Earnings Call Transcript - SSB Q3 2021

Operator, Operator

Hello and welcome to the SouthState Corporation Third Quarter Earnings Call. My name is Melissa, and I will be your operator. I am now pleased to hand it over to Will Matthews to begin. Will, it's yours.

Will Matthews, CEO

Good morning, and welcome to SouthState's third quarter 2021 earnings call. This is Will Matthews, and joining me on this call are Robert Hill, John Corbett, Steve Young, Doug Williams, and Pat Oakes of Atlantic Capital, who are also joining us to provide some color on their quarter. The format for this call will be that we will provide prepared remarks and we will then open it up for questions. Yesterday evening, both companies issued press releases to announce earnings for Q3 2021. We've also posted presentation slides that we will refer to on today's call on our Investor Relations website. Before we begin our remarks, I want to remind you that comments we make may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements we may make are subject to the Safe Harbor rules. Please review the forward-looking disclaimer and Safe Harbor language in the press release and presentation for more information about risks and uncertainties that may affect us. Now I will turn the call over to Robert Hill, Executive Chairman.

Robert Hill, Executive Chairman

Good morning and thank you for your interest in SouthState. We are pleased to report our performance for the third quarter. The performance was solid and the team made nice progress in each of our three areas of focus: soundness, profitability, and growth. We knew going into 2021 that this would be a year of significant change for the company, building the foundation for a larger bank which included new technology and talent. These are difficult changes and take time to adjust but this year has positioned us well for the future. As an investor, it’s hard to see the benefits in the short term of a merger of equals, but the third quarter provided a glimpse into the future opportunities for SouthState. Just as 2021 was a year of change, 2022 will be a year focused on our internal opportunities for growth, efficiency, advancing talent, technology, and building our culture, which are real and meaningful. We have a great market, a strong and growing team, and many opportunities to make our company better. We look forward to reporting to you the progress we make in these areas over the next year. I will now turn the call over to John.

John Corbett, CEO

Thank you, Robert. Good morning, everybody. Hope you and your families are doing well. Throughout the pandemic, we've talked about the population migration to the Southeast, the rapid reopening of our markets, and our growing loan pipelines. Not surprising, loan production increased significantly last spring following the vaccine rollout, and that trend continued in the third quarter. In fact, loan production of $2.6 billion in the third quarter is a record for us and is 72% higher than a year ago. Our previous guidance was for mid-single digit loan growth in the second half of this year, and we exceeded that guidance in the third quarter with 10% annualized loan growth. Most of the growth was in commercial and industrial loans, which has been the trend over the last few quarters. A portion of the commercial and industrial loan growth this quarter was associated with seasonal businesses that support hurricane cleanup efforts for large power companies, so some of this quarter's growth is seasonal and temporary. Our cash position at 14% of our balance sheet is materially higher than our peers, and we're working to deploy that excess cash as interest rates drift upwards. Securities increased by over $700 million last quarter, and loans increased by $573 million, excluding PPP. So we deployed about $1.3 billion of our surplus cash into earning assets. The growth in loans and rising rates resulted in our core net interest income growing by $5.8 million in the quarter. We were encouraged by the Fed's commentary a few weeks ago about tapering their asset purchases, and we believe that SouthState is in a unique position to benefit from rising rates over the next year. Asset quality continues to be a non-event with net charge-offs of zero basis points during the quarter. As a result, we released $38.9 million in reserves. After the reserve release, our adjusted earnings per share landed at $1.94 and our return on tangible common equity was 18.7%. Doug is here with us and will comment later in the call on another strong quarter at Atlantic Capital, they had 12% loan growth. I do want to report that we received regulatory approval for the acquisition from the OCC and we are now awaiting Federal Reserve approval. The shareholder vote is scheduled for November 16, so we're hopeful for a close in the first quarter. We originally thought there was a chance we could convert the computer systems in the first quarter, but it looks more likely in the second quarter. So that will push back the cost savings by about 90 days. We've accomplished a lot strategically in the last two years, with the merger of equals in 2020 and the opportunity with Atlantic Capital in 2021. As we look ahead, it only makes sense that 2022 will be a year that we are internally focused, rather than focused on bank mergers and acquisitions. We're focused on continuing our recruiting, our organic loan growth, refining our processes and new technology, and improving our profitability. As we saw in this quarter's results, 10% loan growth with an improvement in the expense base, and a little lift in interest rates can have a powerful compounding effect in the quarters ahead. I'll turn it over to Will now to provide further details on the quarter.

