SouthState Corporation
Q2 2015 Earnings Call Transcript

Published: 25 Jul 2015

[Operator:]

Good morning and welcome to the South State Corporation Quarterly Earnings Conference Call. [Operator Instructions] I will now turn the call over to Donna Pullen, South State Corporations' Senior Vice President.

[Donna Pullen:]

Thank you for calling in today to the South State Corporation earnings conference call. Before we begin, I want to remind our listeners that our discussion contains some forward-looking statements regarding both our financial condition and financial results. We have included slides for this call that outline our results and our general comments this morning. Let me first refer you to Slide number 2 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 our call.

[Robert Hill:]

Good morning. I'll begin our call today with a few summary comments about our start of 2015 and then John Pollok, our Chief Financial Officer and Chief Operating Officer, will provide some detail on our operating performance. We will then provide a brief update on our branch initiatives prior to concluding the call with a Q&A session with the research analyst community. As we began 2015, we set two primary objectives for the company. First, improve our processes, operating leverage and efficiency levels, and second, ensure that we have the right structure, accountability and focus to drive organic growth. We have made good progress through the second quarter in each area. You can see these results in our net loan growth, improved efficiency levels and in operating leverage, strong core deposit and loan growth and continued performance improvement in our mortgage and wealth management areas. The impact of this focus is a year-over-year increase in net income of 39% and a year-over-year increase in operating income totaling 19%. And from a linked quarter perspective, operating earnings improved by 10% to a record $26.3 million. This represents $1.09 per diluted share compared to $0.99 last quarter. Our second quarter was highlighted by an increase in total revenues of $4.8 million from the first quarter consisting of an increase in net interest income and growth in every non-interest income category. We are also beginning to gain efficiencies through some of our process improvement initiatives which helped contribute to a reduction in total operating expenses of $1.2 million from the linked quarter. These improvements in revenue and lower expenses had a positive impact on our operating leverage and produced strong performance ratios. Our operating return on average assets totaled 1.32% and our operating return on tangible equity totaled 16.9%. Our operating efficiency ratio improved from 65% to 61.2% this quarter. Asset quality which has always been a hallmark strength of our company continued to be strong with net charge-offs of 12 basis points and a very low level of non-performing loans. We are particularly pleased with the loan growth that we experienced this quarter, our non-acquired loan growth of $202 million and net loan growth of $84 million, represents net loan growth rate of 6% annualized. Our organic growth is the result of several factors. First, the markets in which we operate are experiencing very good improvement in their local economies. Second, we are continuing to have the opportunity to add excellent bankers to our team and we continue to experience much success against the larger banks. And third, our size, our brand and our enhanced product set really differentiate us in the market. This is allowing us to compete more successfully and in a broader range than we have in the past. And finally, after a period of steady M&A growth, we have been able to ensure that we have the right accountability and structure to grow organically. We also typically perform our best when each area of the company performs well, as we did this quarter. North Carolina, South Carolina and Georgia, all experienced strong organic growth and we experienced good diversity in our loan growth by loan type. Our C&I growth of $34 million and our commercial under occupied growth of $32 million were two of our stronger areas of loan growth. And while we experienced good loan growth in most of our markets, the Charleston market certainly stood as a major contributor, especially so soon after our recent integration. And the Georgia market was also a major contributor to our loan growth this quarter. So bank-wide, every line of business performed well this quarter. We experienced record mortgage banking income of $7.1 million which is a 51% improvement on a year-over-year basis. We also have solid results from our wealth management area with income totaling $5.1 million and assets under care and management totaling $4 billion and quarter-end. Retail banking also produced very strong results, opening approximately 13,000 new transaction accounts, a 58% increase from the second quarter of 2014. I will now turn the call over to John Pollok to give you some more detail on our financial performance this quarter.

[John Pollok:]

Thank you, Robert. On Slide no. 6 you can see that our net interest margin of 4.75% is relatively flat when compared to the past several quarters and is identical to the margin a year ago. From a linked quarter perspective, we declined 3 basis points as slightly lower yields on earning assets were almost fully offset by a decline in our cost of funds. The gold color bars on this slide represent the net interest margin adjusted for the effect of the amortization of the FDIC indemnification asset. This blended margin increased 5 basis points as the amortization expense declined linked-quarter from $3.2 million to $2 million. This amortization expense which is reflected in non-interest income, is lower due to the expiration of the CBT commercial loss share agreement. We should continue to see the blue and gold bars pull closer together as the negative impact of the amortization lessens going forward. On Slide no. 7, you can see our efficiency ratio has declined from around 72% a year ago to 63% this quarter. Our operating efficiency ratio which excludes onetime items, totaled 61% for the quarter, down from 65% linked-quarter. All components of the efficiency ratio improved with the biggest impact coming from higher non-interest income. Absent onetime items, non-interest expenses were down $1.2 million with significant decreases in salary and benefits expense as well as OREO expense. Our branch consolidation efforts which began in mid-May, have helped reduce expenses as we have completed eight of the 14 planned. The remaining branch closures and sales will be completed in the second half of 2015. Deposit run off has been modest in these markets. As recently announced, we have received regulatory approvals to proceed with the purchase of the 13 Bank of America branches and currently anticipate closing on August 21. We continue to expect this transaction to be immediately accretive to operating earnings per share and mid-single digit accretive in 2016. I will now turn the call over to Robert for some summary comments.

