CenterState Banks, Inc. (NASDAQ:CSFL)
Q4 2013 Earnings Call
January 22, 2014, 10:00 AM ET
Ernest Pinner - Chairman, President and Chief Executive Officer
John Corbett - Executive Vice President; President and Chief Executive Officer, CenterState Bank of Florida, N.A.
James Antal - Senior Vice President and Chief Financial Officer
Stephen Young - Senior Vice President and Treasurer; Executive Vice President and Chief Operating Officer, CenterState Bank of Florida, N.A.
Jennifer Idell - Chief Financial Officer, CenterState Bank of Florida, N.A.
Brady Gailey - KBW
Kyle Oliver - Raymond James
John Rodis - FIG Partners
Good day, ladies and gentlemen, and welcome to CenterState Bank of Florida fourth quarter earnings call for CenterState Banks. (Operator Instructions) I would now like to hand the conference over to Mr. Ernie Pinner, President of CenterState Banks. Sir, you may begin.
Thank you very much. Good morning to all. Thanks for calling in. As I welcome you, I'd advise to you, if you're aware of the package that we sent out, I'll take you on the last couple of pages as the Safe Harbor language, so be aware of that.
In the room with me today is John Corbett, who is President and CEO of the operating bank. He's also the EVP of the company. Jim Antal, who is the CFO of the company; Steve Young, who is our Corporate Treasurer of the company and the Chief Operating Officer of the bank. Today we also have with us Jennifer Idell, who is the CFO at the bank level.
As I sit here, you can have a look outside and think about the weather, it's turned as magnetic work in Florida. It's attracting people by the [ph] busloads, which is good for us. Because you can't help, but remember the fewer months, the incident, Florida's population, and that is very visible, that is looking out the U.S. [indiscernible], more importantly when you look at the data that we have seen released in the last few months.
When you go back to several years ago from 1955 to 1970, Florida grew at a rate of about 3% a year, which at times grew well over 1,000 people a day. As of October 2013, we're growing at about 1.3%, which is about 650 people a day. So we're gaining back on our growth that we've had in the years past. I don't know that we'll ever go back to what we had.
However, we are now approaching 20 million. I think I've read recently, we have now gone over a total of 20 million people in Florida, which make us the third most populous state in the union. When you think about the impact of people throughout the economy, it drives the course, the construction and building business.
Building permits in 2012 were up 32% from the preceding year. In 2013 through November we were up almost 37%. So we've had two great years of growth, but it's coming off a very little number, we still have ways to go. But without a question, we see the population impacting us by a way of building and that's good for the banking business.
When you think about beyond just new building permits, think about existing home sales, which I take a lot of comfort in. We peaked out in Florida in 2005. This year, as I think of August of this year, it's the last data we have, we are now almost 92% of the peak existing home sales.
So when I look at permits in the several of the existing homes, the construction business has started back and we're beginning to feel that throughout our entire franchise. The downside of that of course is Florida is still the highest state in the union with foreclosures. And when you look at the 10 metro areas, the 10 larger metro areas in the nation, eight of those are in Florida with regard to have foreclosure.
And we did fall off the top of list, as adding the most non-current mortgages. Mississippi has squeezed us out. They're number one, we're now number two. So Florida is doing great. We're sitting here at 42 degrees, and I'm sure some of you are worse than that.
The fourth quarter was very busy for us, but at the same time that gives me a promise, as I look out to the future, I think the next visible quarter will stay on a much more positive trend. You remember in July, we announced the acquisition of Gulfstream Business Bank in the South Florida area. It was a $550 million bank. And we indicated it would be double-digit accretive to our earnings. That closed by a way of a stock pool on January 17, they are now part of our company.
We are scheduled for February 15, to convert the entire system over. We've had five months working towards that. Everything is going smooth and we think that will happen without any glitches. And they're off to a great start with their earnings and the impact that it will have for us.
Jim will give you some more color on our earnings. It's $0.06 a share. It's well below our vision, but I think he will give you some insight on that as well as some of the accounting with regard to our FDIC loans, the SOP 03 stuff, which impacts us, but in the long run it's still a very good deal for us.
John's going to highlight with regard to some of our loans as well as then get speed on some of the things that are taking place with regard to efficiency. Steve is going to give us great insight into our interest rate sensitivity. So with that, again, welcome to the call.
And I want to turn this over to Jim Antal.
Thank you, Ernie. Good morning, everybody. As Ernie just said, we are in $0.06 a share this quarter; $0.07, excluding merger-related expenses and net income of $1.8 million. That compares to $0.10 a share or $3.1 million in the prior quarter. Why the decrease?
