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Seacoast Banking Corporation of Florida (NASDAQ:SBCF)

Q3 2013 Earnings Call

October 28, 2013 10:00 am ET

Executives

Dennis Hudson – Chairman & Chief Executive Officer

Bill Hahl – Executive Vice President & Chief Financial Officer

David Houdeshell – Executive Vice President & Chief Credit Officer

Analysts

Scott Valentin – FBR Capital Markets

Robert Madsen – Stephens

Jefferson Harralson – Keefe Bruyette & Woods

[Tyler Oliver] – Raymond James

Operator

Good morning and welcome to the Seacoast Q3 2013 Conference Call. My name is Brandon and I will be the operator for today’s call. (Operator instructions.) Please note that this conference is being recorded. I will now turn it over to Mr. Dennis Hudson. Sir, you may begin.

Dennis Hudson

Thank you very much and welcome to Seacoast’s Q3 2013 Conference Call. Before we begin as always I direct your attention to the statement contained at the end of our press release regarding forward statements.

During the call we may be discussing certain issues that constitute forward-looking statements within the meaning of the SEC Act. Accordingly our comments are intended to be covered within the meaning of Section 27A of that Act. With me today is Bill Hahl, our CFO, and David Houdeshell, our Chief Credit Officer.

While we certainly achieved some critical milestones this quarter our regulatory agreements and capital restrictions were completely terminated over the summer as we had previously announced; and as indicated this morning in our release our sustained earnings improvements and our earnings outlook allowed us to bring the deferred tax asset back onto the balance sheet.

Most pleasing to me anyway, however, was our continued earnings improvement this quarter. When you exclude the one-time impact of the DTA recapture our Q3 earnings before tax increased 62% over last quarter to $4.7 million. This is the third quarter in a row with greater than 50% sequential growth in earnings. So our before-tax earnings trend has been quite positive this year with us earning $2 million in Q1, $3 million in Q2 and well over $4 million in Q3; and we expect to close out the year with continued strength.

This improvement is a result of our expense reductions, a portion of which was redeployed into new investments that are designed to grow revenue; and also it was due to reduced credit costs.

These improvements in quarterly earnings together with the DTA recapture resulted in GAAP earnings for the quarter of $45.9 million. Our tangible booked value per common share increased as a result and stood at $1.62 at September 30. Return on average assets for the quarter including a normal tax provision but excluding the impact of the DTA recapture was 0.53% on an ROA basis, and return on average equity was 6.78%.

Our asset quality continued to improve this quarter as it has done for many quarters. Nonperforming assets, which last quarter fell below 2.0% of assets were further reduced during the quarter to 1.6% of assets. We booked net recoveries during the quarter which negated the need for a provision. The allowance for loan losses actually increased to 1.64% of loans from 1.59% last quarter. Coverage ratios have clearly increased substantially and we believe our asset quality today is, simply stated, now satisfactory.

Looking ahead we see an improving local economy. We see population growth returning to Florida and most importantly we now see construction activities starting to increase all over our markets – all of which suggests to me that the state is now moving through an important inflection point, an improving economy. I believe now is a critical time for Seacoast to push forward faster with our revenue and our growth initiatives, again to drive better results, and we’ve been challenging our team to do just that.

Earlier this year we rolled out an innovative business banking platform in three metro Florida markets. Accelerate Business is an integrated business banking solution built around strong and experienced commercial lending teams called Accelerators, and local professionals that we call Achievement Advisors who have been operating in markets together for many, many years. Accelerate Business is fueled by Seacoast to help move small- and medium-sized businesses forward further and move them faster.

We’ve integrated our comprehensive suite of internet banking services with our new business mobile platforms and have added deposit capture across all of our digital channels to bring branch services right into the office of every one of our business clients. The bank comes to you, not the other way around, and when we’re asked where our nearest branch is we tell them “It’s right here in your office.”

We added a couple of slides towards the end of our deck that was posted for this call that provide a little more color on this latest growth initiative and invite you to take a look. So far the results that have been produced have been quite impressive. Since rollout we have more than doubled our pace of business loan production and our new core business deposits. We expect this project will help us drive better performance going forward into 2014 and we expect it to drive revenue growth at a higher pace in ’14 than we’ve achieved in 2013. And I want us to find more ways to redeploy our legacy expense structure into further expansion of both this platform and other digital innovation projects our teams are working on.

With that I would like to turn the call over to Bill for a few more comments on the quarter. Bill?

