth this quarter. While we saw our commercial real estate to risk-based capital decline to 218% of capital. We will continue to experience churn in the loan portfolio and begin to be impacted by Durbin this quarter. While this creates some short-term earnings headwinds, our balance sheet, talent level, and markets have us well positioned for the future.
Our board has declared a quarterly cash dividend of $0.35 per share, $0.01 higher than last quarter, payable to shareholders of record as of August 17, 2018. I will now turn the call over to John Pollok for more detail on the financial performance for the quarter.
Thank you, Robert. On slide number four, you can see the $600,000 increase in net interest income linked quarter to $129.6 million in the eight basis points of contraction in our net interest margin. Interest-earning asset yields were up two basis points, with the acquired loan yield expanding seven basis points and the non-acquired loan yield advancing five basis points. Slide number five shows the acquired loan book representing a little less than 30% of interest-earning assets this quarter, compared to 32% last quarter, and the non-acquired loan portfolio now representing over 55% of interest-earning assets. While both portfolio yields expanded, this change of mix resulted in a one-basis point decline in the overall loan yield. Our interest-bearing liability cost increased 14 basis points to 55 basis points this quarter, reflective of higher rates offered due to the recent Federal Reserve rate hikes.
Our overall cost of funds increased only nine basis points to a modest 40 basis points as our average non-interest-bearing deposits increased $129 million this quarter, and we continued to reduce borrowed money and brokered deposits acquired in the Park Sterling merger. At quarter end, customer deposits represented 96% of our total funding. Turning to slide number six, you can see the impact of purchase accounting accretion enhancing the contractual yield earned on our acquired loan portfolio, as well as the remaining discount to be accreted in future periods. Slide number seven shows a $2.4 million reduction in non-interest income, excluding security gains and losses linked quarter. The reduction is primarily related to a $1.6 million lower mortgage banking income and $800,000 less in acquired loan recoveries.
As a reminder, during the second half of this year, we anticipate lower interchange income of approximately $8.5 million due to the impact of the Durbin Amendment. Our adjusted efficiency ratio decreased linked quarter from 60% to 57.3%, as shown on slide number eight. During the quarter, we achieved additional cost saves after having completed systems conversion and branch closings. Non-interest expenses, excluding merger costs, declined $5.8 million to $96.4 million for the quarter. We should see modest additional cost saves in the third quarter. We expect next quarter's overall run rate to be comparable to this quarter's number. Slide number nine shows the adjusted earnings per share of $1.43 for the quarter, bringing the year-to-date total to $2.82. This year-to-date adjusted EPS represents a 21% increase from the first half of 2017.
On slide number 10, you can see our tangible book value increased $0.59 to $34.64 per share, which includes the impact from the revaluation of the Park Sterling initial day one fair value estimates. I will now turn the call over to Robert for some summary comments.
Thank you, John. We're excited about the rest of this year and our plans for 2019. Our strong and growing team and our recent organizational changes put us in a good position to increase market share and generate attractive financial results over the long term. This concludes our prepared remarks. I would like to ask the operator to open the call for questions.
Thank you. We will now open the line for questions. If you'd like to ask questions, please press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Stephen Scouten of Sandler O'Neill. Please go ahead.
Hey, good morning, guys.
Hey, Stephen.
A question for you first, if I could, around loan growth. I'm curious how much of that came from the consumer real estate sector this quarter. I know it was about $29 million last quarter. Also curious about how much runoff is still to come from that SNC book and the builder finance book, if you could give us an update there.
Stephen, this is John. I'll start. I think the last part of your question, on the SNC book, that's complete. We've finished that. We have roughly about $50 million more in the builder finance book. On the consumer real estate, if you look at the overall growth on that in total consumer real estate, this would include equity lines. We were up about $84 million linked quarter.
Stephen, this is Robert. Just to give you, I guess, a broader loan growth picture overall. Production in the second quarter was about the same as it was in the first quarter. The real difference is kind of some of the churn that we've talked about. If you look by category, CRE was basically flat. The consumer real estate book was up about 10%, commercial owner-occupied up about 13%, and C&I up about 9%. From a productivity level, consumer, commercial, CRE is about a third, a third, a third. We felt pretty good about the balance.
