South State Corporation (SSB) CEO Robert Hill On Q1 2016 Results - Earnings Call Transcript

| About: South State (SSB)

South State Corporation. (NASDAQ:SSB)

Q1 2016 Results Earnings Conference Call

April 21, 2016, 10:00 AM ET

Executives

Jim Mabry - EVP -IR

Robert Hill - CEO

John Pollok - CFO and COO

Analysts

Christopher Marinac - FIG Partners

Jefferson Harralson - KBW

Jennifer Demba - SunTrust

Stephen Scouten - Sandler O'Neill

Tyler Stafford - Stephens

Nancy Bush - NAB Research

Operator

Good morning and welcome to the South State Corporation Quarterly Earnings Conference Call. Today’s call is being recorded and all participants will be in listen-only mode for the first part of the call. Later, we will open the line for questions with the research analyst community.

I will now turn the call over to Jim Mabry, South State Corporation’s Executive Vice President, in charge of Investor Relations and M&A.

Jim Mabry

Thank you for calling in today to the South State Corporation earnings conference call. Before beginning, I want to remind listeners that the discussion contains forward-looking statements regarding our financial condition and results. Please refer to Slide number two for cautions regarding forward-looking statements and discussion regarding the use of non-GAAP measures.

I would now like to introduce Robert Hill, our Chief Executive Officer, who will begin the call.

Robert Hill

Good morning. I’ll begin the call today with the few summary comments about our start to 2016, and then John Pollok, our Chief Financial Officer and Chief Operating Officer, will provide some details on our operating performance. I will then close with the few summary comments prior to concluding the call with the Q&A session with the research analyst community.

We're very pleased with the performance of our team and with our results during the first quarter of 2016. Operating earnings totaled $25 million or a $1.04 per diluted share. This represents an operating return on average assets, intangible equity of 1.18% and 15.36% respectively.

The performance this quarter reflects the significant steps forward our Company has made the last few years. We continue to focus on ensuring a strong and efficient operating platform, a culture that is consistent through the bank in generating organic growth.

I'm very pleased that our culture continues to attract great bankers and our team is having success in building excellent banking relationships. We are seeing success in each line of business and market we operate in.

Our culture and business model are significant differentiators for us, and we see excellent opportunities for continued growth. We achieve strong net loan growth this quarter of $160 million or 10.7% annualized.

The growth came from many of our markets, most notably in Savannah, Charlotte Greenville and Columbia. I was especially pleased to see the success we're having in building C&I relationships which had significant growth this quarter.

Our core funding increased by $120 million or 8% annualized with non-interest bearing checking account balances increasing by $45 million to over $2 billion. A year ago, we announced the Bank of America branch acquisition that closed in the third quarter of 2015.

We're very pleased with our results to-date, particularly with the engagement of these new employees and the new business opportunities that these teams are generating. This quarter we also continue to experience asset quality improvements which further declines in NPAs and non-acquired net charge-offs of only 9 basis points.

During the quarter the tangible book value increased by $1 to $28.88, an annualized increase of over 14%, and the Board of Directors has declared a quarterly cash dividend of $0.30 per share which represents a $0.02 increase from the previous quarter and a 25% increase from a year ago.

I will now turn the call to John Pollok for more detail on our financial performance this quarter.

John Pollok

Thank you, Robert. On slide number six we show you the increase of net interest income from $81.4 million linked quarter to $81.6 million. This increase is primarily the result of strong growth in the non-acquired loans this quarter making up for the decline in the higher yielding acquired loan portfolio balance.

This resulted in a small increase in interest income. When coupled with decrease in interest expense, net interest income increased to $170,000. Net interest margin increased 5 basis points linked quarter from 4.32% to 4.37%.

The non-acquired and acquired portfolios both had small increases in yield, but the aggregate yield decline by 8 basis points due to the change in the loan portfolio mix. In the fourth quarter, the higher yielding acquired portfolio represented roughly 31% of the loan portfolio compared to 29% in the first quarter.

This change was more than offset by positive change in mix resulting from deploying some excess liquidity into securities and loans. The end result is a 5 basis point increase in the yield on earning assets.

