SouthState Corporation (SSB) Q2 2018 Earnings Report, Transcript and Summary

Good day. My name is Imani, and welcome to the Second Quarter 2018 Earnings Conference Call. I will be facilitating the audio portion of today's interactive broadcast. This event also features streaming audio, which allows you to listen to the show through your PC speakers. [Operator Instructions]. At this time, I would like to turn the show over to Gray Fleming, Chief Risk Officer. The floor is yours.

Thank you, Imani, and thank you all for joining us for our second quarter earnings call. With me today to discuss our results are Doug Williams, Chief Executive Officer; Patrick Oakes, Chief Financial Officer; Rich Oglesby, General Banking Executive; and Kurt Shreiner, our Corporate Financial Services Executive. As a reminder, the Atlantic Capital earnings release is available in the Investor Relations section of our website. I wish to caution you that we will be making forward-looking statements during this call and that actual results may differ materially. We encourage you to review the disclaimer in the earnings release dealing with forward-looking information. This disclaimer applies equally to statements made in this call. In addition, some discussions may include references to non-GAAP, GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, may be found in our SEC filings and in our earnings release. And with that, I'll turn the call over to the CEO of Atlantic Capital, Doug Williams.

Thank you, Gray, and good morning. As you've seen by now, after the close of the market yesterday, Atlantic Capital reported net income of $8.2 million or $0.31 per diluted share for the second quarter of 2018 compared to $5 million or $0.19 per diluted share in the first quarter. We calculate operating net income for the second quarter, excluding the gain on sale of Southeastern Trust Company, at $6.9 million or $0.26 per diluted share compared to $5 million or $0.19 per diluted share in the first quarter. Higher loan yields, disciplined expense management, excellent credit quality and good growth in our Atlanta market and corporate specialty businesses drove these record results. The March to June increases in the federal funds rate drove the loan yields higher. While deposit costs were up as well, we benefited from another quarter of core net interest margin expansion. Noninterest expense declined 6% from the first quarter and was 1% lower year-over-year as a result of cost reduction initiatives undertaken in late 2017 and early 2018. Net charge-offs in the second quarter were 3 basis points compared to 5 basis points in the first quarter. The lower level of charge-offs, favorable credit migration and a $24 million decline in total loan sale for investment resulted in negative provision expense of $173,000. Our Atlanta commercial and private banking and corporate specialty businesses recorded strong loan growth in the quarter. The Atlantic commercial and private banking teams grew $26 million or 20% annualized, and our SBA and franchise finance teams grew $16.4 million or 35% annualized during the quarter. Loan balances in our large corporate or shared national credit book were down $21 million, and commercial real estate was down $6 million. There was heavy refinancing activity and accelerated repayment velocity in both of these businesses during the quarter. Our Tennessee business continued to underperform and suffered a net loan balance decline of $16 million. There was additional planned or managed runoff in the TriNet, mortgage warehouse and other purchased portfolios. Now Pat Oakes will share additional financial highlights with you, and then I'll return with comments on our priorities and the outlook for the second half of the year. Pat?

Good morning, everyone. As Doug mentioned, our margin expanded 3 basis points to 3.54% in the second quarter. Excluding the impact of purchase accounting, the core margin grew 5 basis points, 3.47% from another quarter of higher loan yields. Loan yields increased 21 basis points during the quarter as we continue to benefit from increases in the Fed Funds rate. If you exclude the impact of accretion income, core loan yields increased 23 basis points. With approximately $1 billion in loans tied to 1-month LIBOR, we've also been helped over the last few quarters as the spread between LIBOR and Fed Funds has increased. Our overall cost-to-deposits increased by 12 basis points to 69 basis points in the second quarter. The increase was more than we have experienced in previous quarters during this cycle but was expected as we raised rates in some of our money market products. Our year-to-date deposit beta is now approximately 48%, and the total beta for the current interest rate cycle is closer to 33% compared to our modeled beta of approximately 50%. Noninterest income totaled $5.3 million for the quarter and included a gain of $1.7 million on the sale of the trust company. Service charge income increased $116,000 from higher account analysis fees and other non-reoccurring fees. SBA income in the second quarter totaled $1 million, a decrease of $305,000 from the first quarter. We experienced a slight decrease in funded loan originations during the quarter due to a delay in some loan closings. Year-to-date loan originations are up 22% compared to year-to-date 2017 and the pipeline remains strong. We were also seeing some pressure on SBA premiums along with higher loan yields. This could result in the bank deciding to retain the government guaranteed portion of some loans in the future. Trust income totaled $507,000 for the second quarter and includes all the remaining income we anticipate to receive from this division. The second quarter noninterest income also included a loss of $169,000 from the disposal and sale of fixed assets related to the relocation of our Atlanta headquarters. Managed expense totaled $17.4 million in the second quarter, which is a decrease of $1 million from the first quarter. Salaries and employee benefits expense decreased $1.2 million, including a $1.1 million decrease in severance expense. We anticipate salaries and benefit savings in the third quarter of approximately $300,000 from the closing on the sale of the trust company. Professional fees increased $128,000 mainly due to expenses related to the sale of the trust company. Lastly, other noninterest expense included a $228,000 impairment on an SBIC investment. Now I'll turn it back over to Doug.