Will Matthews, CEO

Thanks, John. I'll cover some highlights on margin, non-interest income and non-interest expense as well as credit and a provision for credit losses. As shown on Slide 11, net interest income for the quarter totaled $260 million. Core net interest income excluding all accretion, including PPP accretion, improved by $5.8 million from Q2, with $2.5 million of that due to an additional day count and the remainder due to stronger net interest income per day. Our loan growth and continued improvement in deposit funding costs helped improve our core net interest income. Our net margin was 2.86% for Q3, flat with Q2. Loan yields of 4.07% were up slightly from Q2, but loan yields excluding PPP loans were down 10 basis points to 3.91%. New loan yields in Q3 were 3.18%, down 24 basis points from Q2. As a reminder, and as illustrated on Slide 16, the average 10-year Treasury yield was down 26 basis points in Q3 versus Q2. Overall cost of funds declined 4 basis points to 0.13%. Core loan growth excluding PPP loans was $571 million. Our commercial and industrial loans grew by $336 million, followed by owner-occupied commercial real estate at $93 million and construction, which includes consumer construction for mortgages at $85 million. Single-family residential excluding construction permit loans declined by $14 million in the quarter. Our commercial pipeline remained strong at $4.7 billion at quarter end. As you'll note on Slide 12, we have another good quarter of loan production. On the deposit side, our cost of total deposits declined to 0.03% to 0.09%, and total deposits grew over $318 million after a $344 million reduction in CDs. We continue to deploy some of the excess cash into both loan growth and securities with securities grown by $615 million versus Q2 balances. As you can see on Slide 17, investments moved to 15.7% of assets and our Fed funds sold balances were 13.9% of assets. We remain below peers in securities to assets and well above peers in cash to assets. So we continue to have extensive dry powder. Additionally, you'll note our asset-sensitive profile and low historical deposit beta illustrated on Slides 18 and 19. Turning to non-interest income, non-interest income of $87 million was up $8 million from Q2. It’s highlighted on Slide 13, mortgage banking income improved by $5.5 million from last quarter's $10.1 million that remains well below last year's record third quarter. Production was $1.3 billion with purchased loans representing 70% of total volume. We sold 54% of our volume in the secondary market down 3% from Q2. After last year's record margins, gain on sale margins have returned to levels more consistent with historical levels with a slight improvement from Q2. Turning to Slide 14, correspondent income was $25.2 million, down slightly from Q2's $25.9 million. Deposit fee income also increased to $2.2 billion, some of which is attributable to fee waivers last quarter associated with our core system conversion. Our non-interest expense, total non-interest expense excluding merger-related expenses was $214.7 million, down approximately $4 million from Q2 in spite of a loss on the sale of a piece of acquired other real estate due to a zoning issue and higher health insurance expenses due to claims activity. Q3 also reflects a full quarter of merit increases, which were effective July 1. Also, as John referenced, we've refined our conversion date for Atlantic Capital and it is now expected to occur in the second quarter of 2022 rather than Q1. So with respect to non-interest expense and 2022 modeling, this was slightly pushed back much of our cost realization by a few months. I will now discuss credit, with respect to CECL and the allowance improvements in economic projections impacting our loss drivers leading to another reduction in the allowance for credit losses. These improved economic forecasts caused us to record a negative provision for loan losses of $38.9 million. For this quarter's weightings of Moody's economic scenarios in our CECL modeling, we reviewed the underlying assumptions in the Moody's baseline and S3 scenarios and decided to move to a slightly more conservative weighting than Q2 with the baseline at 60% and S3 at 40% versus two-thirds, one-third last quarter. On that note, as shown on Slide 24, we had another quarter of excellent loss results with less than $50,000 in net charge-offs. This brings our five-quarter cumulative net charge-offs to 5 basis points or an average of 1 basis point per quarter. Our past dues, NPAs, criticized, and classified assets remain low. Our ending reserves excluding PPP loans are shown on Slide 29 and we are at 135 basis points or 147 basis points including the reserves for unfunded commitments, the $75 million and remaining unrecognized discount on acquired loans represent another 33 basis points. Turning to capital, with the pending Atlantic Capital merger and safe harbor limitations, our repurchase activity was more muted during the quarter after announcement with total repurchases of 485,000 shares in Q3, and an additional warrant of 20,000 shares in early October. We were out of the market until the Atlantic Capital shareholder meeting which is scheduled for November 16. Even with the increase in loan growth and repurchase activity, our capital ratios remained strong, with a leverage ratio of 8.1%, CET1 of 11.9%, and total risk-based capital at 13.7%. TBV per share ended the quarter at $43.98, up 10.4% over the last year. I'll now turn it over to Doug to give a few highlights on Atlantic Capital's quarter.