First, net interest income was less by $500,000 between the two quarters, and this was primarily due to less interest accretion on our FDIC covered loan portfolio. Our average balances are decreasing, obviously, there is a decay rate. And the average yield decreased to about 13% this quarter from about 14% in the prior quarter.
Now, you may recall, over the previous several quarters, we experienced several cases, when we received the payment or a transfer of OREO in an amount greater than the carrying balance of a particular pool in the portfolio. And all of that amount in excess of that particular pool balance is required to be recognized as interest income immediately.
This occurred in the third quarter resulting in the 14% yield. Without that event, the third quarter yield would have been around 13%, similar to the current quarter yield, when no similar event occurred. Just so in terms of guidance, we expect the yield of no less than 13% on this covered portfolio next quarter.
The second item, loan loss provision. The provision expense was $1.5 million higher this quarter. In the third quarter we recorded a negative provision of $1.3 million and during the current quarter we recorded a net provision of approximately $200,000. That's the difference. That equates to $1.5 million swing.
Our SFAS 5 factor continues to decrease from 1.57% last quarter to the current quarter at 1.47%. The percentage drop this quarter was less than the drop between the second quarter and the third quarter and also we had some increase in specific reserve this quarter. So even though we continue to release reserve, the income statement effect was a little less this quarter than it was in the last quarter.
Well, a $500,000 decrease in our net interest income before the provision, plus an increase of $1.5 million loan loss provision, that equates to $2 million decrease in our net interest income after a loan loss provision. This is almost exactly what the decrease is in our pre-tax income between the two sequential quarters. Now, there is some noise beneath this topline, but for the most part those variances are offsetting to each other.
Couple of comments on our indemnification asset. The expected losses in our covered loan portfolio continue to improve. I was not surprised there. It seems like I report this almost every quarter. Because of that, we continue to expect less reimbursements for these losses from the FDIC, losses we no longer expect to occur. So we have, as we have done in the past quarters, increased our IA amortization expense.
At December 31, our indemnification asset was $73.4 million. Of that amount, we expect to receive $39.5 million from the FDIC to reimbursements of expected future losses. And the remaining $33.9 million, almost $34 million, we no longer expect to recover from the FDIC, because we expect to receive or have received that amount plus 20% from the borrower or through the sale of OREO. So this additional amount, this $33.9 million, will be amortized as expense over the shorter of the life of the related loan pool or the remaining term of the loss share agreement.
You'll notice in the schedule in our 8-K earnings release that most of this amortization expense is expected to occur within the next 18 months to two years. Briefly, as Ernie just said, Gulfstream was closed as of last Friday, the 17. And as Ernie also alluded to, the total merger-related expenses are estimated to be around $2.8 million.
Some of these charges were expensed in 2013. We expect a charge in the first quarter for the remaining acquisition-related expenses related to Gulfstream of about $2.3 million. Also we gave some earning guidance in our release as well related to Gulfstream. We believe that Gulfstream could add approximately $4.7 million after-tax to our 2014 consolidated net income. And this is just to be clear, this is after merger-related expenses.
And so at this time, John's going to describe some of our announced efficiency and enhanced profitability initiatives and phasing of our expected $6 million annual increase reduction. So thank you for your time.
And I'll turn it over to John at this time.
Good morning, everybody. We've repeatedly mentioned that our operating goal as a company is to achieve 1% return on assets and 65% efficiency. So the two headwinds to us getting there are: number one; some of this FDIC accounting that Jim mentioned and it effects the timing of when we receive revenues and the timing of when we have to write-off that IA, all of which is a positive development in the long-run, but can be a negative headwind in the short run. The second headwind that we've got in our operating results is our bond sales department in our correspondent banking area, because of the spike in long-term interest rates this last summer.
Outside of those two issues, I characterize 2013 as a year that we're very pleased with the progress that our teams made in the three areas that we've been particularly focused on. The first is organic loan growth. After several years in the southeast, the loan portfolio is declining. CenterState enjoyed 9% organic loan growth for 2013, and that's how we finished the year as well in the fourth quarter at about 9% organic loan growth. Total loan production for the year was $360 million that's the most we've ever had as an organization.
The second area that we've been focused on outside of loan growth is M&A, and Ernie touched on Gulfstream. We feel very good about the integration process, since we began working with Gulfstream a year ago. It's gone very smooth. The team is onboard. The team is committed. And they're very focused on continuing to grow loans and their profitability as they become a partner with us at CenterState.