You can see the changes in the average balances on slide number seven. Average short-term earnings assets are down over $200 million, while average securities and loans are up $78 million and $162 million respectively.

On the funding side, our cost of interest bearing liabilities decreased by 1 basis point to 16 basis points bringing our total cost of funds to 12 basis points. Our balance sheet is predominantly core funded, which continues to be a great source of strength to our company.

At quarter end, non-interest bearing checking accounts and transaction accounts makeup over 81% of our funding. Switching to the non-interest income side, our totals were flat on a linked quarter basis after excluding the OTTI charge in the fourth quarter and the gain on sale of securities this quarter.

Fees on deposits decreased $950,000 mostly result of seasonally lower NSF fees. Offsetting this decrease was an increase in mortgage banking income of $1 million and $140,000 increase in trust and investment services income.

Amortization of the FDIC Indemnification Asset was $1.5 million. The commercial loss share agreement from the Habersham acquisition expired on March 31, and we continue to have discussions with the FDIC regarding early termination on all of the remaining agreements.

Our entire experience with the FDIC since the start of the loss share agreements has been very positive and we anticipate final settlement of these agreements in the second quarter. First quarter EPS would have been approximately $0.05 higher assuming we had no amortization of the Indemnification Asset and assuming we retain all the recoveries received on the covered assets.

Turing to the expense side, non-interest expenses excluding one-time items were up $800,000 linked quarter in total $71 million. This increase is primarily related to a seasonally increase in payroll taxes this quarter.

As previously announced, we are still on track for future cost saves from the 11 branch consolidations, eight of which are plan for the second quarter with the remaining occurring in the third and fourth quarters. On slide number you can see our operating efficiency ratio increase slightly from the fourth quarter due primarily to the increase in overhead expenses.

Finally on slide number nine, you can see this significant progress we have made over the years in operating EPS. The first quarter of 2016 is only a $0.01 shy of the annual results in 2011.

I will now turn the call over to Robert for some summary comments.

Robert Hill

Thank you, John. This is a solid start to 2016. We have a very strong balance sheet, significant liquidity, a strong culture and dedicated teams and excellent markets, clearly a formula to continue to build shareholder value.

The company is operating as well today as it has in the years. But there are still many ways we can improve. We look forward to providing updates in the coming quarters on our progress.

That concludes our prepared remarks. And so I would ask the operator to open the call for questions.

Question-and-Answer Session

Operator

We will not open the lines for questions. [Operator Instructions] Our first question is from Christopher Marinac with FIG Partners.

Christopher Marinac

Thanks. Good morning. John and Robert, I was curious if you could talk to us about the provision expense, and should we see this be repeated or is it just going to be depended on loan growth?

John Pollok

Chris, this is John. I think when you look at our legacy provision, I think you'll see more dollars go in the provision, I think their percentage probably could come down some. If you look at our charge-off rates, our last four quarter charge-off rate was 11 basis points. The last eight quarters was 12 and the last 12 quarters was about 18 basis points in charge-off. So, I think you'll see some growth in dollars, but you could see that percentage come down some.

Christopher Marinac

Okay, great. And then, I was just curious I guess your observations on your markets and how they have been acting. And so bank has any acceleration trend or perhaps any changes you've noticed this last 90 days?

Robert Hill

Chris, this is Robert. I would say that overall really the markets that we operate in continue - we continue to see improvement. I think that's obviously reflected in our loan growth this quarter. First quarter is normally a seasonally low quarter for us or low quarter for us from a growth perspective, but our pipeline was really strong and all of our growth was really all cores, no new lines of business, no shared national credits. It's all really coming from the geographies that we operate in today.

I think some of that is our position in the market, but I think lot of it is we just happened to be in great markets. And you saw that particularly Georgia performed really well on the first quarter, Savannah in particular, we saw and continue to see a very strong in Charlotte, the Greenville market, the Charleston market, the Columbia market are all really doing quite well.

Christopher Marinac

Great. And I guess last question, some of big pictures, just the pricing trends. Robert, would you say anything less competitive or any easier on the pricing front?

