SouthState Corporation (SSB) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the South State 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, South State Corporation’s Executive Vice President, in charge of Investor Relations and M&A.

Thank you for calling in today to the South State 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.

I'll begin our call with an overview of the 2016 accomplishments, and then provide insight into our focus for 2017 and beyond. John Pollok will review the year in more detail, and then we will conclude the call with questions from research analysts. We are pleased with our performance in 2016. For the year, adjusted EPS totaled $4.55, up 5.6% from 2015. Tangible book value increased 12% to $31.22 per share, and the Company increased the quarterly cash dividend rate to $0.33 per share. The results for the year were strong across all areas of the Company. Loan growth was over 11% and spread across the footprint. Including a 26% growth in C&I lending. Even with the meaningful increase, loan compositions remained balanced and quality stayed at high levels. Asset quality was excellent, with net charge-offs for the year of only 6 basis points. Loans are funded primarily with core deposits, and this is important to us. Core deposits were up over 7% for the year, with an increase of over 8,000 new transaction accounts. The growth in loans and deposits is a recognition of a strong team, and the continued strong growth of the South State brand. We continue to see opportunities to acquire share from the larger banks, and I'm pleased that our Company continues to attract great talent. We recently completed the acquisition of Southeastern Bank Financial Corporation. And the process of combining the two companies is well underway. We have been working closely with the team at Southeastern for a number of months, and are optimistic about what we can do together. Conversion of the systems will take place in February. And we are looking forward to the contributions from this partnership. With the merger, South State has grown to almost $11 billion in assets. We have planned for some time for the regulatory and financial implications of crossing $10 billion in assets. This process has resulted in meaningful investments in people and systems, and is already benefiting the Company. With these investments, we have substantially completed building a platform for growth. We have also focused on ways to improve the customer experience and becoming more efficient, serving the 600,000-plus customers of the Bank. Looking forward, we are focused on making the combination with Southeastern work well. Increasing share in our existing markets, and preparing for new opportunities. I will now turn the call over to John Pollok for more detail on our financial performance this quarter.

Thank you, Robert. Net income in the fourth quarter totaled $24.2 million or $1 per diluted share, which represents a return on assets in tangible equity of 1.08% and 13.42% respectively. Adjusting for merger and branch consolidation expenses, earnings totaled $28 million or $1.15 per diluted share. This represents an adjusted return on average assets and tangible equity of 1.26% and 15.44% respectively. From a balance sheet perspective, we achieved 9% annualized loan growth for the quarter, and 4% annualized growth in non-interest-bearing checking account balances. Total MPAs as a percentage of assets continued to improve to 0.43%, and annualized non-acquired net charge-offs totaled only 5 basis points. On slide number 5, you can see the decline in net interest income in margin linked quarter. Net interest income declined by $646,000 due to lower loan interest income. The increase in legacy loan interest income totaled $1.5 million for the quarter, but was more than offset by a $2.2 million decline in acquired loan interest income, the result of lower balances and less accretion. Turning to slide number 6, you can see the $104 million increase in interest-earning assets, as the net loan portfolio average grew, and the investment portfolio average remained unchanged. Although we had little impact in the quarterly average, the increase in yields after the election at the end of the quarter provided an opportunity to increase the securities portfolio to just over $1 billion at year-end, which represents a $73 million increase from the third-quarter period in balance. We also grew the legacy loan book by $233 million from the end of the third quarter, with much of the growth coming in December. The ending legacy loan balance is $139 million higher than the fourth-quarter average balance. We think the recent increase in rates, and the continued increase in interest-earning assets will help us increase total interest income in the quarters ahead. On slide number 7, you can see a decline in non-interest income, mostly due to a lower mortgage banking income and lower acquired loan recoveries. Partially offset by higher wealth management revenues. The $1.8 million decline in mortgage banking income is mainly due to a lower secondary market pipeline, which is mostly due to some seasonality factors, as well as higher mortgage rates. On the expense side, non-interest expenses increased $2 million linked quarter to $75.2 million, which included $4.6 million in merger costs related to the Southeastern merger that closed on January 3. Adjusted non-interest expenses, excluding merger cost and $200,000 in branch consolidation items, declined linked quarter by $2.1 million. The reductions came primarily in the salary employee and benefits expense, which was lower by $1.2 million, and OREO and troubled loan related expense, which was lower by $500,000. On Slide number 8, you can see our efficiency ratio increase due primarily to merger-related expenses, and our adjusted efficiency ratio remained flat as improvements in overhead were offset by reductions in revenue. Finally, on slide number 9, you can see the significant progress we have made over the years in earnings per share growth. I will now turn the call over to Robert for some summary comments.

