Earnings Call Transcript - SSB Q1 2024

Operator, Operator

Ladies and gentlemen, thank you for being here. My name is Abby, and I will be your conference operator today. I would like to welcome everyone to the SouthState Corporation First Quarter 2024 Earnings Conference Call. I will now turn the conference over to Mr. Will Matthews. You may begin.

William Matthews, President

Good morning, and welcome to SouthState's First Quarter 2024 Earnings Call. This is Will Matthews, and I'm here with John Corbett, Steve Young, and Jeremy Lucas. As always, John and I will make some brief remarks and then move into questions. We understand you can all read our earnings release and the investor presentation, copies of which are on our Investor Relations website. We thus won't regurgitate all of the information, but rather, we'll try to point out a few key highlights and items of interest before moving on to Q&A. Before we begin our remarks, I want to remind you that comments we make may include forward-looking statements within the meaning of the Federal Securities Laws and Regulations. 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 our forward-looking statements and risks and uncertainties which may affect us. Now I'll turn the call over to John Corbett, our CEO.

John Corbett, CEO

Thank you, Will. Good morning, everybody. Thanks for joining us. As you've seen in our earnings release, SouthState delivered a solid and steady quarter that was consistent with our guidance. At a high level, it was another quarter of positive but modest growth for both loans and deposits. Asset quality continues to be good with past dues, non-accruals, and charge-offs all declining in the quarter. Net interest margin dipped to the low end of our guidance but should be at or near bottom. And capital ratios are on the higher end of our peer group and have grown every quarter over the last year. Like every other banker and investor, we're trying to understand the broader macro picture, the risk of recession, and what the yield curve is going to look like. At the same time, we believe the dynamics will be different in every region of the country. As we study our bank in our markets, commercial loan pipelines took a sharp drop of about 25% following the banking turmoil last spring, and they stayed low through the summer and early fall. But by November, pipeline started growing again, and the last few months have now returned to the same level they were before the banking turmoil, and the momentum seems to be building, which is encouraging. But with rates where they are, CRE activity, not surprisingly, is much slower. So nearly all the pipeline growth and momentum has been in the C&I portfolio. In fact, as it relates to commercial real estate, our concentration ratios for both CRE and construction are at the lowest levels they've been in three years. Dan Bockhorst and our credit team are doing a great job servicing and analyzing our loan portfolio. And while rising interest rates are putting pressure on debt service coverage ratios, the South is disproportionately benefiting from net migration, and we clearly see that in the rental rate trends on all types of commercial real estate. In the last three years, rental rates in our markets have increased 16% for office compared to 3% outside our markets. Rental rates are up 21% in multifamily versus 14% outside our markets, and rents are up 38% in industrial compared to 24% outside our markets. On fee income, we were up for the quarter. We saw some improvement in mortgage as the gain on sale margin opened up. Wealth management continues to be a reliable and growing contributor, and we now have assets under management over $8 billion. Our correspondent division recently expanded with the addition of a new team that specializes in the packaging and sale of the government guaranteed portion of SBA loans. This is a long-standing and experienced team based in Houston, and Steve can give you more information. Lastly, as we think about capital management, over the last year, we've maintained a level balance sheet, it's $45 billion in assets while earning a return on tangible common equity in the mid-teens. As a result, we've seen our capital ratios increase every quarter. Our CET1 currently sits at about 12%. We've also significantly increased our loan loss reserves, which currently sit at 1.6%. And I mentioned earlier that we're all trying to play economists and forecast the yield curve. Obviously, we don't have a crystal ball. The only thing we know for sure is that all of our forecasts will be wrong. So our goal is flexibility and optionality. With these higher levels of capital reserves, we're in a perfect position to be opportunistic regardless of whether we have a soft landing, a hard landing, or no landing at all. I'll pass it back to Will now to walk you through the details on the quarter.