Thank you, Pat. You will recall that our priorities for 2018 are to, one, leverage our Atlanta success; two, invest in high-growth businesses; three, focus on core deposits; four, improve efficiency; and five, benefit from realignment of our Tennessee businesses. Results year-to-date in our Atlanta market have been strong. Loans in our Atlanta commercial and private banking businesses have grown at an annualized pace of 15%, and the pipeline from the remainder of the year looks particularly robust as we expected. Average deposits in these businesses are up 5% year-to-date. We've invested to grow our specialty businesses including SBA lending, franchise finance and payments banking, and the results have been very good. SBA and franchise finance loans were up 47% year-to-date, annualized to over $200 million, and the pipeline indicates that the pace of growth is sustainable. ACH payments volume and fee income have increased more than 25% year-to-date, annualized. The new business pipeline for payments is particularly stout and we expect sustained seasonal build in related deposits over the second half of the year. Transaction deposit account balances were up 12% -- over 12% annualized in the first -- in the quarter, in the second quarter and 8.5% year-over-year. As you'll remember, we deployed Atlantic Capital Exchange for Business, or ACE for Business, the small business companion to our corporate treasury management platform, ACE for Treasury, early in the second quarter, and sales activity for both ACE solutions is accelerating. We expect sales of these next-generation online treasury management capabilities and continued progress on our payments business to drive sustained growth in core customer transaction deposits. As I mentioned earlier, cost-saving measures taken late last year and early this year have improved our efficiency. While the pace of decline in our expenses will moderate over the next couple of quarters, better revenue growth and productivity improvements should result in declining efficiency ratios. While we were disappointed that the loan balances continue to decline in our Tennessee and Northwest Georgia franchise, deposit balances were up 5% annualized year-to-date as a result of reinvigorated sales activity and competitive deposit promotions. Our banking team there is active in the market and loan pipelines are better than they have been over the last few quarters. We're cautiously optimistic that we will have better results in the second half of the year in Tennessee and Northwest Georgia. Overall, based on current pipelines, we expect loan and customer deposit growth to accelerate over the second half. While the effects of President Trump's intensifying trade salvos have yet to show up in the economic data and the economy appears generally sound, there's evidence that with the resulting risk and uncertainties on the trade front, business owners and managers are becoming somewhat more cautious as they consider new capital spending and hiring. Still, we expect a healthy economic environment on all of our markets over the next 2 to 3 quarters. Atlanta looks particularly strong. That outlook, combined with merger-induced market turmoil, has presented an attractive opportunity of -- to build our Atlanta franchise over the next 12 to 18 months, and we expect to shift and invest resources accordingly for stronger growth and improved operating leverage. Now I will attempt to answer your questions.

[Operator Instructions]. And your first question comes from the line of Brady Gailey with KBW.

Maybe we'll just start with loan growth. You had a little free cash this quarter, which basically gave back the loan growth from Q1. And then we've talked about loan growth being in kind of this high single-digit level. And it doesn't look like that will happen this year but hopefully we'll see some nice loan growth in the back half of the year but for a full year, although it sounds like you'll be a little under that. But as we look to next year and beyond, do you still think that high single-digit growth rate is appropriate?

Well, I'll answer this way, Brady. That's what we expect and that's what we aspire to. And as you know, we had a 10% growth expectation for this year and that's -- we guided you accordingly. As you point out, we haven't seen any growth year-to-date because of the growth that we had in the first quarter were sort of given up in the second quarter. But if you step back and look at our loan portfolio as a whole, half of the portfolio is designed for runoff that would include mortgage warehouse, TriNet and other purchase portfolios; or for low single-digit growth and that would include our commercial real estate business, our large corporate or SNC business and our consumer businesses. The other half of the portfolio is designed for a high-level growth, mid-teens or better, and that would include our Atlanta commercial business, SBA, franchise finance in Tennessee. At the midway mark of the year, all of our units are performing at or around, perhaps better than their budgeted numbers except Tennessee. And we do expect growth to accelerate in the second half of the year, and I think we'll end the year in a pretty strong place and that should suggest that we'll have some momentum going into next year.