Doug Williams, Executive

Thank you, Will, and good morning. I'm pleased to have this opportunity to share Atlantic Capital's third quarter results with you. As you know, we filed our earnings release and investor presentation last night and those are available on our website. First, I'd like to thank my Atlantic Capital teammates for another great quarter. Despite the added work of merger integration planning and related distractions, they remain focused on helping our clients pursue opportunities and meet challenges. While the economic recovery slowed during the quarter due to the Delta variant surge, and there are uncertainties about the effect of fiscal and monetary policies on the course of the economy, our clients are performing well and continue to make investments for the future. Those investments are driving our new business pipelines and resulting loan growth. With strong growth in loans, deposits, and revenue, Atlantic Capital recorded another quarter of solid operating results, as we reported, Atlantic Capital earned $0.65 per diluted share for the third quarter of 2021 compared to $0.58 in the second quarter and $0.40 per diluted share in the third quarter of last year. Pre-provision net revenue was $14.7 million, a 9% annualized increase from the second quarter and an increase of 36% compared to the third quarter of 2020. Loans held for investment, excluding PPP loans grew 12% annualized from the second quarter of 2021 and 14% year-over-year, loan origination volume was strong across all our banking teams, and net loan growth was particularly strong in the commercial and industrial and commercial owner-occupied real estate categories. Since Atlantic Capital became a public company almost six years ago, these commercial loan categories have grown at a 13% compound average growth rate. Credit quality is excellent. There were no net charge-offs during the quarter. Non-performing assets as a percent of total assets was 0.10% at quarter end and criticized and classified loans decreased 34%. As you've seen, we recorded a negative provision of $2.4 million for the quarter. The allowance for credit losses, excluding PPP loans was 1.18% at quarter end. With a sharp focus on corporate treasury management business for Atlanta-based enterprises and for high-volume payments and fintech companies across the country, Atlantic Capital has built a strong core deposit franchise. Since we became a public company almost six years ago, average total deposits have grown 20% compounded annually. And average demand deposits have grown at a 30% compound average growth rate. Payments volumes, service charges, and average deposits in the payments and fintech business continued to grow in the 40% range. For the third quarter average deposits increased 13% annualized on a linked-quarter basis and grew 38% year-over-year. The average cost of deposits was eight basis points, down from 10 basis points last quarter. Non-interest bearing demand deposits averaged more than 39% of average total deposits. As we look ahead to the fourth quarter and into 2022, our new business pipelines are robust and we expect continued strong momentum in loan, deposit, and revenue growth. Pat Oakes and I will be available to answer your questions during the Q&A portion of our call this morning. Now back to John.

John Corbett, CEO

Thanks, Doug. So we're encouraged with the healthy loan growth in the quarter. Our progress on expense savings and growth in core net interest income. And with the strength of Atlantic Capital's results in a rising interest rate backdrop, we're feeling good about our momentum as we head into 2022. Operator, let's open the line for questions.

Operator, Operator

Thank you. Our first question today comes from Jennifer Demba of Truist. Jennifer, please go ahead.

Jennifer Demba, Analyst

Congratulations on a very good quarter. Do you think your pipeline and your business momentum right now could mean better than mid-single digit loan growth continuing over the near term?

John Corbett, CEO

Yes, Jennifer, there's a slide we put in the deck on page 12, which I think is very illustrative of what's going on through the pandemic and the rising loan production that we've experienced. This quarter, with loan production origination to $2.6 billion. That's up from last quarter and it's up 72% from a year ago. From a net growth standpoint, it's the highest net loan growth we've had at $573 million. If you go back 2.5 years, it's more than double the net loan growth dollars that we've experienced. Part of this is on a seasonal basis; we did some business with some clients to do hurricane cleanup for power companies, and that was a part of the growth this quarter. Our pipelines are growing into October. But at the same time, we're continuing to see sales of some operating companies and sales of some commercial real estate properties with these low cap rates. So I think our guidance, Jennifer, originally it was mid-single digit for the back half of this year. We wound up at 10% for the third quarter. As I look ahead into the fourth quarter, maybe because of some of these seasonal businesses, as well as some of these pay downs, we might be looking at low to mid-single digit growth in the fourth quarter. But I think our trajectory as we head into 2022 is going to look like mid to upper single digits, which I think is the guidance we've given previously. So I think we're on track for mid to upper single digits in 2022.