Thank you John. Across our footprint, our customers are voicing more optimism about their prospects for growth, and having crossed the $10 billion threshold, South State is now well-positioned to take advantage of future growth opportunities. That concludes our prepared remarks. So, I would ask the operator to open the call for questions.

We will now open the line for questions. [Operator Instructions] First question comes from Jennifer Demba of SunTrust.

Thank you, good morning.

Hi Jennifer

Good morning.

I have two questions. One, just curious about your loan growth outlook for the year. Are you seeing any tangible evidence of increasing demand post the election? And then I have a second question on M&A.

Okay, you want me to answer one first, Jennifer?

Sure.

This is Robert. The loan growth I guess first let me just speak to 16. I mean overall 9% annualized growth in the fourth quarter. 11% for the year. I think at the beginning of this year, we said kind of high-single digit loan growth was kind of what we were estimating for the year. Geographically, we saw a really good mix. Our Georgia franchise now getting ready to cross the $1 billion mark outside of Augusta. With Augusta, it will be $2 billion-plus. So, double-digit growth. Charlotte, which was really one of our highest performing markets this year going over the $1 billion loan mark there. Our Upstate franchise, way above double-digit loan growth there, and way above the $1 billion market. And then in Columbia, what we call the central area, the same thing approaching the $1 billion mark in double-digit growth. So, we just saw very consistent steady growth. I would say building throughout say building throughout the year. Same thing in terms of the components of growth. We saw in the fourth quarter, we had 31% which I think speaks a lot to your question about kind of what are we seeing and hearing. We have in the fourth quarter 9% growth and we actually reduced our consumer real estate book by about 4.5%. So, just the business activity, the business pipeline, the loan pipeline, it feels very good. What we're hearing from our customers is a lot of optimism. So, we continue to feel like the pipeline today is very consistent with where it's been the last couple of quarters. Does that build? That would be a great thing, but we certainly feel like there's lot of positive momentum.

Jennifer, just a reminder. This is John. Of course, very balanced. We are still well below our CRE and C&D thresholds from a regulatory standpoint. We didn't go out and buy a book of wholesale loans. This is all in-market organic growth. We see that continuing.

Thank you. On the M&A front, does the surge in stock prices at year end make you think any differently about your strategy with regard to acquisitions? One of your like size Southeast peers obviously is doing a large deal in the Carolinas. I know you guys want to be bigger in North Carolina overtime. Can you just give us your thoughts on what you are thinking at this point?

I wouldn't say the stock price really drives how we think about it. I think it's more, I mean, we think about building this Company over a long period of time, not over where kind of where the stock price is at one point in time or another. So, it's the right partners at the right time. That's always been the most important thing for us. Obviously, we operate in some of the best markets in the U.S. So, I don't know why other banks really wouldn't want to come here. The strength of our markets is really why we wanted, we’ve talked about going deeper and denser a lot over the years. That's one of the main reasons, we’ve wanted to do it, because we feel so good about the markets that we're in. And we've been in them for 80 years. So, we really feel very well positioned. So the market is competitive. It has always been competitive. It is competitive on the M&A front, it's competitive on the banking front. In my 30 years here, I have never seen it any different, and don't expect it to be any different on a go-forward basis. It's always been competitive, always will be competitive. From an M&A perspective, for us it goes back to the right partner, the right fit at the right time. I think stock prices aside, what is more for – I would say, in terms of M&A, is more opportunistic for us or timing for us. It's having the Southeastern deal closed. We've done the first phase of integration. Those banks fit together really well in terms of taking a company over 10 culturally, line of business-wise. It has just fit really, really nicely. We’ve come out of the gate strong over there from a growth perspective, and a pipeline perspective. We're on the cusp of the merger integration, which should be pretty clean. We don't really have any speed bumps there in terms of our optionality to do another deal. So, I’d say we are very open for business on that front and but it all comes down to the right bank and right people.

