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Edited Transcript of CSFL earnings conference call or presentation 24-Jul-19 6:00pm GMT

Q2 2019 CenterState Bank Corp Earnings Call

Davenport Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Centerstate Bank Corp earnings conference call or presentation Wednesday, July 24, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ernest S. Pinner

CenterState Bank Corporation - Executive Chairman of the Board

* John C. Corbett

CenterState Bank Corporation - President, CEO & Director

* Richard Murray

CenterState Bank N.A. - CEO & Director

* Stephen Dean Young

CenterState Bank Corporation - Executive VP & COO

* William E. Matthews

CenterState Bank Corporation - CFO

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Conference Call Participants

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* Brady Matthew Gailey

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* John Lawrence Rodis

Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts

* Michael Edward Rose

Raymond James & Associates, Inc., Research Division - MD of Equity Research

* Michael Masters Young

SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst

* Stephen Kendall Scouten

Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research

* Tyler Stafford

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the CenterState Bank’s Second Quarter 2019 Earnings Release. (Operator Instructions) As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Mr. Will Matthews, Chief Financial Officer. You may begin.

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William E. Matthews, CenterState Bank Corporation - CFO [2]

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Thank you, Catherine, and welcome everyone to the CenterState Second Quarter Earnings Call. Thank you for joining us.

Joining me in our presentation today are; Ernie Pinner, our Executive Chairman; John Corbett, our CEO; Steve Young, our COO; and Richard Murray, the CEO of CenterState Bank.

Before we begin our remarks, I want to remind you that our comments 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 on Page 12 of our earnings release.

I'll also remind you that you can find our earnings release and other financial information in the Investor Relations section of our website. I'll now turn it over to Ernie Pinner, our Executive Chairman.

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Ernest S. Pinner, CenterState Bank Corporation - Executive Chairman of the Board [3]

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Thank you, Will. I want to be sure I welcome everyone to the call today. I want to thank you for your interest and support of CenterState, and we appreciate you being on the phone.

My comments, brief would be that from my point of view, the quarter was busy, especially when you consider that we -- what we saw on, in my opinion, that excellent deal with the NCOM operation. Interesting, from my point of view again is, it's been a great mix, the cultures have met very well, all the people are working excellent with each other, and we are on track to have our conversion in September. So within that process, there's a lot going on at all times, and we appreciate the support you've given us in the processing [in that view]. So this time, I'll turn this back to Mr. Corbett. John?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [4]

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Thank you, Ernie. Good afternoon, everybody, and thank you again for your interest in CenterState and taking the time to join the call.

For the second quarter, CenterState produced a net income of $54.5 million with $0.42 per diluted share. If you exclude merger costs, the net income improved to $66.5 million and earnings per share increased to $0.51. The adjusted return on assets for the quarter was 1.6%. Return on tangible common equity was 18% and the efficiency ratio landed at 52%. So basically, stable with the first quarter, though we still have the cost savings to achieve from National Commerce. Even with dividends and modest dilution from 2 large acquisitions in the last year, our tangible book value per share still grew 16% year-over-year. We closed National Commerce on April 1, and are on schedule to completed the systems conversion by the end of the third quarter.

We went back and we added together all the conversions that have been completed by CenterState, Alabama National, National Commerce and combined our teams have completed over 50 conversions. So as challenging as conversions can be, this has been a great opportunity for our teams to grow closer together, by sharing ideas and collaborating on best practices.

Richard and Will are joining Steve and me a couple of days each week in their offices in Atlanta. And as anticipated, they've been great partners as we work on recruiting and retaining and inspiring our team about the future opportunities in CenterState.

In addition to working on the integration, we spend a lot of time discussing the economic cycle and the inverted yield curve. And from those discussions deciding, how we want to position the balance sheet at this point in the cycle.

Three things are clear to us. Number 1, macro risks are increasing; Number 2, desirable growth that fits within our credit appetite is more challenging; and number 3, our company is highly profitable and our capital formation rate is strong. So it leads to the question, how do we deploy our profits and excess capital? Do we want to leverage our capital by investing in riskier [linked] cycle loan growth, or is it the point in the cycle to use our capital to invest in CenterState stock in a lower risk profile that we dealt earlier in the cycle.