[Robert Hill:]

Thank you, John. On Slide 8 you can see the strong improvements in operating earnings in the past several years and the nice pace we are on so far in 2015. As a result of this performance, the board of directors has declared a quarterly cash dividend of $0.25 per share, which is a $0.01 increase from last quarter and a 19% increase from a year ago. In closing, we are pleased with our progress year-to-date and we look forward to executing well on the branch acquisitions in the third quarter. While good progress has been made, we continue to see many opportunities for further improvements. Organic growth and continued efficiency improvements will remain our focus as we continue our progress towards our long-term performance goals. That concludes our prepared remarks and so I would ask the operator to open the call for question.

[Operator:]

[Operator Instructions] Our first question is from Jennifer Demba with Suntrust Robinson Humphrey.

[Jennifer Demba:]

Question on the BAC branches. One of your counterparts I guess had a little bit more deposit attrition when they bought some BAC branches recently. Just can you refresh us on your assumptions there in terms of deposit and attrition type assumptions you have there or any revenue assumptions you have there?

[John Pollok:]

Sure Jennifer. This is John. As we announced at the time of last quarter, it was $580 million in deposits and we said they will be about 15% in runoffs. That’s kind of what we said. We kind of looked at their expenses. We looked at the revenue. We kind of said next year would be kind of mid-single digit accretive. Where we are right now, we are about within 30 days of closing. So our merger booklets have gone out. We are in the process of training to see how we do against the 15%. It's still a little early to tell but that’s kind of what we have put out there in terms of what we think the run off would be.

[Jennifer Demba:]

Okay. And in terms of the branch closures in the second half. Do you think this is a good expense run rate going forward or do you think you've got some more leverage from a core basis to bring that down?

[John Pollok:]

Well, in terms of the branch closures, what we announced was about $4.5 million in cost saves annually and what I would report to you today is we are about, we realized about 60% of that. So if you look on a quarterly basis, that’s right at about $700,000 that we were able to recognize this quarter. What I would say in general, Jennifer, about cost saves is you know we are just continuing to work at it. There is a lot of things that we still have under review and still got a ways to go there but in terms of the branches we are about 60% of the way there on our announced cost saves.

[Jennifer Demba:]

Okay. If I could ask one more question. Just curious, if you look at your Charleston loans now, loans outstanding, how does that compare with maybe your plan when you first announced the FSCH deal?

[Robert Hill:]

Jennifer, this is Robert. I think with the magnitude of the integration and the conversion, we thought we would get to the point where we are today but we were thinking it would take more time. And so I would say with where we are today in terms of both retail growth, wealth growth, mortgage growth, commercial growth, I think we are about a year ahead of where I thought we would be. And all of those lines of business in that market are leading the company in growth. So we feel very good about the traction that we are getting in that market.

[Operator:]

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

[Stephen Scouten:]

I wanted to dig a little deeper maybe the operating efficiency ratio and kind of where you think you can drive continued leverage from here. I mean is most of that, is going to come on the revenue expansion side at this point? It sounds like, John, I appreciate the color there on the branch progress so far, but it sounds like maybe $300,000 a quarter less there. So any other costs that you think will come out or where are you envisioning that efficiency ratio heading?

[John Pollok:]

Yes. Steven, this is John. I will start and then I will throw it to Robert. I think as we mentioned in last quarter. Last October we kind of got together and began to lay out our roadmap on how we wanted to look at making sure that we operated the company efficiently. So we are still looking internally at a number of things. All of our lines of business, how we do mortgage, how we do wealth, how we deliver our products and services to the customer. So I can't give you an exact number today. I feel like as we approach the end of this quarter, we will probably have some more clarity around that. But there is clearly some things we can do on the expense side. And then obviously when you look at the revenue side in the lift that we are beginning to get, there is a tremendous amount of momentum outside. So I feel really good about both sides of the equation.