Very helpful. Thank you.

Your next question is from Jefferson Harralson of KBW.

Hi, good morning guys.

Good morning.

Could you guys talk about your margin outlook for this year?

Jefferson, yes, this is John. Clearly, we just closed the Southeastern transaction, so we're still in the midst of really looking at all the fair values. If you just kind of took and put them in stand alone, without any really fair value marks, our margin would be around 390. I think as we think about this year, what I think we are focused on is trying to get closer to that target of $5 per share EPS, and feel like the Southeastern deal really helps us with that. As Robert mentioned, we got the integration this quarter, so realizing our cost saves to really take care of that. But I think margin outlook, after we get past the fair values, obviously we had an interest rate increase in December. That's clearly going to help us in terms of all the core funding that we have. You know, what it appears, who totally knows is that we ought to get a couple more increases this year, which could clearly help us from a net interest income dollars. Overall, as you know on the margin, we've got acquired loans running off. They're coming off at a higher rate. So that's going to continue to keep pressure on kind of that percentage. But as we’ve said in the past, our goal is to try to really grow these net interest income dollars.

Okay. All right. Then I will follow up with one as well. Does the Pinnacle Bank in North Carolina deal change anything about how you think? Is it time now to go after and try to hire teams? There's been several deals in North Carolina now. Is it time to get more aggressive in buying banks maybe in North Carolina? There's less left, I suppose or how do you think that deal changes anything, if anything competitively or on an M&A front?

You know, we have a long-term strategy, we're executing our strategy, Jefferson. This is Robert. We don't really think about it that way at all. And we don't really see that it would change anything that we would do strategically. I mean we've been building the Company in great markets for decades, have great position, great share, great team. Obviously, very good organic growth. So, we've got our plan, and we're executing it. We've been very disciplined on the M&A side. I think that is going to serve us very well, as we're in this expansionary period. I think it will also serve us very well when we're not in an expansionary period, or in a down economic environment. I wouldn't say it really changes anything about our view of how we would do anything. Certainly not, wouldn't change our view about how we would perceive M&A. It's all going back to the right bank at the right time with the right partners. If we did no M&A, which I don't think will be the case, but if we did no M&A in the coming years, I would feel really good about our ability to build this Company organically. I mean I would feel great about our ability to grow organically. Better today than we have in the past because in the past we’ve had such low share. Today, we have really good share and really good markets. And we don't have to rebuild everything. So we're just well positioned to continue this organic growth momentum that we've kind of been on. I think the reality is that piece will continue to come, the efficiency is that now that we're past 10, and that's in the rear-view mirror, the efficiencies we have to really focus there versus focus on regulation in getting past 10. We have significant opportunities there. All of that M&A aside and then when the right deals come along, we’ll certainly be willing to look at those and want to pursue those as well.

All right, that makes sense. Thanks for your thoughts there.

The next question comes from Tyler Stafford at Stephens.

Hey, good morning, guys.

Good morning.

I want to start on expenses. You guys did a good job managing expenses last year. I think up just 2% or so. Before the impacts of Southeastern, is that low-single digit growth range on the legacy South State expense base an appropriate way to think about 2017 expense growth?

Tyler, this is John. I think the answer to that is yes. We've really done that the last two years. That's one of the things that we're excited about as we've been able to really bend down our expense growth, but yes, that's a good way to think about it.

Okay. And Southeastern I believe pushes your loan to deposit ratio down from call it 92% now to the mid-80%s. Do you want to increase that back towards the current level? And if so, how long do you think that would take you?