Okay, good. That's helpful. Then maybe thinking about the NIM for a second and just some of the pressure you saw on deposit costs this quarter. I know you mentioned last quarter you guys were going to get a little more aggressive on core deposit pricing just to do some of the remixing that you completed this quarter. Did that cause that quarter-over-quarter move in interest-bearing deposit costs, which I think was 15 basis points, if I'm not mistaken, to be a little more elevated this quarter? Should that abate somewhat? Or is this kind of the new run rate of what we might see on deposit costs when we have a Fed hike in a quarter?
Stephen, this is John. I'll start. I'd say a few things. I think first is, overall, our cost of funds, when you look at it, is 40 basis points. It's still relatively mild. As we talked last quarter on really the remixing is if you look at the Park Sterling transaction, then you look at the GBT transaction, between those two companies, there was over $500 million between Federal Home Loan Bank advances and broker deposits. Our view, I think as we said last quarter, is we'd rather fund our bank with core deposits from customers. We saw an opportunity there to get more aggressive. We feel like there's two more rate hikes coming, so you don't want to be too far behind on that. Felt like clearly that looks like that's going to happen.
Clearly, when you look at us, we're 96% funded with deposits. I think our view in general on deposits, we're very good at generating them. Clearly, you can see it in the non-interest DDA growth. When we think of betas, we think of non-interest DDA growth in there, too. We also think of wholesale borrowing costs in there, too, as we look at it. I think it's a combination of things. I think it's a combination of remixing the two balance sheets that we got and clearly seeing where rates are going.
Okay.
Robert, just to add on, we have always felt that we create the most value by creating loans and deposits and relationships in our footprint. Certainly, while we saw more deposit competition over the last few months, it was not all that. We felt like that we had kind of lagged the first few moves and that with our customer base, certainly we want to protect that and pass along some of that to them, and we felt this was the right timing to be able to do that, especially with some additional rate hikes coming. We felt like we were getting to the end of the balance sheet remix and had gotten rid of the majority or all of really the wholesale borrowings that were kind of just very clean in terms of our balance sheet leverage today.
We continue to see good customer activity, and we've opened about 30,000 checking accounts so far this year, and that feels to be on a good run rate. Clearly deposit pressures had gotten our balance sheet kind of remixed, and also wanted to get a little bit ahead of the curve.
Okay. If we saw a 60% beta on those interest-bearing deposit costs this quarter, would you think that would be tracking on the 40%-50% range in the near term, or is this 60% level just as a function of some of those lags in the incremental rate hikes you're talking about, the more likely or expected run rate from here?
I think it's too early in the quarter to tell.
Okay. Fair enough. One just clarifying question, John, when you said expenses kind of similar to this number in Q3, are you referencing kind of to the $96.4 million if we exclude the one-time charges? Is that the number to think about?
Correct.
Great. Thanks, guys. I appreciate the color.
Thanks, Stephen.
Our next question today comes from Jennifer Demba of SunTrust. Please go ahead.
Thank you. Good morning. Couple of questions for you. Robert, with the production you're seeing and CRE pay-downs and the exit of the builder finance, what kind of loan growth outlook are you guys looking for in the next two to four quarters? My second question is on M&A interest now that you've converted Park Sterling. Thanks.
Thank you, Jennifer, for your questions. First on loan growth, what I would see, the production levels are really good. It's been unusual. The production in the first quarter, I think we had 2% loan growth in Q1. We had 7% in Q2, and the productivity during both of those quarters was pretty much the same. It's a little bit hard to predict. I think 2% is probably on the low side, 7% is probably on the high side. Between now and the end of the year, we feel like the majority of that remixing will kind of take place. I think as we move into 2019, we'll just be on much more consistent footings in terms of our overall loan growth projections, which typically have been more in the high single-digit range. Anything else on that?
No, that's great. Thank you.
On the M&A front, what I would say, kind of overall, M&A deposits, let me just kind of step back overall for a minute, is the conversion went really well. We had 99% retention of the customer base overall, and we've had good productivity. Kind of to Stephen's question, North Carolina last quarter had loan growth of around 8%. South Carolina had loan growth of around 10%. Overall, the Park Sterling related markets feel really, really good. We wanted to get these org changes behind us. You can see some of those. The current exec is going to be with us a while, but we wanted to get that new org change, go ahead and get that in place. Really now our decks are very clear. We've had more inbound opportunities in the last month than we've seen in a while.