William Matthews, President

Thank you, John. Total revenue for the quarter was in line with forecasts as NIM came in at the lower end of our guidance range at 3.41%, and noninterest income to average assets came in above guidance at 64 basis points. Deposit costs increased 14 basis points, which was 2 basis points less than last quarter's increase and the cost of deposits at 1.74% was in line with our guidance. Loan yields increased 8 basis points, bringing our cumulative total deposit beta to 33%, and our cumulative loan beta to 37%. Deposit mix shift was part of that deposit cost increase, though the shift appears to have slowed. The average mix of DDAs to total deposits at 28.5% in Q1 was down from Q4's average of 29.9%. However, Q1's beginning, ending, and average mix were all in the 28.5% range. Steve will provide some color on our future margin guidance in the Q&A. Relative to Q4, our net interest income declined by $10 million with one fewer day. Noninterest income was $6 million higher. Total revenue declined by $4 million sequentially. The noninterest income beat was driven by better mortgage revenue and lower interest on swap variation margin collateral. NIE, excluding nonrecurring items, was down $4.9 million versus Q4, but that's partially due to the adoption of the proportional amortization method for low-income housing tax credits. This adoption shortens the period over which these credits amortize, essentially reducing NIE by a net $2.1 million and moving about $3.5 million in passive losses to the income tax line. Thus, in comparing NIE and PPNR for Q1 versus Q4 on a normalized basis, if you adjust for this accounting method adoption, Q1 NIE would have been down $2.8 million compared with Q4, and Q1 PPNR would have been down $1.5 million from Q4. We had some positives and negatives in NIE. The first quarter had the usual higher FICA and 401(k) expense, which was offset by lower professional fees associated with projects, as well as lower business development and travel expenses. For the full year, we still think NIE in the $990s million to $1 billion area is a good estimate, dependent, of course, on expense items that vary with revenue. With respect to income taxes, in addition to the impact of the accounting method adoption I mentioned, we had two nonrecurring items related to a state DTA revaluation and amended state tax returns driving our tax expense up by $3 million. For future quarters, we expect to see an effective tax rate in the 23.5% range, absent any other unanticipated discrete or nonrecurring adjustments. Our $12.7 million in provision for credit losses versus $2.7 million in net charge-offs caused our total reserve to grow by 2 basis points to 1.6%. NPAs were down slightly. We saw some continued loan migration into substandard as we monitor and downgrade credits due to higher interest costs. With many of these being floating rate borrowers that could reduce their rate by 150 basis points or so if they fixed their rate using the swap curve, but many are reluctant to do so at this point due to expectations of lower rates or a sale. I'll note that the largest addition to the substandard list from Q4 paid off in Q1 with the property selling for an amount that was approximately 134% of our loan balance. That was clearly a substandard loan with very little risk of loss as evidenced by the margin of safety and the sale price versus our loan balance only one quarter after our downgrade. I'll note that our expectation continues to be that we will not see significant losses in the loan portfolio based upon current forecasts. Lastly, on the balance sheet front, growth was moderate with loans up 3.5% annualized and deposits up 1.4% annualized, with brokered CDs essentially flat. We repurchased another 100,000 shares in the quarter, and our capital ratios remain very healthy, putting us in a good position with plenty of optionality, we believe. Operator, we'll now take questions.

Operator, Operator

We will take our first question from Stephen Scouten with Piper Sandler.

Stephen Scouten, Analyst

I'm wondering if you can discuss the net interest margin from here. Last quarter, we anticipated four interest rate cuts in 2024 and four in 2025. Considering the recent changes in the forward curve, how might that affect your guidance on the net interest margin?