All right. And then on the SBA front. I heard your comments about some of the dynamics there, maybe you're thinking about retaining more of that SBA production versus selling it. How should we think about SBA fees over the rest of this year and into next year? Should we use 2Q as kind of a good run rate or do you think we'll see some decline off of the 2Q run rate?

I think it's too early to say. So I think for your modeling purposes, I'd go with Q2 at this point as a good run rate. But I wouldn't grow it much off of that.

Okay. Then, Pat, I know last quarter we talked about 3Q being a little under $17 million in expenses. It looks like you all will hit that pretty easily. But any updated thoughts on how you're thinking about the expense base in the back half of the year?

No. It's coming in exactly like we expected. You're right, so we're a little above that $17 million number now. You take out the $300,000 for the rest of the trust company expenses and some of the other unusual expenses and you get below that $17 million. So I think we're right on track to where we thought we would be.

Your next question comes from the line of Stephen Scouten with Sandler O'Neill.

I just wanted to follow up maybe on Brady's question around loan growth. I mean, obviously, loans are down slightly year-over-year. What gives you the level of confidence that we're at that kind of inflection point? Is it really that you're seeing -- that you're through the SNC on a lot of the payoffs or paydowns you expected in Tennessee? Is it that you think CRE paydowns or corporate paydowns in general, might flow? Or what kind of gives you that level of confidence that you seem to be exuding here?

The confidence that we have is really based on the pipelines that we have in each of these businesses as we look out over the second half of the year. We expected them to pick up, and they have picked up. In the second quarter, the level of payoffs was 20% higher than it was in the first quarter of the year. So we did have an accelerated level of payoffs, and most of that was in the large corporate book or the SNC book. And there has been a lot of refinancing activity in the large corporate arena. A lot of these revolving credit facilities are being recast on a basis that is not attractive to us in terms of pricing and terms, so we've chosen to get out of some of that business. But the level of refinancing activity there has been particularly high in the second quarter but balances are down accordingly.

Okay. Yes, that's really helpful. And then maybe one more for me, just on the NIM. I mean, do you guys continue to think that in quarters where we see rate hikes, you could see kind of the 5 basis point improvement to the NIM or is there going to be increased pressure on deposits when you actually have to grow those again, presumably, as you begin to grow loans again. And also, within that, what are those deposit specials that you guys said you were running on the money markets?

Yes. So first, around the margin. No, we should continue to see expansion there. I mean, 2/3 of our portfolio is floating rate, right? So we'll benefit from each rate increase. It just depends on how much pressure we see on deposit costs. I think Quarter 2 is a little bit of a catch-up there, so we don't expect that to have a beta going forward. We model 50% beta and we've come in less than that. We think that will continue to be the case.

And the level of those deposit specials on the money market currently?

Yes. So I think, on average, in the second quarter, I think the rate was around 1.2%, 1.3% or so that we were raising.

Your next question comes from the line of Jennifer Demba with SunTrust.

I have two questions. First, if you could talk about the Tennessee bank and the loan portfolio there. When you're expecting it to stabilize if you have any visibility there? And then my second question is what is kind of your provisioning outlook with these low levels of loan losses and problem loans?

Okay. The first question about Tennessee. Jennifer, we are seeing a better pipeline in Tennessee than we have seen, really, to date. And we're hopeful that in the second half of the year, we'll see some growth in the Tennessee portfolio. It's really what we need to turn the picture around there. It is good that we've seen some deposit growth that suggests that our sales activity is being helpful. It's working. So we're hopeful that in the second half of the year we'll see some loan growth in addition to sort of a slowing of attrition that we've seen so far. Gray, you want to take the provisioning question?

Jennifer, as far as provision, I'd say that we expect that will track with loan growth. Our credit quality remains very good. We hope that charge-offs will remain low, but the numbers are so low that we'll see some of that. But we think that will probably pick back up and, in some ways, we hope so, with loan growth.

Your next question comes from the line of Steven Comery with Gabelli & Company.

I just kind of wonder if you guys can kind of quantify the production levels. I know you mentioned they were down year-over-year. But I think we talked about $92 million in production in the first quarter and then funding on your existing $36 million. I was wondering if you could kind of show what that was in Q2.

I'll give you a combined number. So both production of the new loans and change in existing loans was in the $110 million range for the quarter. That compares to maybe $130 million or so in the first quarter.

Okay. Good. That's helpful. And then just kind of...