Robert Hill

I would say, it's pretty consistent, I mean, it's always competitive, right. I think one of the - we're continuing to see our overall loan yields kind of remained in the high threes where they've kind of been for quite a while. You see in some kind of stretch on maybe longer terms. But overall ours seem to still be very much in the box from a pricing perspective. I don't see too much kind of out of the norm in that regards.

I think the other indicator that we see in terms of just overall economic health of our markets, this quarter Chris, was really the core deposit number. We tend to look at the loan growth number, but I think core deposits tells a lot about what's going on in the local economies and core deposits of 8% specially in the first quarter which normally is not that strong a deposit growth quarter that made us feel really good and the pipeline is strong. So, we continue to see steady improvement I would say in really all the markets we operated.

John Pollok

Chris, I would add if you look at the loan growth side and you go back to the first quarter of last year and the year before, those are two years we shrunk loans. So, economically, we are really seeing some nice balanced loan growth in our markets.

Christopher Marinac

Sounds great, guys. Thank you for the feedback.

Robert Hill

Thanks, Chris.

Operator

The next question is from Jefferson Harralson at KBW.

Jefferson Harralson

Great. I was going to ask you about the FDIC receivable and the indemnification possibly going away and just the match and $0.05 so. The asset stands at $2 million. You had an amortization of $1.5 million, maybe one more quarter of that in anyway. So it seems like you are really closed to having that amortized all the way down. On the other side of it, you had $0.04 in the receivable cost and then I guess I’m backing into $0.01 of recovery. There is lots of numbers there but going forward if you were to buy it out, the main stream that we would get is the recoveries. So can you just help me -- am I thinking about that correctly or can you think about help me one could imagine what happens if we buy it out?

Robert Hill

Sure. Jefferson. We think the tangible book value you earn back is clearly lessening you. One of the things that’s a little bit different about what you said about the negative amortization is we have a true-up on the other side, so the negative amortization would not go away in a quarter. It would continue to trail down. So if you look next quarter, our prediction was it would probably be in the $1.3 million range but it would continue to trend down and so we have a true-up on the receivable too because we just did that around the losses. So, you got that component and then we obviously don’t have to share 80% of the recoveries back with the FDIC.

So, our view is this year we’d have probably about a $0.05 a quarter impact through the remaining of the year and then next year it would probably be in that $0.03 to $0.04 a quarter for what we would see next year. The only caveat to that is we could do a lot better on the recoveries and as the economy gets better we just continue to do extremely well on the recovery side.

Jefferson Harralson

Okay. Lastly, I will ask you about the -- any expense efforts that maybe underway. I’m pretty sure it’s an ongoing thing but you do have acquired loan book that is shrinking down and some headwind there. Are you thinking about offsets on the expense side from here?

Robert Hill

We are. I think a couple things on the headwind. One thing we’ve been real clear about is we needed to get north of 10% loan growth to kind of outrun the accruable yield. You can kind of check that box this quarter. As we mentioned a minute ago, we have typically shrunken the first quarter. So, we are very excited about where our loan growth is and our pipelines are very strong.

On the expense side as we announced last quarter, we’ve got some branch consolidations we are doing so we are going to close eight branches in the second quarter. And our FTEs are down 19 linked quarters and most of that FTE reductions came late in the quarter. So, as you know, Jefferson, we continue to work at expenses. We know that’s something we’ve got to continue to do. So, we feel really good about the momentum we have both on the expense side and the loan growth side.

Jefferson Harralson

All right. Great. Thanks guys.

Operator

The next question is from Jennifer Demba at SunTrust.

Jennifer Demba

Thank you. Good morning. M&A, just wondering about any change in strategy at this point, what you are seeing in your pipeline and how you feel about your capacity to purchase other banks right now?

Robert Hill

Hey, Jennifer. Thanks for the question. This is Robert. I’d say that how I feel about the company overall from a growth perspective is better than I have in a long, long time. And when I say better, I think it’s just overall better position for growth. And what I mean by that is the support infrastructure in the company just much stronger than we have been in a long time. Our preparation, we worked very closely with our regulatory bodies in terms of preparation for the $10 billion hurdle, feel really good about where we are on the $10 billion front, our balance sheet, the capital build that we have and our liquidity. It’s just really -- we really are poised for some good things ahead.