Stephen Young, CFO

Sure, Stephen. This is Steve. As you mentioned, just to kind of give you the framework of the NIM discussion, last quarter, we were at 3.41%, and deposit costs were 1.74%. Our guidance going forward continues on three things: it's interest-earning assets, our rate forecast, and deposit beta. So on our interest-earning assets, the first part, we've mentioned the full year would be at an average around $41 billion. So there's really no change to that guidance. We still think loan growth is sort of mid-single digits. We think deposit growth is in that 2% to 3% range, and then we use the investment portfolio runoff to fund the loan growth. I think from an interest-earning assets, that really hasn't changed. On the rate cut forecast, last quarter, I think Moody's mentioned four rate cuts in '24 and four in '25. This quarter, Moody's baseline shows two cuts in 2024 and four cuts in '25, so that's two fewer rate cuts than we were originally projecting. The third piece is just deposit beta. On Page 17, we show our cycle-to-beta at 33%, and we would expect going forward for deposit costs to increase sort of in the 5 to 10 basis points in the second quarter. Assuming we get a rate cut in the third quarter, which is what the Moody's baseline says, we would peak somewhere in the mid-180s on deposit costs. So with all those assumptions, we would expect NIM for the full year 2024 to range between 3.40% and 3.50%, starting from the lower end in the first quarter to the higher end in the fourth quarter. As you mentioned, I guided 3.45% to 3.55%. Really the difference in the guidance is based on the rate cut forecast having only two cuts versus four cuts, which really cost us about five basis points in 2024. That's kind of how we're thinking about based on the Moody's baseline and happy to answer any additional questions on that.

Stephen Scouten, Analyst

Yes. No, that's really helpful, Steve. And so based on that change, you guys in practice look like you're slightly liability-sensitive then if the NIM is a little better with more cuts. And does this move into more C&I lending start to change that dynamic slowly over time?

Stephen Young, CFO

Yes. I think, Stephen, it probably does over time, but I don't think it materially changes anything in the short run. I mean, one of the questions that investors have asked us is if rate cuts stay flat, how does that affect your NIM? For us, we've talked about our fixed rate book that continues to be a tailwind to margin. This quarter, our total loan yield went up, I think, 8 basis points. We’ll probably continue to see that somewhere between 7 and 10 basis points of movement in the loan yield on a go-forward basis, assuming higher for longer in the rate cuts. Our deposit costs probably will go up somewhere between 5 and 10 if we continue on this path. We kind of see the NIM bottoming out. For us, we think that each rate cut from here, whenever that happens, would yield somewhere between 3 and 5 basis points of NIM improvement per cut. We can go into that math if you like at some point, but that's sort of how we're thinking about that 3.40% to 3.50% range. If we have two cuts, we probably see it getting into the upper 3.40s by the end of the year; if no rate cuts, it's probably in that 3.40% to 3.45% range being our current expectation.

Stephen Scouten, Analyst

Got it. Very helpful. And then just the last thing for me. What kind of metrics might you guys have on hand as you looked at stressing your portfolio for higher rates, for potentially higher for longer? What that looks like as these fixed rate loans reprice higher? Do you have any metrics kind of showing what happens to debt service coverage or what gives you comfort around the loan book as a whole?

John Corbett, CEO

Yes. Stephen, we had a tick-up in our substandards really for the last few quarters, and it went up a little bit this quarter, a little less than it did the prior quarter. To your point, it's predominantly a rising rate story, and then some of it is from tenant downsizing in the office portfolio. But as Will said earlier, we don't see loss content in that portfolio. Stepping back, there's tangible nonsubjective asset quality metrics, and then there's subjective grading metrics. The tangible metrics—past dues, non-accruals, and charge-offs—were all down for the quarter. And as we think about loan grading, we've seen a lot of different approaches in the banks we've acquired over the years. Our approach is simple: if a loan is $1 below breakeven cash flow, we grade it substandard even if it has 50% cash equity and the guarantor has millions in liquidity. There's no risk of loss. But I'll give you some specifics. Our largest loan, as Will mentioned, in the fourth quarter added a substandard loan that paid off at a substantial profit. The largest one that added in the first quarter relates to a floating-rate multifamily development loan in Georgia. I checked on it yesterday; it's reached 90% occupancy, but it has a 0.93x debt service coverage because it's a floating rate, and it's scheduled to go to the permanent market—the Fannie Mae market—in the fourth quarter. It's going to cash flow fine because the exit rate is about 125 basis points less than the current floating rate. We’ve got detail in the deck that shows you our average debt service coverage ratios. We’ve kind of gone in with quarter-by-quarter at the rate reset risk over the next two years, showing that we're about 7% or 8% of our commercial real estate loans reset per year for the next two years. So it's not a lot. As we stress those to the current rate, they're all still cash flowing in the low 1s. So we just don't see a lot of loss content there, even though we may move the substandards up.