The third area besides organic loan growth and M&A that we have been focused on is expense reduction, and we communicated that to you in the last couple of quarters in the calls that we've had. Earlier last summer we hired a consultant from FIS. We've been comparing our efficiency with the cornerstone report that compares our ratios with $1 billion to $10 billion banks by each and every position in the bank. And this morning we're ready to discuss our plans in more detail.
As Jim mentioned, the bottomline upfront is that we will look to achieve a $6 million decrease in our non-interest expense and that will be phased in and it will be fully achieved by the second quarter of 2015.
We've had nine acquisitions through the credit cycle and most of the efficiency efforts have been as we've onboarded these banks, and a lot of the expense cuts have been with the targets. In 2013, we really concentrated more on our own business model, as we're much bigger bank than we use to be, and making sure that we can get the efficiencies out of sized organization we are.
On January 10, we announced our plans internally with our employee base to reduce our operating expenses by $6 million. It equates to about $0.09 a share, including the Gulfstream pro forma shares. There will be a first quarter charge associated with this efficiency initiative, up $2.8 million in the first quarter.
Jim just mentioned to you that we're going to take a $2.3 million charge relative to merger expenses for Gulfstream in the first quarter. They're collectively between the efficiency initiative one-time charge and the Gulfstream merger-related one-time charge that will total $5.1 million of one-time expenses in the first quarter of this year.
The biggest area of savings, one single area, was branch rationalization. And we just studied the business model in the zero interest rate environment that we've been in. And we mentioned to you in the past, we've studied the bottom 20% of branches in our organization. And the ultimate decision was to consolidate seven branches plus one standalone drive-thru. So it represents about 13% of our branch network that we're going to be consolidating. Overall, it's 13% of the branch network, it's really only 5% of our core non-time deposits.
These are our smallest offices, and what we really study, making these decisions, is which offices had the fewest number of customers or checking account customers, which ones had the lowest service charge income and which ones were in markets where we were not achieving loan production and didn't think that we would be able achieve high levels of loan production in the next few years.
In addition to the branch consolidation, we did evaluate our commercial lending team and we have eliminated some of the less productive positions, but also restructured our credit administration approval process to streamline and speed-up the approval process, improve the quality control of our underwriting. And we've also raised the limit of the dollars that our portfolio management group is going to review on an annual basis, but still we're going to be able penetrate most of our commercial loans annually to these service.
Really, all areas of the bank were analyzed. We did make cuts in the correspondent area. We made some changes in our wealth management area, our IP area. And then long-term we're going to make some changes in our communication expenses, when the contracts come up. And finally healthcare cost, we did eliminate our PPO plan and we revised our high deductible health insurance plan that they were sharing more of the insurance healthcare burden with our employees.
Since the reduction in forces already occurred and the branch closures have already been announced, we feel comfortable giving you some forward guidance of these expenses in the quarter that they're going to occurs. So Jim has a table in there that shows you each quarter and you'll see there is a cumulative row their in that, and that eventually adds up to $1.5 million per quarter, which in essence equates to the $6 million of annual run rate savings.
With that, let me stop and turn it over to Steve, and let him talk about correspondent remark.
Thank you, John. Good morning, everyone. I just want to report quickly out on correspondent banking segment results, also just a real quick update on non-interest income initiatives and just some ALCO management strategy.
So first of all with correspondent banking segment. Revenue increased approximately $250,000 from the third quarter and recorded $4 million of non-interest income compared to $3.8 million in quarter three. Most of that is attributable to higher fixed income revenue of $200,000. In addition to that, we had some reoccurring fee revenue, which is our payments business, which grew about a $100,000.
However, the net loss for the quarter, we still had a net loss of $0.01 fully allocated in the slight profit, if you exclude the corporate overhead allocation. So there was in the numbers this quarter a one-time product development cost of a $170,000 that will not be a run rate item. So you might see that the expense base changed a little bit, and that's because of some of the new products that we're putting out.
If you think about the forecast that we gave last quarter, I think it kind of came in based on where the 10-year treasury was on the fixed income. It's primarily driven, the 10-year treasury continues to rise during the quarter from the lows at 2.50 at end of the year at 3.03, and the average 10-year treasury yield was 2.73 for the quarter. So still a little bit volatile in the fourth quarter, but I do think we are starting to gain some traction in getting that range figured out.
So from a forecast, as I think as long as the 10-year continues to trade in this range from 2.75 to 3. We continue to expect revenue to uptick slightly from what we thought in the quarter four, as we have more of a trading range. If rates moved down in the 2.50 range, we would expect to see better results compared to maybe quarter two of this year. And likewise, if rates go to 3 in the quarter, which there is clearly some noise out there, that potentially it could, we would expect some more revenue in this quarter.