Bill Hahl

Thanks, Denny, and good morning everyone. My remarks will reference the slide deck we posted for this call on our website, and I will begin on Slide 3. And then Denny and I will take your questions.

As Denny mentioned we did reverse the deferred tax valuation allowance which increased net income for the quarter by $41.2 million. Without the reversal it was still a much improved quarter without any negative surprises with net income before tax of $4.7 million, linked quarter up $1.7 million and up $4.0 million compared to the prior year. Pre-tax income for the first nine months excluding the DTA reversal was $9.7 million, up $10.6 million from last year’s net loss of $950,000. Net income available to common shareholders year-to-date was $48.1 million or $0.51 per diluted common share compared to a net loss of $0.04 last year.

Total revenue excluding security gains for Q3 were $22.9 million and were up $1.3 million compared to a year ago. On a linked quarter basis revenues were up approximately $500,000, reflecting the seasonally slower Q3 and the impact of higher interest rates which lowered residential loan demand and fees from mortgage banking. Year-to-date our tactics designed to build noninterest income had positive impacts with fees higher by 15.9% year-over-year.

Total revenues year-to-date grew year-over-year by $2.9 million or 4.5% with mortgage banking up 28.5%, service charges up 8.0%, interchange fees up 19.9%. Slide 6 has some additional highlights about noninterest income growth for the quarter.

Total assets increased year-over-year by $67 million funded by core customer funds with solid growth in non-interest bearing transaction accounts which were up 10.7% year-over-year and now comprise about 27.0% of total deposits. Likewise, total transaction accounts were up 7.7% year-over-year and they now comprise 53.0% of total deposits.

Loan production year-to-date has increased nearly 30% compared to 2012 and total $430 million, and is the result of our investments in additional loan production personnel over the last 12 to 15 months. We look forward to taking advantage of all the opportunities ahead of us and to positively leverage the strong core franchise that we’ve built.

Our focus has been on expanding our products and services through our already stellar deposit franchise and enhancing customer experience by providing convenient access to their accounts through digital technology. Nearly 40% of online customers have already adopted our mobile products, and the annual growth rate for the mobile product adoption in the current quarter was over 92%. We have more to come as we increase our services per household and our revenues from our core deposit accounts. If you take a look at Slide 10 you can see some of the things that we are doing to grow the franchise and the results we are producing.

Now I’ll turn to Slide 4 for a few comments about cost reductions of noninterest expenses compared to a year ago. Over the last year, quarterly expenses have been managed lower as a result of cyclical credit costs declining and our branch consolidations, as well as other cost cutting initiatives. In order to improve the margins and continue to grow loans we have invested a significant portion of the expense reductions into additional business bankers and credit support personnel, and more recently in enhancing the customer experience with additional ways our customers can access their accounts through our digital channel.

This quarter expenses are lower by $1.8 million or 9% compared to a year ago, and are down $6.3 million year-to-date. This, together with revenue improvements, is reducing efficiency ratio indicating operating leverage is improving. We want to continue to grow revenues at a faster pace and to look for ways to redeploy and reduce our legacy costs as we better align our delivery channels with evolving customer needs. The goal is to continue to improve operating leverage while improving our overall top line growth rates.

Loan production over the last twelve months totaled $573 million and is up 120% compared to a year ago. Net loans were up 5.2% year-over-year. The improvement in loan growth is the result of continued growth across most of our portfolios, including much better growth this year coming from commercial and business lending. We predicted on last quarter’s call that our commercial volume would be a little softer due to the summer season and the higher interest rate environment, and it was. However we are seeing stronger pipelines and expect higher production through the rest of the year.

Now some color on the net interest margin: after declining seven basis points in Q1 and three basis points in Q2, the margin increased 13 basis points this quarter. Several factors contributed to this improvement. The loan portfolio positively impacted by lower nonaccruals and higher average balances. Additionally the margin was positive impacted by ten basis points from the recovery of interest income on a loan that had been on nonaccrual. So net of this recovery the margin improved three basis points.

Prepay speeds declined and yields increased by six basis points in the securities portfolio in response to the increase in yield curve. Our continued progress in improving core customer funding and the improved deposit mix reduced both non-interest bearing and sweep repo costs by one basis point. These results all contributed to the increase in the margin for the quarter.