We certainly very much have the capability on the M&A front. There are more conversations taking place today than there were maybe three to six months ago. I'd say our whole focus has shifted. The last three years, it has been, how do you prepare and get past $10 billion? How do you help pay for that? How do you integrate Park Sterling? We did some major technology updates in Q1. That has really been our focus. Now our focus is really back to basic blocking and tackling. How do we get more efficient and productive? How do we leverage the capital that we're generating at a high rate? How do we continue to add talent, and how do we look at expanding our franchise?
Thank you very much.
Ladies and gentlemen, as a reminder, if you'd like to ask a question, please press star then one at this time. Today's next question comes from Will Curtis of Piper Jaffray. Please go ahead.
Hey, good morning, everyone.
Morning.
Just wanted to go back real quick on the expenses. I think you said the third quarter should be around the $96 million or so. Beyond that, should we just assume a normal growth rate, or do you have any planned investments or initiatives that may cause some pressure on that normal pace?
Will, I'll start. This is John. As we do every year, we're entering into our budget season for next year. Really everything's on the table, just like we do every year. We're going to begin to evaluate that. The dust really settles next quarter, right? You'll see the Durbin in the number. You'll see our expense run rate, we'll get into forecasting. I think as we get towards the end of the year, we'll be able to share more detail exactly how that looks.
Okay. All right. Let's see, Robert, one for you. I think last call you'd mentioned having around $1 billion or so of CRE capacity, but you also talked about the areas you're watching closely. I think you also mentioned limited CRE growth this quarter. I'd be curious to get any updated thoughts on CRE in the current environment. Thanks.
I think our CRE pipeline continues to be overall very good. We continue to see churn, I think is that point in the cycle. You've certainly seen a lot of hospitality construction, multi-family construction in our marketplace over the last few years. Some of that certainly we've done. You've seen more of that begin to go to the permanent market, which is really appropriate. We tend to do construction mini-perm and then step out on the longer-term fixed rate stuff. It feels to me like the natural cycle for CRE that if it's growing a lot right now, I think there would be probably some questions, and obviously, we have some of the Park Sterling churn. I think the good thing for us is the pipeline in that category continues to look good. We've certainly not shut it down.
We have some really good borrowers, have some great projects. I was with one last week, great opportunities there. We still have, now it's about $1.2 billion in overall CRE dry powder because our CRE to risk base came down to 218% of capital. It's something we've been very disciplined around. We've used very carefully on key relationships. We have a lot of dry powder there, and we think actually some of the better opportunities are coming because there are a lot of banks that are full in that area.
All right. Thank you very much, guys.
Our next question today comes from Christopher Marinac of FIG Partners. Please go ahead.
Thanks, guys. Just to follow up on loan pricing, is the change in yields we saw this quarter more reflective of mix shift, as you were mentioning earlier, Robert and John, or is it also part of sort of how you're looking at new business opportunities in the Carolinas and just sort of types of business you're pursuing?
I'd say, let me just kind of macro, I think John can give you maybe more color on the segments, but from a macro perspective, what we're seeing is nice increases in loan yields. There certainly was some remixing. We certainly had some of the CRE roll-off. We had some heavier one to four-family growth this quarter. Our C&I yields, our owner-occupied CRE, which were a big part of our growth this quarter were really good, and we've continued to see step-up. Beginning of the year, new production was coming on slightly above four, now is coming on in more like the 440 range. We're continuing to see improved yields on our new and renewed loans.
Chris, what I would add in the mortgage space, as you've seen with us, our history is as fees go down, refinances go away, fixed rates go up. We are big believers in the ARM business on balance sheet when the yields get to this place. We're doing more three ones and five ones and seven ones. We like that product. We find that product churns pretty nicely. If you look in the construction and land development book, you saw a pretty nice decrease there. The majority of that was construction loans going permanent. Some of them going into the secondary market, some of them keeping that ARM option on balance sheet. We clearly have seen some consumer growth, and that's kind of muted the overall yield increase in our portfolio right now. We like that business.