Now, our main focus was organic growth. We wanted to make sure after a period of high growth that we really had the organic machine going and I think you can see. You’ve seen steady progress over the last few quarters. But I think first quarter you certainly saw, I think a full effort of where we are having success companywide from a lending perspective and organic growth perspective. So that kind of checks a very important box for us. So, we are wide open to looking at the right next acquisition but the key is going to be finding the right partner. But we are ready for that when the right partner comes along.

Jennifer Demba

Thank you very much.

Operator

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

Stephen Scouten

Hey guys. Good morning.

Robert Hill

Good morning, Stephen.

Stephen Scouten

Wanted to ask you kind of what your thoughts are on the pass for NII from here and kind of along with that what you experienced from an accretion standpoint in the quarter and any kind of movement, kind of non-accretable or accretable, if there was any big things of note there that’s helping them?

John Pollok

No big things of note on the accretable side. We had, as we always do a few one-time events that happened that have kept that acquired loan yield a little over eight. But I think as you know, Stephen, when you are remixing out of assets that you are yielding 8% on and you are putting them in assets that you are yielding 4%. There is really going to be some compression there but we still are sitting on a tremendous amount of cash as you know, you can see that in the margin table.

So, as we deploy that cash that’s clearly going to help but the overall NIM margin number, there is going to be some pressure as we said all along from a rate standpoint just because of the remixing of the acquired loans into the non-acquired. But what we are excited about is look at the net interest income line and then think about the negative amortization going away and as you know, I’ve always theoretically tried to take that negative amortization and make it as part of the margin and we have that slide out there for you. So, overall, we feel really good about our net interest income dollars growing.

Stephen Scouten

Okay. Great. So, you feel like you can grow that with the positive organic loan growth even in spite of some additional compression?

John Pollok

Assuming, we can stay at that 10%, north of 10% loan growth that’s kind of what we’ve directed over the last year, I think that would feel like we did accomplish that.

Stephen Scouten

Okay. Great. And just to clarify some on the IA amortization, the FDIC termination and so forth. Were you saying, when you were saying that the IA amortization would trail down to 1.3, were you just saying that ex the termination or were you saying that even with the termination that would still trail off, not just go away completely?

John Pollok

Talking about ex the termination, which is kind of standalone, I was trying to get Jefferson back to the answer to his question because I think he felt like all the negative amortization be gone, which you can go in our disclosures and look, all banks are going to have some type of -- most all banks would have some type of true-up and so that’s a liability you would have to pay out in the future so you would have to continue to fund that up.

Stephen Scouten

Yes. No, definitely. Okay. Just want to make sure I heard that right. Okay. And then you mentioned kind of some strong C&I traction in the quarter. I’m curious what do you think is kind of leading that? Is that just an internal push or new lenders in the C&I space, or what do you think has really helped you guys grow that book disproportionately maybe?

Robert Hill

Stephen, this is Robert. I would say that we had a strong C&I quarter. We’ve had a pretty good C&I year last year. It’s really the position of where we are in the market now. A lot of these customers, obviously bank with larger companies and we didn’t have to really position the brand, the share historically. Today, we have really strong share, really strong brand and really good market and we are certainly perceived today in the market as the alternative bank to the large banks and there is really not another alternative. So, we are just -- we are kind of uniquely positioned I think with our size and with our brand and that is -- and obviously the quality of our bankers we continue to hire great bankers. We have tremendous bankers in the field but I think where the bank is positioned competitively has certainly been a huge part of opportunities that we are having to move some really good companies into our company.

Stephen Scouten

Okay. Super. And maybe one last one for me here. Any near-term kind of structural risks to service charges that you guys see? I know the CFPB at one point, so they were going to put out some guidance this year. Now it sounds like it is maybe next year. Who knows the space that would do anything but is there anything that you see there that you are concerned about from the scale of that opportunity for you guys moving forward?

John Pollok

Well, Chris, I think it’s just going to evolve over time. It’s not all regulatory. The consumer is becoming more mobile, right, just doing a lot more things with their phone. I think you’ve just got to continue to adjust with the environment. Clearly, if you look first quarter of this year compared to first quarter of last year, the BoA acquisition, one of the reasons why we are so focused on core deposits. Look at the fee income increase year-over-year, very, very strong. But I think you’ve just got to continue to adjust as you move forward and I’m not so hung up on the regulatory side. But I think it’s more how do you present your core products to the consumer and be high touch but also be high tech and that’s something we are extremely focused on today.