Operator, Operator

We will take our next question from Catherine Mealor with KBW.

Catherine Mealor, Analyst

It's a follow-up question. So on the average size of some of the substandard loans that increased, I know your average loan size is very low, and that's part of what we love about the risk in your portfolio. But could you talk a bit about some of the changes that we saw in office and multifamily in the substandard? Are there any larger credits within that? Or is it still a lot of smaller credits? Or are there a couple of larger credits that were kind of speaking to some of the details that you just gave within that, John?

John Corbett, CEO

Yes. So the move, Catherine, in the first quarter, there are probably four or five loans that make up 75% or 80% of those. The largest of which is that multifamily loan I mentioned that's at a 0.93x debt service coverage. It's going to be fine; it will go to the permanent market in the fourth quarter. There are a couple of office loans in there. One of them is a tenant remix story, but it has a good guarantor and good location. We don't think there's a loss in that. There's one that's in the $10 million to $15 million range; we might take a reserve on that of $2 million, but that gives you a flavor of the top three or four.

Catherine Mealor, Analyst

That's helpful. And your comment, Will, on the situation you mentioned earlier—that if the borrower chose to move the loan from floating to fixed, then they would be fine—can you just kind of talk about that dynamic and what you're seeing your borrowers' appetite for that?

William Matthews, President

Sure. I will, and John can fill in what I'll leave out. Essentially, with an inverted yield curve, that presents that opportunity. I mentioned in the remarks that the fixed-rate loan would be at a lower rate. But a lot of the borrowers have plans to, in many cases, exit the property, like the one that happened in the first quarter, and they don't want to fix the rate even though the debt service requirement will go down. Some have plans to go to the permanent market, but maybe they're not at the stage—maybe playing the rate game a little bit and think that rates may go down from here. Some may be finalizing stabilization period or early in stabilization period, so they can't yet go to the permanent market. All those kinds of factors are in play there.

Stephen Young, CFO

Yes. And then maybe just to add that, obviously, nobody wants a prepayment penalty right before you sell it. So that would probably be the other factor there.

Catherine Mealor, Analyst

That makes sense. Okay. That's great. And still, as you're seeing and you're looking at your classifieds today, are there any that you look at that you may have or you think there's a high likelihood that they migrate from substandard into nonaccrual? Or is it more just this kind of rate dynamic that's driving all of it?

John Corbett, CEO

Yes. When you dig into that substandard portfolio, the past due portion of that is only 12 basis points. So really, this is not a payment issue or a collateral issue. It's really just a cash flow issue that we think is temporary because of this rate phenomenon.

William Matthews, President

Yes, it's not that we know for certain that our NPAs don't move up from here a little bit. It's hard to have a crystal ball in that regard. But two things I'd say are: one, our team digging through our portfolio still does not see material loss content; and secondly, as you know, from following us—as we highlighted in the deck—we've built our reserves proactively pretty significantly over the last couple of years as well.

Catherine Mealor, Analyst

Yes, for sure. That's all really helpful. I don't dig into credit, but I just wanted to clarify a couple of those things. And then the one thing on the margin I wanted to ask about, in the higher for longer rate scenario that you kind of laid out, Steve, do you think—it's amazing that you still think that scenario so that deposit costs are just kind of increasing by that 5% that you said about 5 to 10 basis points kind of the quarter and still the margin is able to stabilize. Can you just talk about in a higher for longer rate scenario maybe where you think deposit costs peak out versus the 180s range that you talked about if we start to get cuts in the back half of the year?

