SouthState Corporation (NASDAQ:SSB) Q1 2024 Earnings Call Transcript

SouthState Corporation (NASDAQ:SSB) Q1 2024 Earnings Call Transcript April 27, 2024

SouthState Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by. My name is Abby and I will be your conference operator today. At this time, I’d like to welcome everyone to the SouthState Corporation First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers’ remarks there will be a question-and-answer session. [Operator Instructions] And I would now like to turn the conference over to Mr. Will Matthews. You may begin.

Will Matthews: 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 will turn the call over to John Corbett, our CEO.

John Corbett: Thank you, Will. Good morning everybody. Thanks for joining us. As you have 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 are 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 and 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 surprising, 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 have 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.

And 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. And finally, as we think about capital management. Over the last year we’ve maintained a level balance sheet, it is $45 billion in assets, while earning a return on tangible common equity in the mid-teens. As a result, we have seen our capital ratios increase every quarter. Our CET1 currently sits at about 12%. We have also significantly increased our loan loss reserves, which currently sit at 1.6%. And I mentioned earlier that we are all trying to play economists and forecast the yield curve.

And obviously, we don’t have a crystal ball, and the only thing we know for sure is that all of our forecast will be wrong. So our goal is flexibility and optionality. And with these higher levels of capital and reserves, we are in a perfect position to be opportunistic regardless if we have a soft-landing, a hard-landing or no landing at all. I will pass it back to Will now to walk you through the details on the quarter.

Will Matthews: 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 non-interest 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. That brings 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 29.9%. However, Q1’s beginning, ending and average mix were all in the 28.5% range.

Steve will give some color on our future margin guidance in the Q&A. Relative to Q4, our net interest income declined $10 million with one fewer day. Non-interest income was $6 million higher. Total revenue declined by $4 million sequentially. The non-interest income [beat] (ph) was driven by better mortgage revenue and lower interest on swap variation margin collateral. [NIE] (ph) excluding non-recurring 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 and essentially reduced NIE by a net $2.1 million and moved 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 expense. For the full year, we still think NIE in the $990 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 non-recurring 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 non-recurring 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 fix 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 will note that the largest addition to the sub-center 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 will note that our expectation continues to be that we will not see significant losses in the loan portfolio based upon current forecast. 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 will now take questions.

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Q&A Session

Operator: Thank you. And we will now begin the question-and-answer session. [Operator Instructions] We will take our first question from Stephen Scouten with Piper Sandler. Your line is open.

Stephen Scouten: Hi, good morning everyone. Thanks for the time here. I’m just wondering if you guys can walk through kind of — I was just thinking about the NIM from here. I think last quarter, we were looking at four cuts in maybe ’24 – four in ’25. So just given the move in the forward curve and how that might shift your guidance on the NIM?

Steven Young: Sure, Stephen. This is Steve. Good morning. As you mentioned, just to kind of give you the framework of the NIM discussion, last quarter, we were at 3.41%, deposit costs were 1.74%. Kind of our guidance going forward continues on three things; it is interest-earning assets, our rate forecast and deposit beta. So on our interest earning assets, the first part, we’ve mentioned full year would be an average around $41 billion. So there is really no change to that guidance. We still think loan growth is sort of mid-single digit. We think deposit growth is in that 2% to 3% range, and then we use the investment portfolio runoff to fund the loan growth. So 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 2025. So that’s two less — two fewer rate cuts than we originally projecting. The third piece is just deposit beta. Page 17 shows our cycle-to-date beta at 33%, and we would expect sort of going forward that deposit costs to increase sort of in the 5 basis points to 10 basis points in the second quarter. And some — 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% and sort of start from the lower end in the first quarter to the higher end in the fourth quarter.

And as you mentioned, I think in the previous quarter, we guided 3.45% to 3.55%. And 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 5 basis points in 2024. So that’s kind of how we are thinking about based on the Moody’s baseline and happy to answer any additional questions on that.