Robert Hill

And Stephen, this is Robert. I would just add. I think one of the unique parts of our company compared to many is our just strong retail presence. I mean, we have close to 700,000 customers. We have a very strong card base in that customer base. So there are lot of opportunities as maybe one form of revenue flattens or declines to cross sell other forms of revenue because we have such a large customer base.

Stephen Scouten

And that’s a great point. Appreciate the color, guys.

Operator

The next question is from Tyler Stafford at Stephens.

Tyler Stafford

Hey. Good morning, guys.

John Pollok

Good morning, Tyler.

Tyler Stafford

Hey. Congrats on a good quarter. I just had one more follow-up that I may have missed it in the opening remarks. I apologize if I did. Just a question on mortgage banking. Looks like some better than expected at least for me mortgage activities this quarter, can you talk about just what you saw in that business, what production was margins, et cetera? Just any data on that you could provide would be helpful? Thanks.

John Pollok

Stephen -- or Tyler, this is John. I think that the first thing I would start with is our pipeline continues to build. You saw now the 30-year fixed rate is down in the 3.5% range. So, we just see the pipeline continuing to build from a -- if you look at from a margin standpoint on what we sell on the secondary market, not including the servicing income that we are going to get over the life of the loan, we are in that 2.5% to 3% range. So, yields remain extremely robust. I would say on the in-house portfolio side, one of the things we are excited about is if you look and Robert talked earlier about loan balance is now consumer real estate makes up a little under 38% of our loan portfolio.

We’ve mentioned in the past when that was up at 40%, we wanted to remix that and so we feel good about the balance that we have there. And then the last piece I would kind of mention is on the construction side, we’ve just seen a lot of good construction business. We have a very strong construction team and this is for primary and secondary residences and so that looks to be very, very favorable. But the pipeline, it continues to build and typically the first quarter has historically been a little soft.

Robert Hill

Tyler, this is Robert. Just a couple of comments I would add is one, there are obviously a lot of regulatory changes on the mortgage front over the last year. I think we were able to execute on those regulatory changes really well and I think that that has really helped our position in the market. We’ve continued to add some really talented mortgage bankers in the markets where we are and now this is just South Carolina but we are number two in mortgage market share in the state. And so, I think it’s just kind of the velocity of our mortgage engine continues to be very strong.

Tyler Stafford

That’s helpful color, guys. Thank you.

Operator

[Operator Instructions] Our next question is from Nancy Bush at NAB Research.

Nancy Bush

Good morning, guys.

John Pollok

How are you, Nancy?

Nancy Bush

Good. A couple of questions on the liquidity side. First, could you just update us on the retention in the Bank of America branches and just give us your thoughts about if you had opportunity - if you have an opportunity to do a similar deal in the future, any different ways that you would handle it?

John Pollok

Nancy, the retention has been very good. I think as we mentioned last quarter, we're getting ready to go in Phase 2 of Bank of America transaction, so we're consolidating six offices, some of them were there, some of ours historically, so we're excited about being able to begin to get a little bit cost saves out of it, but we feel very good about that.

The thing that was so unique for us on the Bank of America transaction, it was the only way that we could kind of fill out the center of the state of South Carolina. It’s a very, very unique transaction for us. So, I'm not sure there's another one like that, but for us it was just the only way we could kind of figure out that we could really get the center part of our franchise build out.

We're starting to see loan growth in those branches. As you know, we didn't really get many loans that came over and now our teams are really beginning to hit their stride on the loan growth side. So, overall been an extremely positive experience.

Robert Hill

Nancy, Robert. I'd just add a couple of things. First is when we underwrote the purchase of those branches we really didn't - we did not taken any cost saves. So this is all - none of that was really in their original underwriting of the purchase of those branches. And then we're also starting to add really good banks. Bank of America obviously has a huge branch network, but not necessary a leader in each of the markets that they serve and we've been able to add some good talents in these additional market - this new markets to us.