Let me just say, Steven, that's against a 20% increase in payoffs in the second quarter. So about $130 million of payoffs in the second quarter compared to about $110 million in the first quarter -- or $109 million in the first quarter.

Okay. That was actually my next question, which is aggregating the payoffs. So $130 million is the answer. Okay. Those are my only 2 questions.

Your next question comes from the line of Nancy Bush with NAB Research.

I want to beat the dead horse of Tennessee a little bit more, if you don't mind. You said your banking teams there are active and you're cautiously optimistic about the second half of the year. Can you just give us a little bit more color [Technical Difficulty] banking teams are new to the company.

Yes. I think that's an important point, Nancy. I mean, this banking team has been with us a little over a year now and it does take a while to get traction in the market. As we track our pipeline, we note that the pipeline is building and that is evidence of the results of their sales activity. It does take time, and we're hopeful that we'll see improved results in the second half of the year.

Do you think you will reach a point, either maybe early next year, in which you'll want to add additional loan production teams there or is that still a long way off?

I think that's still a long way off. We still have a lot of capacity that's unused at this point and we want more productivity out of the team there, so I don't see adding any resources in Tennessee. I think we're going to want to add resources in Atlanta, where we need more capacity to take advantage of the opportunity.

Okay. Secondly, you mentioned the pressure on the SBA, or Pat mentioned the pressure on the SBA margins. What is the source of the pressure and do you expect -- is it intensifying? Do you expect that there's going to be any moderation? If we could just kind of get a -- because it seems like everybody's going into the SBA business or growing in the SBA business right now, and so is it competition is pressuring margins?

Well, I think the pressure -- what I meant was the pressure was more on loan premiums, the sale premiums. They come down a little bit, which you would expect. And then on top of that, obviously, these are all prime-based loans. Those rates have increased, obviously, significantly so with the economic benefit of selling versus holding, and that's what we're weighing going forward.

It looks like the benefit to holding loans on the balance sheet may be -- or the benefit may be shifting to holding loans on the balance sheet versus getting down sale income when originated.

The spreads really haven't changed on the stuff we're originating.

It's a fixed-income business. So as rates go up, premiums come in a little bit.

Okay. And the third question is sort of philosophical. I would -- I kind of look at second quarter and think, okay, the "trauma" is mostly passed at this point or we hope it's mostly passed.

Right.

And you've got 11% tangible capital or close to 11% tangible capital. I mean, is there a point at which you are thinking about introducing even a nominal dividend because, as you know, that broadens the group of people who can invest in your stock. To me, it seems to be a symbol that, okay, we're past the damage and can go on from here. I mean what are your thoughts about that?

Yes. I think there are couple of perspectives on that. One is, as we do -- as our earnings become more predictable, and we understand -- and we have a better grasp of how much capital we're generating quarter-to-quarter, the possibility of a dividend, increases. The other perspective is, what's the appropriate level of capital for our business, for the risk in our business. And we think we're appropriately capitalized now. As we build capital, obviously, that gives you some flexibility to think about giving some of it back.

Okay. So do you see that as possibly a 2019 event? I mean, I'm assuming that your board talks about it pretty frequently.

We do. Yes. We look at it, certainly, in our annual planning process and we'll look at it again this fall as we move into next year. And again, with more stability in the earnings picture and generation of capital, I think we have more flexibility to think about that.

[Operator Instructions]. And your next question comes from the line of Christopher Marinac with FIG Partners.

I wanted to ask more about deposits and particularly, your ongoing focus in the treasury management space. Is that giving you flexibility on deposit rates, deposit beta, et cetera? Or is that customer going to be demanding as we move up the rate curve?

Yes. The treasury management product really generates demand deposits and other transaction account activity, and of course, those are low cost. And we think we've got very good treasury management capabilities and we expect that will continue to drive core customer transaction deposits.

Doug, have you been happy with that sort of progress this last quarter or just the first six months of the year?

We've been happy with the progress in the second quarter, in particular. We didn't rollout ACE for Business, the small business product, until April of this year. So we're really just getting started in terms of selling that and the sales activity is ramping up, and I think it will continue to build over the course of the year. ACE for Treasury is deployed. That's selling well. A key part of our deposit growth strategy is to deploy treasury management capabilities to the market and we think they are very competitive.

Great. And then, Pat, just a quick one for you. Is the tax rate likely to trend back up to the first quarter rate in Q3?

I think it's -- well, it was 20.5%, I think, the first quarter and 20%, the second. So I think that's a good range, the 20%.

Operator? Operator, are there any more questions? All right. Thank you very much. If there are any more questions, please feel free to call Pat Oakes or me. Thank you for dialing in.