Well, I'm not sure, this is John. I'm not sure on timing. But yes, we would be comfortable in fact, pushing it up above that. You got to remember we are a core-funded company. And so, operating up at a 100% loan-to-deposit ratio level when your core-funded company doesn't bother us at all. But yes, one of the main reasons that we bought it is, the first thing we always look at is core funding. We think that is the most underappreciated asset out there today, our liability out there today. And obviously we're going to see the benefit of that as rates rise.

And then maybe just last one for me on mortgage. Can you share any of those metrics this quarter, what production was new purchase versus refi gain on some margins, anything you can share there?

Sure, so if you look at the fourth quarter of 2016, we did about $365 million in volume, over $200 million of that was on the secondary market. On the portfolio side, we almost did $160 million. Our purchase business was about 53% and refinance was about 47%. And I think as you think about our Company, in terms of mortgage, we kind of had a pivot point rates have moved back up. As Robert mentioned earlier, we actually had our in-house mortgage portfolio shrink. We're always big believers as rates begin to move back up. Our ability to do more ARM business on balance sheet, we love the 3/1 ARM and the 5/1 ARM business I think you'll begin to see a shift of us doing more on balance sheet, less secondary market fees. Obviously our mortgage servicing asset, we got into business with that at the right time. And so you'll begin to see that grow and the value of that increase as you can see in the financials. And then the last thing, I would mention, we've been on this journey since our First Federal acquisition as you know, Tyler, that was a thrift. There was a fair amount of longer term fixed rate, instruments from the mortgage side there. And we've done a really good job kind of refinancing a lot of that fixed rate stuff off the balance sheet.

Okay, great. Maybe just one last do you have what Southeastern's fourth quarter mortgage contribution was or what – not contribution, but what they did in the fourth quarter?

I do not have that.

Okay, no, that's fine. Okay. Thanks, guys.

Next question from Will Curtiss at Piper Jaffray.

Good morning, guys.

Good morning, Will.

Hey, Will.

Just one question from me, I’m curious if you could provide some comments on your expectations for accretion income this year and then just kind of a general sense for how that might trend over the course of the year?

Will, I think the way we look at the year, I think first of all kind of back to a few of the comments, I said to Jefferson is our view today is to try to get closer to that $5 EPS target run rate. And so that's kind of how we view it. We feel like Southeastern gets us there faster than we would have done our standalone. If you look at our acquired book today, kind of before Southeastern, the yield there is about 7.47%. And what we’d look at is really that acquired credit impaired book and when you look at that number on our income, on our balanced sheet. That has about a three-year weighted average life. So that's where the majority of the excess accretable yields coming in. So I think when you think about accretion you have to look at it and in terms of where we have the yield. Our process what we do is the second month of every quarter, we reproject the cash flows and then that kind of lays out the new kind of weighted average life, half of our acquired book absent Southeastern today is residential. And so we feel like the runoff will continue to slow because there won’t be as many refinances out there. But I think when you look at it, you get a really start with that 7.47% in terms of the yield, they kind of look at what you would put in as accretion.

Will, this is Robert, just a couple of things to add. Obviously the accretable yield has been a headwind for a few years we’ve been able to outrun it. And which feels good we’ve kind of I would say we are in the – probably in the later stage innings now of the accretable yield headwind and every quarter you see the decline in the balance is slowdown. As most of the accretable yield comes from the credit impaired book and that’s now just a little over 7% of our interest earning assets. So its just every quarter becomes a smaller and smaller piece so I think if you look at the core business model. And move that aside over the next 12 to 24 months that you begin to see that top line growth really start to pick back up to more normalized basis.

If you get back a year ago, we – our acquired loans went down about $94 million in the fourth quarter and then this year they went down about $80 million. So the runoff is slowing and if you look in our quarterly financials and you look at the acquired credit impaired book, many of those loans now are passed and so we have a lot of really good loans in there. As I’m not sure you know that but we do our acquired credit impairs and pools. And so those loans over time will begin to look even more like the legacy book but we will have to stand the pools until they pay off.

And I think the final piece that obviously is kind of not baked in all the numbers yet, that unfortunately muddies the water a little bit more is going to be the Southeastern merger over time is very, very clean loan book, John, the loan mark on the Southeastern book is around 3%.