Clearly, there's lots of tentacles from that mortgage business on the deposit side that those new relationships that we're bringing in.
Just to give you a little color, John said the mortgage piece has muted the overall loan yield some. If you just look at the commercial segment alone, the loan yields there are closer to four and a half.
That's great, guys. That's very helpful. Thank you for all that background. Just a follow-up, as you continue to generate capital as strongly as you are, where does dividends and general return of capital kind of fall into your mix? Should we really just think that you would redeploy through organic growth and select acquisitions only?
Well, I think our initial thought was that we wanted to kind of earn back the TBV dilution we took from the Park deal. Obviously you saw a slight increase in our dividend this quarter, but we wanted to get through the expense saves out of the Park run rate. We wanted to earn back the dilution that we took as quickly as we possibly could to get our TBV number moving back in the right direction. You saw that certainly make good strides this quarter. Now we're having a lot of discussions with the board on overall capital allocation, and I don't think anything's really off the table there. Obviously, our primary goal would be to try to find ways to leverage that and generate nice returns off of it, and be that through organic means or M&A means.
Dividends have always been an important part of our story, and I think will continue to be.
Great, Robert. Thank you very much. I appreciate it.
Our next question today comes from Nancy Bush of NAB Research. Please go ahead.
Good morning, gentlemen. How are you?
Morning.
Question, sort of bigger picture M&A question. I think when we look at the Southeast, there is the most churn going on in this region of probably anywhere in the country, and it's sometimes easy to lose track of all the deals that are in process. If you could just sort of step back and tell us how you have been impacted by all the consolidation that's going on. What have been the opportunities? What have you had to respond to most immediately, et cetera?
Nancy, this is Robert, I'll start. I wouldn't say there's really been a significant impact. The markets that we operate in, if you look at the share of where those banks have acquired, there's not as much overlap. Where there is, they're typically small market share in a larger market. I wouldn't say that there's really been an impact. We typically compete with Wells Fargo, Bank of America, BB&T, SunTrust. That's who we really compete against. The new names in the market that have come in or consolidated, they're typically low share in the markets where we are, and we really don't run into them a lot. It's mostly us versus the large banks.
Okay.
I would say in terms of strategy, to your kind of strategy question, kind of no different. This is kind of what we've been doing here for 25 years in terms of our focus, our recruitment efforts. I think if you look at our recruitment efforts this quarter, we really added some nice people, and they all came from the larger banks. That's where we recruit from, and that's where we tend to compete on business.
Okay. When you look at the competition, particularly the deposit competition that's going on in Atlanta right now, do you have any particular thoughts about that, about expanding your presence in Atlanta? Are you concerned about over competition there right now? Do you still place that as sort of a high-value market, et cetera?
I think where we're primarily focused on are the large metro markets where we currently operate. That's our number 1 priority. If you kind of go through the list, clearly Charlotte is the top of that list. We're number 5 in share. We've made a major investment there. We've just added additional talent. We've got a really good branch infrastructure there. We can be successful in all four lines of business. We're in the early innings there, and we've been there for a decade, but we're in the early innings. I'd say second, Richmond and Raleigh, both tremendous potential. I was in Raleigh just a few weeks ago, making some calls with our bankers. I think our opportunity there is very strong, and we'll be in Richmond in a couple of weeks, same opportunity there.
Charleston and Greenville, that whole I-85 corridor, really from the outskirts of Atlanta, where we really pick up to Charlotte, is a major growth corridor that we have a really dominant presence in. I think our focus, Nancy, tends to be on those markets. I think Atlanta's a great market. I think there's certainly niches that you would have to find to be able to compete in to compete successfully, because you're never going to be a top 5 player in that market. There's just no way to get there.
Right.
Our focus is really not there today. Our focus is really the opportunities we have in front of us in places like Greenville and Charlotte and Richmond and Raleigh.
My second question would just be on the whole issue of loan paydowns, which have been, I think, more exaggerated in the second quarter than anybody expected. Can you just give us your perspective on that? Is this sort of normal or natural in the face of coming rate increases, and do you expect that this is going to be a condition that goes on?