Loan growth stories have been interesting. We did very strong production in the second quarter. We produced $864 million in new loans, which was 43% more than our 2 companies produced in the first quarter, but net growth was still modest at only 1%. So the payoff story is real. Richard has been analyzing it, and we believe that the payoffs are a reflection of the mindset of our Florida and Atlanta clients, and their risk aversion because of the lasting scars from the Great Recession.

We're finding that many of our clients are skittish about the cycle risk and are just selling the projects or their entire companies. But the opportunities for new lending are still abundant. We analyzed the deal flow in the second quarter and determined that we cast on $700 million of opportunities or 45% of the opportunities we reviewed during the quarter.

Now of the $700 million, we passed on 85% of them, because they didn't fit our underwriting policy and competitors were willing to stretch on loan to value, debt service coverage and recourse. If we had stretched in just 1/2 of the deals we passed on, our loan growth would've exceeded 10%. So with credit teams taking a long range, disciplined approach on length cycle lending. And in the meantime, we use the opportunity to purchase CenterState shares with our profits.

For the quarter, we repurchased 1.3% of the company, which still leaves us with the 10% tangible common equity ratio and capital continuing to build. As we think about the inverted yield curve and the prospects of the lower for loan growth, it reminds us of the summer of 2016 after Brexit. At that time, back in 2016, we laid out 3 strategies to create earnings growth in that challenging interest rate environment.

The first strategy was to increase our loan-to-deposit ratio from 77% and to our goal of 85%, and we've done that. And today, we are at 89% and our net interest margin is up as a result. The second strategy was to invest in noninterest income lines of business that make us less dependent on interest rate margin.

Since the second quarter of 2016, our fee income is up nearly $12 million a quarter. So $48 million per year of new fee revenue. About half of that, new revenue is in mortgage, a third is in our interest rate swap business and the balance in SBA growth. The third strategy was utilizing M&A and branch consolidations as a means to drive efficiency.

Since the summer of 2016, we have completed 6 acquisitions with 147 branches. We have consolidated 63 of those branches or 43%. The result is a 40% increase in our average deposits per branch. Today we stand at $88 million per branch in deposits. So we acknowledge that this is a challenging interest rate environment for the banking industry. But this team has faced this challenge before and proven that it can adapt and be successful regardless of the environment.

So now, I'll turn it over to Steve to talk about our net interest margin and fee businesses. And then Will can talk about our expenses and capital management. Steve?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [5]

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Thank you, John. Good afternoon, everyone. I will report on our second quarter changes in our organic balance sheet. Our second quarter revenue results in both net interest income and noninterest income as well as our stated expectations for both balance sheet and revenue for the remainder of 2019.

So first of all, related to the balance sheet, as John mentioned, net loan growth is 1% annualized in the second quarter and 1% annualized year-to-date. Non-CD deposit growth decreased 1% for the quarter, primarily due to seasonal impacts that have increased 4% for the year-to-date. As a reminder, non-CD deposits increased approximately 9% in the first quarter. Deposit composition remains strong at $6.30, as total checking account balance represent 49% of total deposits, of which 30% is noninterest bearing DDA.

Moving on to the revenue results. Recorded net interest margin remained strong and increased 5 basis points to 445 in the second quarter versus 440 in the first quarter, which was higher than our 425 to 435 guidance. Loan accretion decreased from 49 basis points in the first quarter to 44 basis points in second quarter, but was higher than our expectation. Excluding all loan accretion on acquired loans, net interest margin improved 11 basis points to 401 this quarter, which was in the center of our guidance of 395 to 405. The primary driver of higher NIM is due to NCOM acquisition closed on April 1.

One other item on margin. Total deposit costs increased 13 basis points from the prior quarter to 70 basis points, excluding the impact of NCOM, total deposit costs increased only 4 basis points from the first quarter, while total interest-bearing liability increased only 1 basis points in the first quarter.