Jennifer Demba, Analyst

Okay. Can you quantify how much of that loan production in the third quarter was from that more hurricane-related lending?

John Corbett, CEO

Yes, it's about a third of the net loan growth. That's business that we have some clients that do work for large power companies in the Northeast and the Gulf Coast states that come in after the hurricane. So that business typically increases in the third quarter; it's flat in the fourth. And you see some of it come down in the first and second quarters of the following year. So it's about a third of the overall growth.

Jennifer Demba, Analyst

Okay. My last question is on asset quality. Your losses have been extraordinarily low. What's your outlook for the couple of years, do you think they can stay really low? Maybe not quite this low, but really low?

John Corbett, CEO

I think historically, if you look at the asset quality metrics of our company, which Doug has noted are at 0% charge-offs, SouthState, CenterState, all very conservative underwriters relative to peer groups and the metrics, if you go back through the cycle. Right now, Jennifer, we're sitting on a tremendous amount of cash on the sidelines, with our banks, but also with our consumer and commercial customers. So I would think that, at least in the short to intermediate time period, in the next year or so, we'll continue to see good asset quality metrics, as long as there's so much cash in our clients' balance sheets.

Operator, Operator

Thank you, Jennifer. We are now moving over to Brody Preston of Stephens. Brody, over to you.

Brody Preston, Analyst

I wanted to quickly ask about the seasonal hurricane commercial relationship. In terms of modeling, should we expect it to be similar? I believe you mentioned that it constitutes about a third of the overall growth in commercial and industrial sectors, which translates to around $110 million to $115 million. Should I anticipate that level of seasonality in the third quarter each year moving forward?

John Corbett, CEO

This is like predicting the weather. So our clients this year had client relationships where storms landed, so it might be a little bit outside this year that it would be in the future. But it's a business we like a lot. The counterparty on the other end of the repayment is these large publicly traded power companies. So this year, I think it’s a little more outsized just because of where the hurricanes landed.

Brody Preston, Analyst

Got it. Okay. Okay. Maybe it's on the mortgage, the mortgage business. Could you help? Could you tell me what the size of the servicing portfolio was at the end of the quarter? I think it was $5.8 billion on June 30. Just in terms of the size of the loan you're servicing?

Steve Young, Executive

Hi, Brody, it’s Steve. I don't have the number in front of me, but it's pretty close to that number; it might be closer to $6 billion, and we did grow it a little bit over the quarter. But yes, somewhere in that general vicinity.

Brody Preston, Analyst

Okay. Thank you. And, the last couple of quarters, you've ratcheted down the amount of production you've sold into the secondary market, from like 70% or so closer to like 55%. Just thinking about the puts and the takes between your expectations around growth on the commercial side and then the residential production, should we expect the secondary percentage to kind of remain in the 55% range going forward? Or should we expect it to move back up to the 70% range?

Steve Young, Executive

Hey, Brody, I would think it's probably somewhere in between. I think it's probably closer to 60. I think what's going to happen, if you look at the MBA forecast for next year, the refinance index is supposed to be considerably down, which doesn't bother us very much, because 70% of our business is purchase, but what that will do on our portfolio loans likely is, they'll just allow for less refinance there. And so just the natural evolution of loan growth in our own portfolio will just stick longer, because we won't have as much prepayment. But, obviously, as we think about the economics of whether to sell a loan or whether to keep it, it has to do with the gain on sale margins and what our liquidity positions are. There are several things, but I think 60% is probably a good modeling; that’s how we model it.

Brody Preston, Analyst

Okay, thank you for that. Just on the balance sheet, the securities growth, thinking about the yield that you put on this quarter, what are they? What's the effective duration of the portfolio? And what are your current plans for securities growth here in the fourth quarter?