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

Steven Young: 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, kind of how does that affect your NIM? And for us, we have talked about our fixed rate book — our fixed rate loan book that continues to be sort of a tailwind to margin. And this quarter, our total loan yield went up, I think 8 basis points. So we’ll probably continue to see that somewhere between 7 basis points and 10 basis points of movement in the loan yield on a go-forward basis, assuming higher for longer in the rate cuts. And our deposit costs probably will go up somewhere between [5 and 10] (ph), if we continue on this path.

So we kind of see sort of the NIM bottoming out. And then for us, we think that each rate cut from here, whenever that happens and it’s somewhere between 3 basis points and 5 basis points of NIM improvement per cut. And so we can go into that math, if you like, at some point. But that’s sort of how we are thinking about that 3.40% to 3.50% range, if we have two cuts, we probably see it getting in the upper 3.40s by the end of the year if we are — no rate cuts, it is probably sort of in that 3.40% to 3.45% range being our current expectation.

Stephen Scouten: Got it. Very helpful. And then just the last thing for me. What the kind of metrics might you guys have on hand, as you looked at stressing your portfolio for higher rates or potentially higher for longer? And 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 kind of what gives you comfort around the loan book as a whole?

Steven Young: Yes. Steve, we had a tick up in our substandards really for the last few quarters, and it went up a little bit this quarter, little less than it did the prior quarter. And to your point, it’s predominantly a rising rate story. And then some of it is from tenant downsized in the office portfolio. But as Will said earlier, we don’t see loss content in that portfolio. Stepping back, there’s tangible non-subjective asset quality metrics and then there is subjective tangible — subjective [grading] (ph) metrics. The tangible metrics, past dues, non-accruals, charge-offs, were all down for the quarter. And then as we think about loan grading, we have 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, the guarantor has got millions in liquidity. There is no risk of loss. But I will give you some specifics. Our largest loan, as Will mentioned, in the fourth quarter, they got added a substandard paid off at a substantial profit. And then the largest one that added in the first quarter kind of getting back to your question about stressing it, it is a floating rate multi-family development loan in Georgia. I checked on it yesterday. It is reached 90% occupancy, but it’s got a 0.93 debt service coverage because it is a floating rate. And it is scheduled to go to the permanent market, the Fannie Mae market in the fourth quarter, and it is going to cash flow fine because the exit rate is about 125 basis points less than the current floating rate.

So we have got detail in the deck that shows you our average debt service coverage ratios. We’ve kind of gone in and look quarter-by-quarter at the rate reset risk over the next two years. And we’ve got something in the deck that says we are about 7% or 8% of our commercial real estate loans reset per year for the next two years. So it is not a lot. And as we stress those to the current rate, they are all still cash flow in the low 1s. So we just don’t see a lot of loss content there, even though we may move the sub-standards up.

Stephen Scouten: Extremely helpful color. I appreciate it John, thanks for all the times this morning.

John Corbett: You bet.

Operator: We will take our next question from Catherine Mealor with KBW. Your line is open.

Catherine Mealor: Thanks good morning.

John Corbett: Good morning.

Catherine Mealor: A follow-up question. So — on the — maybe the average has size of some of the substandard loans that increase. I know your average loan size is very low, and that is part of what we love about the risk in your portfolio. But if — could you talk a little bit about some of the changes that we saw in office and multifamily in the substandard? And are there any kind of larger credits within that? Or are there still — is it just kind of I guess — is it a lot of smaller credits? Or are there kind of a couple of larger credits that were kind of speaking to some of the details that you just gave us in that, John?

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

Catherine Mealor: Great. That’s helpful. And your comment Will on [indiscernible] you said, if the borrower chose to move the loan from floating to fixed, then they would be — basically, the credit would be fine. Can you just kind of talk about that dynamic and what you’re seeing your borrowers’ appetite for that?

Will Matthews: Sure. I will and John can fill it well [what I’ll leave out] (ph). I mean, essentially, with inverted yield curve, that presents that opportunity. I just — 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. And some have plans to go to the current market, but maybe they’re not at the stage [indiscernible] — maybe playing the rate game a little bit and think that rates may go down from here. Some may be in finalizing stabilization period or early in the stabilization period, so I can’t yet go to the permanent market. All those kind of factors, I think are in play there.