About 2.5%.

2.5%, so I mean we’ve got a 2.5% book mark there. And we feel really about the quality of the portfolio.

Okay, very helpful. Thank you very much.

The next question is from Christopher Marinac at FIG Partners.

Thanks, guys. Good morning.

Good morning, Chris.

Good morning, Chris.

John, just want to ask about the impact of Durban, could you remind us on sort of when that comes in and again your capacity to kind of outgrow that just with rising transactions in the processing side?

Sure, Chris. It impacts us the second half of next year. So if you look at the second half of 2018 on an annualized basis it’s about $15 million reduction in revenue. So $7.5 million the second half of next year and then the year after that’s about $15 million.

And that’s inclusive of Southeastern?

That’s correct.

Got it. Can you offset some of that just with natural growth, as you continue to push out the customer base and just need to be more with them?

Clearly on the growth side, its helps obviously the growth side helps a lot on the accretable yield but Chris, we are really repositioning our company internally there is a lot of things that we can do if you look at our efficiency ratio its still high. And so we feel like as we get bigger streamline more things there’s lots of things that we can do internally to offset that number.

Got it. Okay, perfect. And then I know we talked a lot about the evolution of Charlotte for you at the Analyst Day in November. Can you just remind us kind of where we are in Charlotte and also either framework of how you think about just progress in 2017 and 2018 or sort of how we should think about that today, important study for you?

Well, in 2016 that was the fastest growing part of our company. We have a tremendous, tremendous team up there. It is – we are very strong on the mortgage side there. We're very strong on the commercial side there. And our wealth business is beginning to get some traction out there as well. So retail banking obviously in Charlotte is tougher. So it's not like we're going to out branch Bank of America or Wells Fargo but in the C&I space, in the commercial banking space and the treasury space quite effective. Very huge part of our overall growth this year, and we just acquired additional space to be able to continue to invest and grow there and we will absolutely a high priority for us.

Chris, we almost have $1 billion up there in loans.

Okay. That’s helpful. Great, thanks Robert. Thanks, John. Appreciate it.

The next question is from Stephen Scouten at Sandler O'Neill.

Hey, guys. Good morning, how you doing?

Good morning.

Nice, Stephen.

I want to follow-up on a question Jenny had from earlier in terms of thinking about the growth and some of the optimism that you said you're seeing in the markets. I mean how do you think we can kind of tangiblize that moving forward. Is that something were you would expect to see line utilization increase as we move through the years. If its optimism holds or kind of what are your thoughts on how to really quantify the benefit of that increased optimism if any?

I think it’s a great question. We're asking ourselves the same question. There are a lot of unknowns, right? I mean we're in the early stages of kind of a new political agenda. I think with that agenda there are some businesses that we are going to win and there are some businesses that we are going to lose. And so I think its somewhat kind of depends on your makeup. I think what happens on the trade front is something that could be certainly impactful here if there are material changes on free trade. So I think there is a multi-faceted issue. I think bottom line though the vast majority of the business owners that we're talking to are seeing organic growth opportunities. That’s still – even up 100 basis points that's still very, very inexpensive and have a very positive growth outlook. So how that bakes in to line utilization or exactly what our net growth number is, is a little bit of a crapshoot. But overall just positive momentum is what we are feeling and seeing in our pipeline. And there is also a governor we are going to put on ourselves. I mean, we are – if organically we are growing this company 20%, 25%, that I’d say there’s probably something wrong there too. So typically when we’ve seen real high-high growth periods, they are followed by periods where there’s some catch-up or some makeup or some speed bump that you hit from a credit perspective. So soundness is the fundamental part of our company, is the number one thing that we focus on our credit fundamentals we are staying very much inside of our box, and been able to do that and get double-digit growth. So, it’s our goal out there to go out there and get 15% or 20%. Our goal right now is to continue to kind of focus on what we are doing and continue the momentum that we have.

Stephen, this is John. There was a lot of positive momentum before the election. If you look at the number of companies that we are moving here, you look at what’s happening to the ports in Savannah, in Charleston is being a right-to-work state. There’s a lot of positives even before the election. I think it just gives out even a little bit more momentum.