Steve Young, Executive

Hi Brody, Steve again. We had a slide in there, I think it's page 16, which just describes sort of the growth in our securities book, and also sort of the position in our cash position. So at the end of the third quarter, we have $5.7 billion in cash and a $6.4 billion securities book. As you mentioned, it did grow $700 million, I think we mentioned on the call. Our best forecast is to grow $500 million or so, the quarter. What happened, of course, in the end of September, we saw a nice rate increase, and so took advantage of some of that toward the end of the quarter. As we think about that portfolio, and as you all model relative to us, and Atlantic Capital combined, today we're around less than 16% of investments to assets. I think for us, as we look at it as a combined company on a $45 billion balance sheet, we're somewhere between 16% and 18%. That's how I would kind of model it, so maybe 17% or so. And then, we're just going to see what the yield curve does from here. There's so much uncertainty, but I think we've gotten to a position we feel a lot more comfortable than where we were a few quarters ago when we were more like 11% or 12% of that. That's it.

Will Matthews, CEO

Brody, it’s Will. I'll just add that, that assumes that we don't have unexpected additional deposit growth. I think the industry received more liquidity coming into deposits this year than many of us expected, so it's hard to predict. But based on what we see today, that's our expectation.

Steve Young, Executive

And if you look at that, and kind of play that out to the end of next year with Atlantic Capital, and with sort of flat deposit rates and with our loan growth, the way John mentioned it, we're still going to have $4 billion of cash sitting on the balance sheet. So I think we're going to have plenty of flexibility to do whatever is necessary when the time comes.

Brody Preston, Analyst

Okay. And I just have a couple more here. On the origination side on the loans, what are new origination yields coming on at? A lot of other companies have had lamented how competitive it is. And so I just wanted to get a sense from you where that's hanging out?

Steve Young, Executive

Brody, I think Will mentioned in his remarks, I think it's 3.18%, this quarter, that was the new production. And part of this is, of course, the duration of the lending you're doing, and you're trying to be prudent there relative to swapping some larger deals. And sometimes that shows up in the yield day one and doesn't show up over a period of time, depending on what LIBOR does. So, yes, our yield was 3.18%. With the backup in rates, I'd expect particularly the five-year treasuries backed up probably 30 or 40 basis points, I would expect those new production yields would start moving back up towards 3.50%.

Brody Preston, Analyst

Got it. Okay. And then, last one, just on the provision, you all took another 20 bps or so out of the reserve ratio this quarter. Could you just refresh me real quick, I thought it was, but the day one combined was 115 percentage? And is that still a good level to think about from a normalized provisioning perspective going forward?

Will Matthews, CEO

Brody, it’s Will. It's a hard question to answer. So, I think that is a reasonable forecast, but the complexity you have with CECL being adopted when it was and then the unprecedented government reaction that has occurred, and then leading to a recession, where people didn't have credit losses is going to impact the statistical historical correlation between recessionary type economic metrics and loss drivers and resulting losses. So, it'll be an interesting issue for the whole industry to tackle when you're going to have a data set come into the historical data that's going to be abnormal at best. So yes, I think that's a reasonable way to model, but I just want to clarify that it's a tough modeling proposition based on the fact that we've been through a period with really no losses in spite of a recession.

Operator, Operator

Thank you, Brody. We're now moving on to Catherine Mealor of KBW. Catherine, please go ahead.

Catherine Mealor, Analyst

I have a question on expenses. So nice reduction in expenses this quarter just given we have the cost savings fully coming in. But we've seen from really most of your peers that have reported so far an increase in expenses just given wage inflation and mixed higher technology costs and all the things. So just do you update us on what your thoughts on expense growth from here and what do you think a kind of fair run rate is for 2022, maybe once they've got ACDI cost savings fully in there?

John Corbett, CEO

Sure, Catherine. We anticipate that for Q4, our projections remain unchanged; there are always unpredictable factors. This quarter, we experienced some fluctuations with health insurance claims since we are self-insured. However, we believe the range of $210 to $215 million we previously indicated is still accurate for the fourth quarter, similar to Q3. Looking forward, we are finalizing our budget and have communicated to the team that we expect low single-digit growth in expenses for next year. We estimate savings of about a third of Atlantic Capital's expense base, which translates to approximately $20 million annually, or $5 million per quarter. With the conversion happening late in Q2, you'll start noticing that in Q3, with more impact in Q4. That said, we are competing in the same labor market as everyone else, but we are focused on keeping our expense growth within that low single-digit range.