Noninterest income. As expected, during the third quarter, noninterest income is a percentage of average assets declined from 96 basis points to 91 basis points due to NCOM acquisitions, but was better than our guidance of 85 to 90 basis points pre-Durbin. Total noninterest income increased $8.6 million from the prior quarter, primarily due to increases in mortgage banking revenue, correspondent banking revenue and the effects of the additional NCOM -- noninterest income.

Mortgage banking noninterest revenue increased by $2.6 million for the quarter to $6.8 million. New mortgage loan origination for the quarter was a record $416 million versus $289 million pro forma for NCOM in the first quarter. 63% of production was secondary, while 37% was booked on the portfolio. The secondary gain on sale margins were 2.61% and purchases were 82% at the closing in the second quarter versus 18% of revised. Correspondent banking revenue increased $2.5 million from the prior quarter and $4.5 million for the prior year second quarter, primarily due to continued increase in the interest rate swap revenue. For interest rate swap program, transactions for the second quarter of 2019 increased by 43%, while notional value increased by 90%. An expanded customer base, flatter yield curve and lower rates are the primary drivers to the increased production. Interest rate swap revenue and pipeline is strong and should continue to be a tailwind in a flat yield curve environment.

So lastly, our 2019 balance sheet and revenue guidance. Loan growth. Based on John's earlier discussion on our credit appetite, our loan production and pipeline and our payoff expectations, loan growth is expected to increase low to mid-single digits for the remainder of 2019. Deposit growth. We expect deposit growth to continue to approximate mid-single digits as it has in the first half of the year.

As a reminder, due to the seasonal nature of some of our accounts, typically we see deposit balances grow at a higher pace in the first quarter and the fourth quarter, but are more muted in the second quarter and the third quarter, so there is no change in our guidance there.

Net interest margin. Based on the new low yield curve as well as our forecasted 2 rate cuts this year, we are revising our NIM guidance ex-loan accretion down to 3.90% to 4% for the remainder of 2019 versus 3.95% to 4.05% in the previous quarter. Reported NIM continued to be a little higher than expected due to higher payoff and higher loan accretion.

Based on our internal forecast, we would expect loan accretion to add approximately 35 to 40 basis points for the remainder of 2019. This potentially remains lumpy based on prepayment rates, which could affect results. In total, we would expect reported margin to be between 4.30% and 4.40% for the remainder of 2019, which increased 5 basis points from our 4.25% to 4.35% guidance in the previous quarter on a smaller balance sheet.

Noninterest income. Noninterest income average assets was 91 bps for the second quarter, which was better than expected due to some of our noninterest income businesses performing at a higher clip. Based on the current environment, we'd expect noninterest income to continue to be at elevated levels in the back half of the year. The third quarter will be our first quarter with the Durbin penalty as it is 18 months since the company crossed $10 billion in assets. The impacted of Durbin is expected of approximately $10 million to $12 million annually or 6 to 7 basis points of noninterest income to average assets. As a result of those, our expectation for elevated noninterest income as well as the Durbin impacts, we would expect the ratio of noninterest income to average assets to range between 80 and 90 basis points for the remainder of the year.

With that, I will turn the call over to Will to discuss credit, noninterest expense and share repurchase results.

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William E. Matthews, CenterState Bank Corporation - CFO [6]

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Thanks, Steve. We had good improvement in our nonperformers this year with our NPA to loans plus OREO down from 51 bps last quarter to 28 basis points this quarter ending the quarter at $26 million nonperforming loans and including OREO, $32 million in NPAs. Our allowance coverage of nonperforming loans rose back to a healthy 154%. Our loan loss provision of $2.8 million exceeded the $2.2 million in net charge-offs.

This represented an annualized net charge-off rate of 8 basis points for the quarter, which brought our cumulative 5-quarter total to 19 basis points. So an average of about 4 basis points annualized per quarter over the last 5 quarters.