Yes, yes. I think you are right, I think you are right. It’d be interesting to see how that plays out. John, I know you talked about the acquired portfolio and the runoff flowing so correct me if this doesn’t sound right, but maybe it flows from $80 million a quarter down to the $60 million, $70 million a quarter range? And then with that on the yields, would you expect the yields to stay kind of flattish or would they actually increases that portfolio, gets smaller at this point?

As I mentioned earlier, we do our recast every quarter and so you’d kind of look at weighted average loss every quarter. And that acquired credit impaired somewhere around three years. Over time those rates are going to begin to look more like our legacy book. With rates going up obviously those contractual yields will begin to increase but over time it’s going to blend in more to the contractual rate.

Okay. That’s really helpful. Okay, great. And then thinking about the mortgage trends I want to make sure I heard you right, did you say that you'd probably see lower fees year-over-year just as you hold more production on balance sheet versus selling that in the secondary market?

That's right. I think our history shows us as secondary market slows down, fixed rates go up, the ARM business becomes much more beneficial to keep on your balance sheet. We're seeing a tremendous amount of construction on primary and secondary residences in the state. So as we've always done in the past is we financed a lot, turn it into the construction loan. Depending where rates are we give them a nice ARM product up front. And so, yes, I think it's just natural as rates now have moved back above 4 not in the low 3s anymore, is we're going to continue to keep more of that on balance sheet.

Stephen, this is Robert. Just to kind of follow-up on first part of your question two is, just on the overall growth outlook. I think and if you go back two, three years, I think the early stages – earlier stages of this recovery and our markets were the businesses stabilize, and the residential real estate market really picked up. Businesses were still fairly cautious I think at that point. They were sound, they were doing well, they were cash flowing. But leverage was not necessarily something that they wanted to take on a lot up. There were certainly ability to take share away from other competitors and that's really was our primary growth engine. I think that the dynamic we're seeing now is that residential market is beginning to slow, there's a low – there's a lack of inventory, so you're going to see construction demand on the residential side pick up. There's going to be more of that just because there is – the inventory level is so low. But on the commercial side now is I think is starting to catch up with where consumer real estate or residential real estate is; just more optimism, more ability to take on leverage, more ability to make investments in the future.

Okay. Yes, that's great. And then one last one for me and this maybe a little odd, but I mean you guys have done obviously a phenomenal job of building a really great deposit franchise as you said core deposits and a low loan to deposit ratio. So when you think about M&A, does that give you some leeway to target maybe a transaction that has a less optimal deposit franchise or would that just kind of run in the phase to what you guys believe in and what you guys tend to want to do for the trajectory of the bank in long-term?

No, I don’t think – I think obviously when we look at a bank we obviously look at their core funding, I mean it's a meaningful part. And how much do they have in debt, how much do they have in wholesale funding because ultimately, typically the relationship is kind of where the deposits are. So that is certainly a part of it. But the other side of the equation is if there's a merger where we've got an extra – we're sitting on an extra billion dollars and liquidity that we could invest through a merger at a faster rate and use our funds to help pay down their debt, we've done those things in the past, we did it with Southeastern even though they had excess liquidity. And that tends to make the numbers look even better. So I think that's how we generally think about it.

Stephen, I would add, I think when you think about M&A, really all options are open, right. We haven't burn capital, we haven't burn liquidity, we don't have a high concentration in any of the – in the loan categories. So I think when you look at our balance sheet and look at the optionality that we have, really all options are open. If we want to go out and do a team carve out, go de novo somewhere, we've got the liquidity to fund that and I think that's what when you step back and look at big picture that is something that’s very, very unique about us.

Yes, fantastic guys. I appreciate it. Congrats on a strong year.

Thanks, Stephen.

Thanks, Stephen.

There are no further questions. So I will now turn the call back over to John Pollok.

Thanks everyone for your time today. We will be participating in the KBW Conference in Florida beginning on February 9, and we look forward to reporting to you again soon.