Nancy, it's probably an unpopular answer. I see it as healthy. I see it as a natural part of the cycle. Most of those big chunky paydowns are coming in CRE, and we saw a tremendous amount of one to four family, we saw a tremendous amount of hospitality. We've seen a tremendous amount, even speculative CRE construction. You see a lot of banks at 300+ in terms of leverage in their capital. That has clearly been a growth play for a lot of banks. I tend to think that has slowed. As rates have moved up, those projects don't work quite as well. There's just been an abundance of it.
I think there seems to be a little bit of a pause in those sectors, and I think now those projects are being completed, leased up, and moved to insurance companies or more permanent markets. I see that as a healthy part. The part that we did not see for a long time was really business investment in operating companies, our C&I growth was up 9% this quarter. Our owner-occupied was up, I think, double digits. Those components were the ones that I feel really much better about. It mutes overall loan growth, but I think it's a much healthier balance than we've seen over the last couple of years.
All right. Thank you very much.
Our next question today comes from Blair Brantley of Brean Capital. Please go ahead.
Good morning, everyone. Most of my questions have been asked and answered. Just want to touch on fee income, just get an update on terms of penetration with your treasury and capital markets platform, and also some overall thoughts on mortgage.
Blair, this is John. I'll start. On capital markets, I really feel like we're beginning to get some traction. We've really kind of moved upscale in terms of loan size from what Park Sterling was doing in the past. They
Had a tendency to do smaller loans and focus their capital markets efforts there. As we move more into this middle market business, you mentioned treasury, we're clearly looking at larger deals. We see a lot of opportunity around the capital markets piece there. On the treasury side, we've gotten through the conversion, feel really good about that. We're really starting to get some traction there, really starting to see some very nice wins on the treasury side. I think our outlook on mortgage, more on balance sheet. Like I mentioned earlier, we like the three and the five and the seven one ARMs. We really like the owner-occupied construction business. We find that gets you a checking account, and that's one of the reasons we do mortgage.
It's another way for us to get more core funding. We see more of it going on balance sheet, in terms of the mortgage business going forward. Our purchase business now is about 85%. With those rates going up, really, there's not that much refinance opportunity there.
This is Robert. My comments just to follow up would be, I think treasury's obviously a component. It's really our whole commercial platform has been rebuilt over the last year. We're now bringing in some really good talent in that commercial middle market space. That feels great. On the treasury side, our technology is now on par. It's very good. We've got a lot of people on our old system still. We've converted all the Park customers over. They were on their system. We kept that system. That's been integrated. All the SouthState Bank customers have not been and will be integrated between now and the end of the year. I think you take the treasury platform, the additional talent, the capital markets piece. We're seeing really nice success in pipeline in all those areas.
Okay, great. Thanks. Just one follow-up. Obviously, with Durbin kicking in, it's going to impact fee income overall. Any view on when that could be kind of earned back, you think, relative to kind of the Q2 or Q1 kind of run rates?
Going to take a while.
Yeah.
Obviously a fairly large number. It's going to take a while. The good news, I think, is we're seeing a core account growth. We're seeing people come in to open checking accounts. We're on pace to do 95 million debit card swipes this year. I don't think there's many banks our size that are going to be able to do that. Blair, it's going to take a while to get that fee income number back up.
Okay, great. Thanks, guys.
Our next question today is a follow-up from Stephen Scouten of Sandler O'Neill. Please go ahead.
Hey, guys. One follow-up question. Can you talk a little bit about how you think about the balance sheet mix? Obviously, securities were down on an end-of-period basis. I'm just kind of wondering how you think about the ability to grow deposits from here to match the loan growth, or if we might see the securities book kind of shrink down to fund some of that loan growth. Thanks a lot.
Stephen, this is John. I think you could see that in the short term. We've typically, if you look at total assets over our history, we've been in the 8%-12% range of total assets. Been a long time since we've been down to eight. I think we will begin to see deposits grow more. We clearly have some seasonality in the second quarter. It's something we're going to be very focused on as we move forward.
Perfect. Very helpful. Thanks, John.
There are no further questions, I'll now turn the call back over to John Pollock.
Thanks everyone for your time today. We will be participating in the FIG Bank Forum in Atlanta beginning on September the 17th and hosting an investor day in New York on December 12th. We look forward to reporting to you again soon.
Thank you. This concludes today's conference. You may now disconnect your lines.