So I guess the bottomline is as we're continuing to find stability for the community banks bond portfolios, we continue to see reoccurring fee income increased quarter-to-quarter, and so based on those factors, and on some of the items John just talked about from restructuring items that we did in correspondent, we think that we'll firmly get back to profitability in that group in 2014.
Moving on to non-interest income, just wanted to highlight because there is a lot of noise continuing to have some good non-interest income growth. This quarter it increased about $250,000 or $1 million annualized. If you look at the improvement from fourth quarter '12, our non-interest income is up about $1.1 million a quarter, if you exclude some of the volatile items like IA amortization and fixed income sales. So there has been some real improvement down in the branch network. A lot of that's related to the service charges and another things that will continue to pass.
Our last item is ALCO management strategy. As we mentioned, and you can look in the release, we started putting cash to work in our securities portfolio. You can notice that our average yield on our securities portfolio this quarter was 2.94 versus 2.62 in the third quarter, so a nice increase on that side. And that's kind of what we need in order to get a better long-term curve there in order to continue to increase revenue. Our cost of deposits was 24 basis points and continues to decline slightly each quarter.
We continue to be mindful of how we're putting assets on the books and at what duration we are right now. Our entire balance sheet, the asset duration is three-and-a-half years. And so we like that position will continue to monitor and shorten up as we continue to think that there is a potential Fed rate hike at the end of somewhere in the middle of '15 to the end of '15. So we're trying to prepare our balance sheet for that and I think we're making some good headway.
So with that I will turn the call back over to Ernie.
Thank you, Steve, and thank you John and Jim for your comments. I think John said it very well, I mean 2013 was a good year and we have a lot of enthusiasm, as we speak events of 2014. So at this point, we would be glad to respond to any questions or listen to any comments.
(Operator Instructions) Your first question comes from Brady Gailey from KBW.
Brady Gailey - KBW
Sorry, if I missed this, I had to hop on a little way, but did you talk at all about the uptick in the non-performing loans? It's kind of first time we saw NPL go up a little bit. So I was just wondering if there was a story behind that.
It's a great question, and I'll let John respond to that because we thought that might come up.
Brady, that kind of surprised us too. So when we think about asset quality for the quarter it was kind of mixed. It was really just a few larger relationship in non-accrual. This is the time of year when we do our servicing, when we late file our tax return extensions then we can do the complete cash flows, so most of the few big loans that came in are continuing to pay. We just couldn't document cash flows, so we had to put them on non-accrual. One of them that did stop paying, we've looked and we're at the 45% loan-to-value, so we don't to see any economic loss in the one that stop paying.
I think there was one loan, where we had to put a $400,000 reserve on the one that became non-accrual. So this kind of thing would have really concerned us two or three years ago. It's a little bit of a surprise that it happened here. But when I talked to the credit folks, they are not particularly concerned about the loss content in that inflow. The positive news, Brady, I don't know if you saw it or not was that our net charge offs for the quarter I think were the lowest we've been since prior to the cycle. Its 12 basis points annualized, less than $400,000, I think.
Brady Gailey - KBW
And then maybe a question for, Jim. If you look at the covered loans and the indemnification asset combined that have been yielding around up almost 6% during the first three quarters of the year, and that dropped to round about 4.2% in the fourth quarter. So I was just wondering, when you look at the FDIC revenue, I know it can be volatile, but when you combine it and look at what those assets are yielding together, where do you think that will shake out in 2014? Is it 5%? Is it higher than that or lower than that?
Brady, as you know, as you just said, it was 4.2% in this current quarter. For the year it was about 5.2%. And if you look back over the last eight or 12 quarters, you can see that there is a lot of volatility in it. And I would expect future volatility in it as well. But if I had to guess, I mean it's going to range between 4% and 5% next year.
Our next question comes from the Kyle Oliver from Raymond James.
Kyle Oliver - Raymond James
Just looking at the consolidation, does this include Gulfstream for the seven branches when you look at their footprint?
Kyle, on Gulfstream they only had four locations and none of those were nearing our locations and none of those are being consolidated. So that doesn't play into the branch closure effort. That was all internal.
Kyle Oliver - Raymond James
And then looking at loan growth, geographically where are you guys seeing the most strength this quarter?