Stephen Young, CFO

Yes, I think you never can measure this by a month or even 45 days. But I'd say the general commentary that we're seeing right now is that post-January, maybe a little bit of February, we did see a little bit of deceleration in deposit costs. Again, there have been three—two inflation reports. The answer is, I don't know. But what we see on the ground is a little bit of deceleration, and that's why our guide is kind of that 5 to 10 basis points of deposit costs versus 14 last quarter. If we stay at a higher for longer, how will that look in the third or fourth quarter? I don't know that we know for sure.

Brandon King, Analyst

So I wanted to follow up on the comments around the acceleration in deposit costs, I guess, some acceleration in the quarter. Could you kind of describe where you saw that as far as what type of accounts and the type of customers, etc.?

Stephen Young, CFO

Brandon, it's Steve. I would call it a deceleration in deposit costs. Last quarter, I think—in the second quarter, it shows it on Page 17. In the second quarter—excuse me, the third quarter, our deposit costs were up 33 basis points. I think in the fourth quarter, they were up 16. In the first quarter, they were up 14 basis points. So it's been coming down. As we look at the first quarter, there's a bit of a remix and some seasonality. The minuses first would be just around public funds. Typically, there's some seasonality. Those typically have a little bit higher deposit cost, and those ran down $200 million, which is typical in the first quarter. On the positive side, we had a really good growth and have over the last couple of quarters in our homeowners association business over $100 million, a team led by Jarrod Hurd. That team brings in a little bit lower cost of deposits, a lot of cash management business. So I kind of look at it as there's a bit of a remix within that whole deposit piece, but I wouldn't—certainly couldn't call it accelerating; I would call it decelerating as a general rule.

Brandon King, Analyst

Okay. I was referring to the pickup after the CPI reports that you alluded to earlier.

Stephen Young, CFO

Sorry. No, I may have misunderstood. What I was saying was that we did see, during the quarter, a deceleration of deposit costs, but it's hard to know as we continue to see these other CPI reports how that plays out in the second, third, and fourth quarters. What we actually see on the ground is a little bit of deceleration, and that's why our guide is kind of that 5 to 10 basis points of deposit costs.

John Corbett, CEO

We're trying to forecast and ask our credit team that same question and we're trying to understand where the loss content might come from in a higher for longer. So we had a meeting the other day and Steve asked our Chief Credit Officer, Dan, not the magnitude of losses, but where would those losses come from the cycle. I thought his answer was insightful. He thought that 40% of it would probably be in the C&I portfolio. He thought that 40% of whatever the potential losses would be would probably be in office, and then the other 20% would be in smaller SBA and consumer kind of losses. So interestingly, he saw no loss content or very little to no loss content in multifamily, retail, or industrial. I thought that was an enlightening answer regarding his crystal ball, but you can't judge the magnitude of this. Right now, it doesn't look like there's much magnitude at all. But that's where he sees potential loss content.

Operator, Operator

We will take our next question from Gary Tenner with D.A. Davidson.

Gary Tenner, Analyst

I just wanted to ask a follow-up on the fee income side of things, particularly in mortgage and correspondent banking. Given that you're at the top end of the range this quarter, what are you seeing in terms of maybe early second-quarter activity in both areas? And is the correspondent piece the pushout of lower rates? Does that just keep the variation margin interest piece higher a little bit deeper into the year? Is that the biggest delta in terms of that line item?