Growing our net interest income remains our focus and we believe we can continue to generate growth even in this low rate environment. The primary opportunities for growth in net interest margin remain an improved earning asset mix in favor of loans and further growth in core customer funding. With that I’ll turn the call back to Denny.

Dennis Hudson

Thank you. You know, something Bill said earlier in his comments I think bears repeating. He said our goal is to continue to improve operating leverage while also improving our overall top line growth rates.

I said earlier that I felt the Florida economy is at an important inflection point and I’m convinced this is going to drive more opportunities for growth here at Seacoast. But I also believe we’re well into a critical inflection point of our own here at Seacoast. All of us are challenging each other to find innovative ways to grow our revenues faster and to fund innovation required with the redeployment of our heavy legacy costs, even as we continue to bring down our overall expense structure.

And we must bring down legacy costs by discovering ways to better align and integrate our delivery channels with customer preferences that are now starting to rapidly change. This is not a process that is going to occur overnight but it must occur over a more compressed timeframe than most community banks believe. And it’ll result I think in greater convenience and an improved experience for our customers.

What I’ve just said is going to drive a lot of innovation over the next couple of years and it’s going to separate the winners from the losers in the marketplace. For me it’s been an invigorating challenge and I’m going to have fun reporting back to you our progress as we continue to discover new opportunities for growth.

With that I’d like to open it up for a few questions.

Question-and-Answer Session

Operator

Thank you, and we will now begin the question-and-answer session. (Operator instructions.) And from FBR Capital Markets we have Scott Valentin online. Please go ahead.

Scott Valentin – FBR Capital Markets

Good morning and thanks for taking my question. Just with regard, you mentioned regulatory agreements have been lifted, the DTA valuation allowance I guess has been recovered. Can you address maybe the TARP repayment or any selling of some preferreds outstanding, just wondering as we approach the reset date in early ’14 if you have any plans?

Dennis Hudson

Yeah, we haven’t announced any plans. That’s obviously something we continue to focus on and explore all of our options, and when we have something to say we will. I would say that we have many options, we’re considering all of them, we’ll take a look at it – anywhere from funding it internally to other capital transactions. So we’ll look at everything and wel’l let you know when we have something to say.

Scott Valentin – FBR Capital Markets

Okay, thanks. And then just a follow-up: loan origination volume was pretty strong but the overall loan growth was less than we expected. Is that just a function of high payoffs during the quarter I assume?

Dennis Hudson

Yeah, we actually did have some fairly unusual and high payoffs this quarter and it included some larger troubled debt restructures which of course were accruing and so forth. So we continue to work through those. I would say our outlook, Bill, is probably for fewer payoffs as we look ahead – we’re kind of running out of large credits to get refi’d and paid off. And David’s shaking his head as well, so probably continued decent volume will result in a little better loan growth as we look forward, that’s our plan.

Scott Valentin – FBR Capital Markets

Okay, thanks. I’ll get back in the queue, thank you.

Operator

From Stephens we have Robert Madsen online. Please go ahead.

Robert Madsen – Stephens

Yeah, good morning gentlemen. I was just curious how many new lenders did you hire during the quarter and kind of how does that shake out year-to-date? And then what is your expectation for the size of books that these lenders should have and kind of the timeline for them to get to a full book?

Dennis Hudson

In the press release we disclosed quite a bit of information about the incremental costs associated with those hires. There’s a table in the back of the release, in the body of the release that describes the investment. And today we’re carrying… One way we look at it is we expect in 90 days we should see a pipeline growing after a new hire; and at the six-month mark we expect to see production actually hitting the books. And so we kind of firmly believe the first six months are really an investment period, and we’re carrying about $0.5 million a quarter of incremental expense which is a pretty significant number on an $18.0 million core overall expense structure. We’re carrying $0.5 million a quarter, maybe $2.0 million a year of incremental expense related to people who have been here six months or less.

We don’t have, and I don’t think we’ve published the number in terms of what we’ve hired this quarter but in aggregate from, if you go back to the middle of ’12 when we started some of this hiring we’ve probably hired 30 plus guys I would say.

Robert Madsen – Stephens

Okay. So then just moving on to the expense side, you’ve targeted it looks like $7.4 million of expense reductions for the year and then you’re adding these lenders, you’re getting increased loan growth. So can you talk a little bit about your goals for the efficiency ratio and where you can see that going over the next year or so?