[Robert Hill:]

Steven, Robert. Not much to add on that. Obviously we feel like we, to go over the $10 billion hurdle we want to make sure that we have got our efficiencies in line to cross that threshold, that’s certainly on our mind. The initial reduction in our efficiency ratio, a lot of it is just coming from the efficiencies gained from the mergers over the last several years in getting that. But I think now we are really past that. Now I think what we will get the next few quarters is more really looking at our lines of business, making sure that we get an adequate return on capital, making sure they are operating as well as they can. Making sure that we are implementing technology. So there are more refinements to the business model. They will ultimately get us down, as we have said in the past, closer to that 60% number.

[Stephen Scouten:]

Okay. That's great color. Thanks guys. And then maybe you just touched on, Robert, that $10 billion threshold and obviously on an organic basis with the runoff asset growth isn't such that, that would be any sort of near term risk. So what are the updates or thoughts currently about putting your currency to work? Obviously, stocks had a great run. Does that make it more likely or more financially beneficial obviously for you to get some near term M&A completed?

[Robert Hill:]

It really doesn’t impact it. I mean our M&A strategy is our M&A strategy. If we find the right partner at the right time and it’s a good cultural fit and has a net positive for both companies then this is certainly something that we are going to take a hard look. But exactly where the stock is trading doesn’t make us more or less aggressive. It's more about right long-term fit for the company. We continue to have a lot of conversations in inbound calls but as you know we look at probably 12 to 15 transactions before we ever pull the trigger on anything. So I would say our primary focus is making sure that we run our company internally as strong as we can, as efficiently as we can. We have got a lot of runway left to get to $10 billion just organically with growth and that is certainly the most profitable thing and the highest return thing that we can do. And if the right acquisition comes along we will certainly, if that is additive, that we will certainly consider that as well.

[Stephen Scouten:]

Okay, great. And maybe one more. On the press release you guys mentioned a strategic increase in the investment portfolio as the percentage of assets. Could you kind of talk about the size of that plan and what you think that'll do in terms of transforming the balance sheet at all, or is that just going to be kind of small incremental growth? Thanks.

[John Pollok:]

Sure. This is John. I think when you look linked quarter, we did see some buying opportunities out there as rates went up. So you can clearly see we come up a little bit. I think the big piece of that Steven is obviously with the Bank of America transaction. We will be getting a lot of cash into the company here in late August. And so what obviously we are evaluating is how do we invest that cash short-term and make sure it comes back as our loan growth increases. And obviously there is going to be some art to that. So I think you will see our investment portfolio on the short-term maybe bump up to 14% to 15% of assets. But we are really trying to time that as our loan growth continues to pick up and have that come back. That’s kind of the view we have right now in terms of what's going to happen as we go forward. But it sure is nice to see some lift in the rates and as you know it's volatile, so we are trying to pick our spot when we want to purchase that.

[Operator:]

The next question comes from Christopher Marinac at FIG Partners.

[Christopher Marinac:]

Robert, I was wondering if you could give us a little thought about the loan pricing environment and maybe talk about how it varies by market across the footprint?

[Robert Hill:]

I would say in our metropolitan markets it's fairly consistent. In some of the rural markets it can be a little bit unique but in the markets where we getting the growth, markets like Charlotte, Greenville, Georgia has been very good. Charleston obviously, the Hilton Head market. So markets like those I would say the pricing is fairly consistent. Our new loan production this quarter compared to last quarter was a few basis point down but nothing meaningful. So we still kind of hover in that plus or minus a little bit 4% range. And we have not seen much movement there. We did see this past quarter, I think some, we saw a lot of activity in the municipality sector. So where a number of cities or towns or municipalities poured money and some of that was tax free so that had a little bit of impact on our new loan yield. And then we also had a lot of growth this quarter, Chris, in C&I, which as you know is typically more variable priced and typically a little thinner margin but typical variable. So we are competing more and larger companies in for C&I business and that is a little thinner margin business. But overall I think it's fairly consistent with what we have seen in the past.

[Christopher Marinac:]

Okay. Great. And then for either you or John, are there other opportunities for re-classes within your acquired portfolio? I mean is that still an opportunity going forward?

[John Pollok:]

Chris, this is John. I want to make sure I understand your question. You said re-classes, are you talking about credit releases?

[Christopher Marinac:]

Yes, credit releases and just re-class like you had a couple quarters ago.

[John Pollok:]

Well, I think when you look at our acquired book and obviously the big credit mark is on the acquired credit impaired book which is a little over $800 million, today we have a little over 5% credit mark on that. And so hopefully things continue to perform well. So that’s still a pretty healthy credit mark. I think one of the things that we have seen Chris and you can see it in our acquired loan yield, is it accelerates up. We have seen some compression in the cash flows. The cash flow is coming back quicker. We obviously had those credit releases out there and actually driving the yield up on those acquired loans.