Nancy Bush

On the whole question of liquidity, deposits in liquidity, I mean you're still in an extraordinarily liquid position and you said you'd be sort of deploying that over -- continuing to deploy that over time. Any thoughts about when you'll be sort of what would consider quite normal liquidity for the company?

Robert Hill

Great question. If you could tell me what the Fed is going to do with the 10-year, I could probably could do better with that answer. I think that rates have just been whip solely [ph] back and forth especially if you file the 10-year. It is nice to see that it's almost back to 190. Hard to believe I'm saying that. But hopefully we can do a little bit more in the investment portfolio, but I think at the end of the day, the main reason we wanted that extra liquidity was to be able to fund our loan growth. So, over time I'm not sure exactly how long it takes but we're just going to continue to chip away at the loan growth side with that excess.

Nancy Bush

And just finally, if I may ask sort of future strategic question, you can't turnaround these days so that reading something, hearing something about Semtech and how banks are joining with online lenders, blah, blah, blah. Can you just give us your thoughts about that? And what kind of strategic planning you're doing for additional technologies and just how you think about the whole subject?

Robert Hill

Sure. Nancy, this is Robert. We see it is probably one of the most exciting opportunities ahead for our company. There's a tremendous opportunity to engage with your customer differently and more proactively, and we're very excited about it. Today about 75% of our customers interact with us electronically on a regular basis, so it’s a normal part of our business environment today.

And the other unique part is the fastest growing component of our customer base for the millennials who are obviously the biggest users of that technology. So, we have seen both it in terms of mobility online lending. We've seen a lot of ways to interact ATMs and deploying a lot of technology to better serve our customers, which will drive, with as bigger retail bankers we have. There is a great opportunity for continued efficiency there, because we're certainly seeing lower branch transactions that we have -- than we have historically.

And then on the lending front, this is not a customer interfacing technology, but it's certainly financial technology. Is in the first quarter we implemented a new consumer leading platform, it’s totally automated. It is significantly more efficient for both the customer and our bankers and our support folks in terms of handling consumer loan volume. So, we're looking at certainly internally, but great opportunity for us and it's been I'd say very successful at this stage.

John Pollok

Nancy, I would add, we also rolled out on online mortgage application last quarter that is customer interfacing, that is a huge step for us. As you know TRID has slowed down. How long it takes to get a mortgage approved. We see this front-end online mortgage application getting our speed back to where we use to be to be able to close a loan, very, very important especially for us in the mortgage business.

And with the Bank of America transaction, we have deployed a lot of ATM technology where we can take deposits at the ATM machine and we're really seeing the mobile part of our customer business grow tremendously.

Nancy Bush

So, just let me make sure I understand, given your what I would call innate conservatism, what you're saying to me is that your efforts online lending et cetera are going to be generally home grown rather than going out and partnering with somebody?

John Pollok

Yes. We'll build our own. I think the reason is scale. To invest, I mean it's not cheap to invest in those things, so you have to have some critical mass and you have to have a large customer base. So, you take card for example, I mean, we are a very large card issuer of Visa, and so we've got a lot of critical mass. We've got 700,000 customers. Our transaction volume is high. So we've got the scale and the density which is critical and now yes, we build our internal products and not kind of co-source to somebody else to drop that volume.

Nancy Bush

All right. Thank you.

Operator

Our next question is from Christopher Marinac at FIG Partners.

Christopher Marinac

Thanks. I had a follow-up just on the BoA branches too, and I was just curious if you look at the fee evolution of those new accounts, would you still be in a early inning there John or Robert or would you have implemented most of what you want to do there?

Robert Hill

I would say that we've implemented most of what we've wanted to do there. There is still room not just for the BoA branches, but in our kind of our legacy franchise, but Chris, if you like from a conversion of their accounts over into our structure that we're kind of through that.

Christopher Marinac

Okay, great. Thanks very much.

Operator

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

John Pollok

Thanks everyone for your time today. We will be participating in the SunTrust Conference in New York beginning on May the 24th, and the KBW Conference in Kiawah, South Carolina beginning on June the 22nd. We look forward to reporting to you again soon.

Operator

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

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