I mean historically our headquarters' is right here in the Lakeland, Winter Haven, MSA, right between Orlando and Tampa and the biggest production area that we've got is right in our own backyard in the Lakeland, Winter Haven area. Next to that, I'd say, Osceola County, up near Orlando is a big loan producer. And then we are seeing some good production, maybe down in the Vero Beach area, it's probably the next area.
Kyle Oliver - Raymond James
And then just one more. Looking at M&A for this year, how are you guys thinking about that with Gulfstream just being closed and how are the discussions going to appear?
We feel real confident on Gulfstream. It was a great acquisition and support very smooth at this point. And we think the conversion together in the middle of February will go smoothly. So at that point, we would be ready to get back into the market and to try to find another partner. We continue to have conversations with people and acquisitions and consolidations is a line of business for us, it has been now from four or five years, and it will continue to be that for the foreseeable future.
And our next question comes from John Rodis from FIG Partners.
John Rodis - FIG Partners
Jim, maybe a technical question for you and I apologize if you already said it or if I missed this in the press release. But the added yield accretion this quarter from the covered loans, I didn't see that in the press release, I guess last quarter it was about $697,000?
That's right, John. In the past number of quarters, we've been getting those for a lack of a better churn accelerated accretions, but we've been doing our very best. We try to anticipate as well as we can and should try to level that out. So in the last quarter it was 14% yield, actually I think it was 14.15%, but if you exclude those accelerated accretion numbers, it brought us down to about 13%. This quarter we didn't have any of those events. And so when you take that event out last quarter, the yields between the two quarters were approximately the same.
John Rodis - FIG Partners
So said another way, the core margin was basically 4.65%, which was the reported margin?
John Rodis - FIG Partners
As it relates to your cost savings plan, the branch rationalization, you're looking for approximately $6 million in savings. To the extent you want to comment, is this sort of the first round? Should we expect more of this later in 2014 or sort of how are you guys looking at that?
So I'm thinking of little bit bigger picture. If you go backwards and you go back to 2012, we had around, I guess you'd say where we consolidated and closed the number of the branches we have bought through acquisitions, and we converted a lot of the backroom systems. There was a lot of expense save initiatives in 2012. We were kind of in analytical mode in 2013, and now we're going to act on the analysis we found here.
But I think that we try to do this as a one-time announcement for a while. I don't think it's a healthy thing in an organization to have these kind of announcements every 90 days. So we're thinking a little bit longer-term about this announcement that we're going to get these saves implemented and then we'll continue, and then now that we've got our team focused on these peer analysis by position, we'll continue to peak efficiencies, now that we've got a little bit better measurement metrics as we go rather than doing it in big announcements.
John Rodis - FIG Partners
Just one other question, I guess follow-up on the growth in the core loan portfolio, the non-covered loan portfolio this year. I'm sorry this quarter. Looks like you saw about $15 million to $20 million winter quarter increase in C&I loans. Can you maybe just talk about that a little bit, was the growth fairly granular or were there a couple of bigger credits in there?
There was one or two larger credits that we had worked on there. One of them was a $10 million CD loan and the other one we made was another institutional credit that we made that was larger. So it was a couple of larger credits.
John Rodis - FIG Partners
And if you guys already comment on this, I apologize. But sort of mid-to-high single-digits sort of non-covered loan growth in 2014?
I think that's a reasonable expectation and that would be an internal goal as well.
And we have a follow-up question from Mr. Brady Gailey from KBW.
Brady Gailey - KBW
So the $4.7 million of net income that's suppose to be added to your earning as a result to the Gulfstream acquisition, that is after including the merger expenses. So if you look at the accretion excluding the merger expenses that's closer to $6.2 million or around $0.16 to $0.17 per share of accretion. Again x the merger charges, that's just a little higher than the accretion that I was forecasting, which was closer to kind of $0.10 to $0.11 a share. I just wanted to make sure I was thinking about that right?
You're thinking about it correctly. The $4.7 million is after merger expenses. So the $6 million, in change, its $6.2 million range that's x the merger expenses is what we expect to add incrementally.
Brady Gailey - KBW
And has anything changed since announcement as far as your thoughts on how accretive this deal has been or have they been pretty constant?
They've been pretty constant. We looked at what they earned in the fourth quarter and for the year in 2013 and compared it to our models, and they've been pretty consistent. And so we feel pretty confident about that guidance.
I am showing no one else in queue at this time. I would like to hand the conference over to Mr. Pinner for any closing remarks.
Thank you, Steve. Again, thank you for your attention and time. And feel free to call us individually, if we could ever respond to any questions. And have a great day. And we'll see you next quarter. Good day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect and have a wonderful day.
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