With respect to CECL, our project team continues to do a great job and has us on track with our plan. As we've noted before, we're not yet at the stage where we're prepared to disclose the expected impact on our allowance levels. But we plan to be in a position to give some guidance there on our third quarter call. We did include in our release on the bottom of Page 6, the current breakout of our $71 million discount on PCI loans, which shows a credit discount of approximately $28 million and a noncredit discount of approximately $43 million, that's a new disclosure this quarter.

Our noninterest expense side, our NIE totaled $106 million, excluding the $15 million in merger-related expenses, which was about what we expected the number to be with the addition of the NCOM CDI amortization and having the Charter conversion behind us. This resulted in an operating efficiency ratio of just under 52%, again, excluding the merger-related expenses. The third quarter will, again, be messy with a smaller component of the NCOM conversion occurring this month in July. But the main NCOM conversion occurring in September, but the fourth quarter should be pretty clean after that. We still expect the NCOM cost saves to be in line with our modeling, but do also acknowledge that our NIE base may fluctuate somewhat from quarter-to-quarter based on a number of factors, including the performance of our noninterest income business lines. Our effective tax rate in the quarter remained pretty consistent in the 23.5% range, which is about where we expect it to remain for the rest of the year.

Turning to repurchases, as we noted in the release, we repurchased 1.68 million shares at a price of just under $23 per share during the second quarter, leaving our remaining unused authorization at 4.8 million shares. As you heard John say, with attractive growth more challenging and with higher profitability, [we're forming capital] at a rapid rate in a quarter where we were active in share purchases and where we had $15 million in merger-related expenses, we still grew our TCE ratio to 10%.

As investors and capital managers, we're going to continue to assess the environment, and we will make capital decisions that we believe are in the best interest of the company and its shareholders. Thank you, Catherine, we'll now take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Brady Gailey with KBW.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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So Will, I heard you that expenses will kind of continue to be messy. But when you look at core expenses in 3Q, should we expect them to be roughly flat with the 2Q level, just due to the timing of the NCOM conversion? And then as we get towards 4Q and then to 2020, that's when you'll see expenses kind of step down as those cost saves are realized?

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William E. Matthews, CenterState Bank Corporation - CFO [3]

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Yes. In a general sense and Steve or John or Richard may jump in and elaborate here and add to my answer. But I guess, a component, in a general sense that's an accurate portrayal. I think the components that are hard to predict would be: Number one, we know we have several noninterest income business lines that have commission-based compensation structures, and therefore, have a variable expense base of revenue. And depending upon the business line and the various variable expenses including comp that could be roughly 50% expense increase for every dollar of revenue.

So if we have additional $2 million in swap revenue or additional $2 million in fixed income sales or mortgage, each one of those would be add another million dollars or so to that quarter's noninterest expenses, so you get that component. And as we approach the back half of the year, there are other things that are harder to predict like our health insurance. We're self-insured and our health insurance run rate is roughly $20 million annualized expense to the company. So depending upon our experience in the back half of the year, there -- that's hard to predict. And then, of course, as you get near the end of the year, you begin to chew up your incentive accruals with a little more precision. And that's always hard to predict halfway through the year as well. So with a lot of qualifiers, yes, your portrayal would be accurate.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay. All right. Then on the buyback, it was great to see some activity this quarter. Would you consider that more of a onetime thing? Or do you think the buyback is going to be something that you'll consider kind of on an ongoing basis?

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William E. Matthews, CenterState Bank Corporation - CFO [5]

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Yes. I think, Brady, we always consider the environment that we face, when we make decisions about capital. And if we continue to face an environment where growth of an acceptable quality is a challenge and an environment as well where bank stocks are pretty much out-of-favor, then we would definitely expect continued return to capital via share repurchases, while also maintaining very healthy capital ratios, so that we can operate from a position of strength, if we are to head into an economic downturn. So based on the current environment, we would anticipate, reinvesting a portion of our profits in share repurchases, but it's likely to be lumpy from quarter-to-quarter based upon what we see.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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All right. And then finally for me, with NCOM, you picked a small kind of below the line, you call it, noncontrolling interest was about $600,000 this quarter. It's not a big number, but as far as forecasting that out, should that number be fairly constant on a forward run rate as we look quarter-to-quarter?