[Operator:]

The next question comes from Jefferson Harralson at KBW.

[Jefferson Harralson:]

I was going to ask about the branch purchase. And could you just talk about, I think you had mentioned down in Gulf south the IRR was in the 30% range. Can you talk about the major components that go into calculating that, if I heard that right down there?

[John Pollok:]

Jeff, you broke up at the beginning. You want to talk about the Bank of America branch purchase.

[Jefferson Harralson:]

That's right. The IRR's and what the major components go into estimating those IRRs.

[John Pollok:]

I think as we said, let's go back, kind of back to the top a little bit. In terms of income, we think it's going to be kind of mid-single digit accretive next year. So you have to kind of look out there where estimates are. That’s probably in that $6.5 million range. We obviously, as I mentioned earlier, is we got roughly $500 million that was going to come over in cash. We are going to invest that short-term. So Jefferson, you could use maybe a 2% yield around that. So that’s a component of it. Obviously these offices produce a heavy amount of fee income. As we mentioned last quarter, these offices were about 45 years old, so they are real old sticky deposits. So we feel really good about the fee income piece. We have, as you know, spend a lot of time over the last year trying to build our infrastructure. So we are not really having to add a tremendous amount on the infrastructure side to add these offices. And then the last piece of that is going to be -- we are entering a lot of new markets is what type of loan growth are we going to get out of that. So those are really kind of the components that drive that to reach the mid-single digit accretive and then obviously that translates into that IRR.

[Operator:]

We do have a further question from Stephen Scouten with Sandler O'Neill.

[Stephen Scouten:]

I do want to jump in for one more if you don't mind. With your commentary on new loan yields and putting that excess cash to work, what do you think kind of the GAAP NIM. And I'm assuming maybe lower accretion at least at some point trending a little bit down over time. But the trajectory of the GAAP NIM, obviously, I think would be down. But can you frame that up at all in terms of the quantity of downside to the NIM, maybe through the end of the year and into '16?

[John Pollok:]

Steve. This is John. Obviously, it's going to begin to get a little messy when you bring that amount of cash from the BofA transaction. So as we said last quarter, we feel like that probably has a 40 basis point impact on the margin. Obviously net interest income dollars would be up. I really think the place to look when you kind of think about where we are headed is on Slide no. 6 that we have. You obviously can see our margins. You can see our margins with the effect of the indemnification asset. I view the indemnification asset as a very important part of our margin. We clearly had some lift there linked quarter. Our negative accretion went from $3.2 million to $2 million. So we still have a couple of million dollars left of that. And one of the things we added when you look at this slide. If you look at the yellow line above that, you can kind of see the lift that we are getting in net interest income, including the amortization of the indemnification asset. And then you can just kind of see the pure margin piece at the top. Obviously, with the amount of loan growth that we have had, we are really beginning to see that line drive. But to kind of go in and frame exactly where we are going to be on the margin, if we get the cash in mid-August obviously that will have some impact. The fourth quarter I think you will be able to get a much clear view of where the margin is, because as you know the rates are very volatile. If rates fall back, we might be sitting along a little bit more of that cash. If we can see some good buying opportunities then we can get that deployed out in the investment portfolio a little bit quicker. I think on the acquired yield side, as you can see is, and we had said this now for a couple of years, is the balances are going to get smaller. It's nice to see some compression in those cash flows that will help drive that yield up but you are going to see a nice yield on the acquired loans but as you know, that’s just going to get smaller and smaller over time. So I hope in terms of giving you get more clarity, it's going to take you another quarter or two. But we feel like we are in very good position in terms of our assets sensitivity and where we are headed in terms of the margin dollars overall.

[Stephen Scouten:]

Okay. That makes sense. That's helpful. But just to clarify, just in that 3Q you're saying it could be a 40 basis point drop in the NIM just from that exit?

[John Pollok:]

That’s a quarter basis, for a full quarter. So obviously we are not going to have it for a full quarter. But think about it, we are going to bring $500 million in and if we invested it at 2% in terms of NIM, obviously the NIM is going to come down but our net interest income obviously is going to be climbing at a very nice clip.

[Stephen Scouten:]

Absolutely. Perfect. It's really helpful.

[Robert Hill:]

And then the question, long-term savings, is how long does it take us to loan out that excess cash. So that’s the ultimate question.

[Operator:]

And this concludes today's question-and-answer session. I would like to turn the call back to John Pollok for closing remarks.

[John Pollok:]

Thanks everyone for your time today. We will be participating in the FIG Partners CEO Forum in Atlanta on September 28 and we look forward to reporting to again soon.

[Operator:]

The conference has now concluded. Thank you for attending. You may now disconnect.