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

Catherine Mealor: 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 — you think there’s a high likelihood that they migrate from substandard into non-accrual? Or is it more just this kind of rate dynamic that’s driving all of it?

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

Will Matthews: It’s not, Catherine, 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 is, one — we — 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 the last couple of years as well.

Catherine Mealor: Yes, for sure. That’s all really helpful. You don’t dig in on 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 kind of amazing that you still thinking that scenario that the deposit costs are just kind of increasing by that 5 — that you said about 5 basis points 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 – the mid-180s range that you talked about if we start to get cuts in the back half of the year?

Steven Young: Yes. I think, you never can measure this by a month or even 45 days. But I’d say, the general commentary that we are seeing right now is that post January, maybe a little bit of February, we did see a little bit of deceleration in deposit costs. Now again, there is been three – and two inflation reports. And so the answer is, I don’t know. But I do think, what we are seeing anyway is that deposit costs are [modeling] (ph). You’ve seen that through the industry, too. And I think we are seeing that so far. But to your point, if deposit costs are still — or if the Fed funds is still 5.5% in December, where were our deposit costs be? I think the way we are thinking about it, they’re modeling it, it is somewhere between 5 basis points to 10 basis points a quarter would be higher.

Our loan yield is going to go up 7 to 10, somewhere there. And we would think margin would kind of hold in there because of those two factors. But that’s — the crystal ball is not that great on the higher for longer, but that’s kind of how we are thinking about it.

Catherine Mealor: Yeah, that make sense. All right. Great, thank you for all my questions.

Operator: We will take our next question from Michael Rose with Raymond James. Your line is open.

Michael Rose: Hi, good morning guys. Thanks for taking my questions. Maybe just for Steve. Just if we are in this higher for longer environment and understanding that you just kind of added a team to the correspondent business, but — just wanted to get your kind of updated expectations as it relates to kind of the fixed income and the swap piece and then the other components and how we should just be thinking about maybe that fee to average asset ratio which was kind of at the higher end of the guidance that you had previously laid out. Thanks.

Steven Young: Yes. No, Michael, [blew] (ph) through the guidance as you mentioned. So I’ll tell you that was a great quarter for fee income, but much better than we expected, to be honest with you to your mention, our fee income was $72 million or 64 basis points which was higher than our guided 55 basis points to 60 basis points in the first half of the year. And as you mentioned, we have two interest rate-sensitive businesses, primarily one being mortgage and one being correspondent. So I think, what we mentioned before was — we thought that non-interest income to average assets would be sort of in that 55 basis points to 60 basis points in the first half of the year until they cut rates, and then it would be 60 to 65 in the back half.

And then as we get into ’25, as they really start moving through rate cuts 60 basis points to 70 basis points. And the way I would kind of characterize it, I’d just say, it’s been delayed a little bit. So they don’t cut rates until the third quarter, I would kind of expect our non-interest income to average assets to be sort of in that 55 basis point to 60 basis point range. And then as they cut rates, that will create some volatility and other things for both mortgage, fixed income and our swap desk and that, we think is towards the end of the year, in that 55 basis points to 60 basis points. And really, our guidance for ’25 hasn’t changed, 60 to 70, which is the 60 to 70 basis points is really what 2022 non-interest income to average assets.

So kind of the pathway is sort of benign, and we are kind of at the lows of these businesses until we start seeing some rate movement and then it will move up 5 or so basis points. And then from there, as we really get down to rate cutting cycle, we’d see it kind of go up 10 to 15, which is a bit more normal.

Michael Rose: That’s very helpful. I appreciate it. And then maybe just one for John. I know, it is really hard to predict the economy, but just wanted to get a sense for the competitive landscape? And I know you guys are somewhat cautious always kind of have been and have a great world view. But is the environment where people are starting to pull back? Is that creating opportunities for you guys with a bigger balance sheet versus a lot of the banks in your marketplace? And just wanted to get a sense for borrower demand and your willingness to make loans at this point in the cycle. Thanks.