Stephen Young, CFO

Yes. Gary, that's right. As we think about correspondent, we're near the bottom on the gross income; we think somewhere in that $14 million to $18 million range over the next few quarters. But you're right, with the move up in long-term interest rates, the variation margin gets to be a little higher. That moves that, I'll call it, contra income account up a few million dollars a quarter. We think the second quarter should be a good quarter, but it's a little too early to tell. We definitely had a spike up in the first quarter. So as we think about the entire picture and think about where noninterest income to average assets, we think it's probably in that 55 to 60 basis points range until we get some footing on whether we get rate cuts and when we get them. The fixed income business, of course, right now with higher rates is a much more challenging business. Moving our SBA team up in Houston that we just recruited over will help that. It takes a few quarters to get that up and moving, but that really is mostly a 2025 event.

John Corbett, CEO

Yes, you're right, Gary. I think our construction development portfolio decreased significantly. It was down by like $500 million roughly in the quarter. Some of these projects just came to completion. But Will, as far as the unfunded piece that's left in construction, do you have that number?

William Matthews, President

Yes. The unfunded piece is around $2 billion. The biggest piece of that would be owner-occupied, which would be the largest property type within that. The second would be the owner-constructed single-family residential. So a loan to build a custom house where the borrower is not the builder. Just kind of a bunch of different categories.

John Corbett, CEO

But the ratio of construction to capital, Gary, dropped pretty significantly during the quarter below 50%, and we really don't see in the near term that moving up even with some of those fundings. We sort of think there are payoffs along the way, and it will kind of drift sideways roughly from here.

William Matthews, President

Yes, we've not been refilling that bucket, and that's why you've seen that number come down as it has the last couple of quarters as well as the reserve for unfunded supportingly as those amounts come down.

David Bishop, Analyst

A quick question during the preamble. I think it was Will noted maybe the loan repricing on the fixed rate side could provide a tailwind. Just to remind us what the dollar volume of repricing looks like over the next few quarters and what they might see pricing to and from?

Stephen Young, CFO

Yes, this is Steve. When we're thinking about loan repricing, basically, in rough numbers, it's $1 billion a quarter. We think we have about $3.3 billion left in 2024, and it's repricing in that—it's a 4.67% coupon. Our average loan yield this quarter was around 7.5%. So it's not quite 300 basis points, but somewhere in that general range. Next year, we have about $3.5 billion of the 4.93% coupon repricing in 2025. So if you look at it over the next seven or so quarters, it's roughly $7 billion. If you add another $1 billion or so in securities repricing over the next seven quarters or so, that’s how to think about it to get you to the end of '25. And one of the questions I think seems to have sentiment has changed to higher for longer. I wanted to think about, a little bit, when rate cuts do happen and we don't know when they're going to happen, the pluses and minuses in our book, and how we're sorting it all out, guiding in that 3 to 5 basis point margin expansion when that happens. We have about $10 billion of floating rate loans. If we get six rate cuts, that will cost us $150 million. We also have a $37 billion deposit portfolio; we're modeling a 20% down beta, it's 33% on the way up and 20% on the way down. So that would help us by about $110 million or so. In the end, the $8 billion or so we just talked about that reprices 2% to 3% above where we are today, assuming a 2%, that's $160 million. So you'd lose $150 million on the floating; you gain $110 million on the deposits; and then you gain another $160 million on the fixed-rate repricing. That’s $120 million or so on a run rate on $40 billion, that's about a 30 basis point improvement. That’s how we're unpacking the 3 to 5 basis points. I know everyone is thinking right now that we're going to be higher for longer, and certainly, that's what the data is telling us. But to the extent the Fed does pivot at some point, that’s how we're thinking about rates now. Not really. Probably just an end-of-the-quarter-type event. Sometimes it moves around a bit. We try to manage the cash book at somewhere around 2.5% to 3% of assets. Sometimes it moves a little higher, sometimes a little lower, but that's generally how we do it.

Operator, Operator

And there are no further questions at this time. I will now turn the call back to Mr. John Corbett for closing remarks.

John Corbett, CEO

All right. Thanks for joining us this morning. We know it's busy with a lot of calls out there. So if we can provide any other clarity for your models, don't hesitate to give us a ring. Hope you have a great day.

Operator, Operator

And ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.