Dennis Hudson

Yeah, we haven’t said anything about the next year but clearly we need to get our overall efficiency ratio in much better shape. It’s begun to move a little better in the last couple of quarters as you can see but we are targeting that down in the mid-60s over the next couple of years. And it’s going to come through a combination of all the things we talked about during the call: revenue growth as well as redeployment, as well as just wringing costs out.

One big factor to that over time clearly is adjusting our distribution costs. So we have a lot of plans in and around that. We’re not pleased with where our efficiency ratio is today. We want to get it down but we also want to take advantage of what we see as a pretty significant turn in the economy here, so we want to be investing and driving revenue growth in this period. That’s the most important thing for us to be doing but all the while finding ways to rationalize our expense structure. And we think in a couple of years it could be in a much better position but it’ll take a little bit of time, but we’re making good progress every quarter.

Robert Madsen – Stephens

Okay, thank you.

Operator

We have Jefferson Harralson online. Please go ahead.

Jefferson Harralson – Keefe Bruyette & Woods

Hi, thanks. I want to ask my first question on the business model change that you were talking about – the Accelerators and your Achievement Advisors. Can you just talk about what you’re doing there and how would you characterize that relative to the former model, and kind of why you went to it and what you expect to get out of the change?

Dennis Hudson

We did a lot of work contacting some of our existing business clients and kind of shadowed them in terms of what they do every day with respect to their need for financial services and banking services, and it really kind of, Jefferson, answers the question – as more and more of our transactions get ported over to digital channels, particularly in the business area we think there’s a great opportunity to do a much better job serving our business clients. And we think the way we serve those business clients is take the bank into their office.

And it kind of answers the question for us, as a community bank, how do we grow our exposure in particularly more metro markets where we’re currently operating in Orlando and South Florida? How do we grow our franchise and our customer base there without a huge branch infrastructure? And couldn’t that actually be a competitive advantage for us to approach it that way? And this project, which we developed about a year ago was something that we felt answered that question and most importantly met customer needs.

With continuing growth in remote deposit capture now rolling out in all of our digital products, deposit capture – we just don’t see the need for the branch particularly when it comes to the business customer. We also focused our selling effort and our marketing into businesses that can connect with this technology more easily, and I think that’s a key focus for us in that business line.

So and yet it also comes with a guy that you know as a business owner, and he is your guy and he takes care of everything you need because he’s backed by a good-sized community organization with all of the products and services that you need. But he brings them into your office. So these guys are less about big office buildings; they’re more about being in our customers’ offices.

Jefferson Harralson – Keefe Bruyette & Woods

Alright, awesome, thank you. I want to follow up with just a modeling question: can I get the bank level leverage ratio and the holding company cash for the model?

Dennis Hudson

We’ll get back to you on those ratios. They’re stronger than the consolidated ratios a little bit so we’ll get back with you on that.

Jefferson Harralson – Keefe Bruyette & Woods

Alright, thank you.

Operator

From Raymond James we have [Tyler Oliver] online. Please go ahead.

[Tyler Oliver] – Raymond James

Hey guys, how’s it going? Just looking at loan growth during the quarter, I know you said there were some large payoffs but where are you seeing the most strengths by market?

Dennis Hudson

I would say the South Florida market. Wouldn’t you agree, David?

David Houdeshell

Yes, I certainly would.

Dennis Hudson

Yeah, the South Florida market is extremely busy today. We’re doing quite a bit in Broward County which would be Boca south. Palm Beach County is doing much better and our Treasure Coast region is doing well. I mean we’re really seeing strengthening occurring all over but clearly a lot of opportunities in South Florida. The Orlando market has also improved quite a bit for us and we’re seeing sort of continued growth in that market. So it’s kind of all over but I would say it’s particularly strong the farther south we go. Miami was very quick to come back and that’s spreading up the East Coast, and we’re feeling that big time I would say up here in Palm Beach County and north finally, which is great.

One thing I mentioned on the call was the return of construction. That’s a key industry in the state of Florida and it was a pummeled industry during the downturn, and you know, you saw a lot of construction cranes in Miami early on as things turned but we’re now seeing lots of houses and construction starting to occur in Orlando and even in the Treasure Coast area where we have a big concentration. And that’s really beginning to drive I think employment numbers in the right direction, and it’ll be interesting to see as we hit the end of the year what kind of impact that has. But a lot of houses, a lot of construction; things are starting to turn in a more remarkable way.

[Tyler Oliver] – Raymond James

Okay, great. And just along with the growth have you started to see the big box competitors come back in those markets or is it still mostly community banks?

Dennis Hudson

Well, I would say many of the community banks were wiped out and many of the competitors that we had prior to the crisis no longer exist. And frankly we find in most of our markets that it’s us competing with the mega banks. The mega banks have become more competitive in the last year as they have struggled I think to maintain some of their lending balances and struggled with the same things all of us are in this low rate environment. So we find it’s become a more stark, bifurcated market that actually is an advantage for us. So that’s one reason we’re so excited about some of the new projects we have to grow revenues – we think we look very different compared to the mega banks and there are very few community banks out there today that are able to compete.

[Tyler Oliver] – Raymond James

Okay, great. Guys, thank you very much.

Operator

And from FBR Capital Markets we have Scott Valentin back online. Please go ahead.

Scott Valentin – FBR Capital Markets

Thanks for taking the follow-up question. With regards to margin, you pointed out of the 13 basis points 10 basis points was recovery of accrued interest, but yet you had about three basis points of core expansion. Is it fair to assume kind of going forward we can get a couple of basis points every quarter due to mix shift?

Dennis Hudson

Generally I would say yes. However, we are going, Bill, into Q4 which we tend to see the balance sheet grow there.

Bill Hahl

Right.

Dennis Hudson

And we’re going to probably have too much liquidity as we go into Q4 which could limit the margin in Q4. So if you go back and kind of… Well, you really can’t because for the last several years we really haven’t had a normal seasonal growth, but we’re looking to try to preserve that I would say in Q4 and then it starts growing as we kind of get beyond the seasonal growth impact that happens in the winter to us.

Scott Valentin – FBR Capital Markets

Okay. And just a follow-up… Oh, sorry.

Dennis Hudson

Just to be clear we are seeing margin expansion out over the next few quarters but there may be some short-term mitigation due to the seasonal impacts. But it is going to yield higher net interest income.

Scott Valentin – FBR Capital Markets

Okay, just a follow-up on the deferred tax asset valuation allowance – is there anything left or did you fully recover the valuation allowance?

Dennis Hudson

Yeah, we fully recovered it.

Scott Valentin – FBR Capital Markets

Fully recovered it, okay. And then the effective tax rate going forward you expect?

Dennis Hudson

38%.

Scott Valentin – FBR Capital Markets

38%, okay. Thank you.

Operator

(Operator instructions.) From Stephens we have Robert Madsen back online. Please go ahead.

Robert Madsen – Stephens

With the improvement in your credit quality and the removal of the regulatory orders when do you think you could start seeing an improvement in the FDIC assessment expense?

Bill Hahl

Those two aren’t really tied for community banks at all; it’s just a straight calculation so there won’t be any improvement in the FDIC expense. We had all the improvement a year ago I think when we switched over. Does that answer your question?

Robert Madsen – Stephens

Yeah, thank you.

Bill Hahl

Thank you.

Operator

And we have Jefferson Harralson back online. Please go ahead.

Jefferson Harralson – Keefe Bruyette & Woods

Hi, a quick one on the regulatory capital. I guess how much of the DTA has come back into regulatory capital and how much still will come in over time?

Bill Hahl

Yeah, Jefferson, nothing really additional. We’ve been recognizing in the past from some tax planning strategies and so we were including some of the deferred tax asset in regulatory capital. So there really won’t be a big change to our regulatory capital ratios as a result of the recovery.

Dennis Hudson

But as you know, as earnings improve and our sort of forward view of earnings improves it will gradually increase more of that deferred asset that can be pulled into regulatory capital. You know, there’s severe limitations on it but you can look at the next year’s earnings estimates and come up with a conservative number you can throw into regulatory capital. And up until recently that obviously has not been as significant as it will be going forward so Bill’s right – we really don’t look for any immediate change of any significance, but over time, and I’m talking over the next year that will gradually increase.

Jefferson Harralson – Keefe Bruyette & Woods

Okay, and how much is left to come through – in the $40 million’s?

Bill Hahl

How much that’s excluded? About $50 million is excluded.

Jefferson Harralson – Keefe Bruyette & Woods

Alright, thank you.

Operator

(Operator instructions.) Okay, it looks like no further questions at the moment. Mr. Hudson, I’ll turn it back to you for any closing remarks.

Dennis Hudson

Thank you very much. We appreciate your attendance today and look forward to next quarter’s results. Thank you.

Operator

And this concludes today’s conference. Thank you for joining; you may now disconnect.

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