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William E. Matthews, CenterState Bank Corporation - CFO [7]

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Yes. Brady, I'll answer that. That is related to, as you may recall, that the factoring business that NCOM [on us]. And when National Commerce acquired that business in 2014, it recorded 70% interest and that's the 30% minority interest piece.

The call option that we own to acquire the remainder of that business, that window opens up during the third quarter. So it would be our intention sitting here today that we would plan to exercise that call option and clean that up, although that's not a final decision we've definitively we made that. That's our likely intent. And so that sort of noise, if you will, will -- minority interest piece will go away in the not-too-distant future.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [8]

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Got it. So if you do exercise that option and owned 100% of the company, then I guess that $600,000 would move up in the income on a quarterly basis?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [9]

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Correct. We'll be paying cash for that component as well, Brady.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [10]

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How much cash would be paid?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [11]

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It is a variable formula based upon a multiple of trailing 12 earnings. So the trailing 12 period is not yet closed out. But in round numbers, it's somewhere in the $12 million, $13-ish million -- $12 million, $13 million, $14-ish million range depending upon how the final 2 months of that trailing 12 period play out.

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Operator [12]

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And our next question comes from Michael Young with SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [13]

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I wanted to start maybe just with the acquired loans? I think the amount you brought over was just a little less than what I was thinking. I would think NCOM was around $3.3 billion at the end of the year and looked like about $2.8 billion came over. I know you kind of mentioned that. But could you just walk through maybe some of the moving pieces, if there were specific portfolios or loans you walked away from, just a little color there would be helpful.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [14]

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Michael, it's Steve. I think what you're referring to is just the drawdown in the acquired book, and of course, in the acquired book there was National Commerce loans, but there was also several other banks loans in there. So those are always kind of a drawdown book. So there wasn't a $500 million payoff in the National Commerce itself. It was...

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [15]

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Full book came over.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [16]

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Yes. It was a full book came over at $3.3-ish million.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [17]

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And every bit is expected.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [18]

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Yes, as expected. So it would have been the entire portfolio including other banks that were purchased that brought that number down.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [19]

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Okay. And is there anything that read into that, just from a bigger picture. I know the comments about kind of the CRE projects and some sales and businesses, but any other loss of lending personnel or anything in specific market?

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Richard Murray, CenterState Bank N.A. - CEO & Director [20]

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No, Mike. This is Richard. Definitely no loss of lending personnel. And I'll give you the answer to that in a second. But the loan growth, in particular, as John mentioned, it was 1% annualized growth rate, had really strong production, $860-some-odd million, which was significantly above what we produced on a combined basis a quarter ago. But we did have roughly $100 million in increased early payoffs and pay downs compared to the quarter before. But the loan production was still really good across the -- all of the market at National Commerce in particular. It was proportional to the size of roughly 25% of the production. Our south region, our west region as well as the central Florida, Orlando over to the East Coast, those were all very strong production regions, and the pipelines to continue to grow. So we're encouraged as we look forward to Q3. We do think loan growth will be more pronounced in Q3. But there does appear to be some pockets of caution that John mentioned, which is probably why we have the $100 million in increased payoffs and pay downs in the second quarter. So we don't feel like this is a time for us to stretch. So we won't get every deal we're shooting for. But the economy is still good. Like I said, the pipelines have continued to increase. So we're getting some good looks, and we've got really good bankers and really good markets. And so we're going to continue to grow organically, and it may be more than what we expect. I mean that would be great.

But given our experience in Q1 and Q2, our expectations are more in that mid -- low to mid-single-digit growth rate. But to mention, the focus on the relationship managers, obviously, we're always recruiting new relation manages, that's been a priority of ours from the beginning. Our relationship manager counts are actually up. We have 234 relationship managers at the end of the quarter. That's about 14 more than at the end of Q1. And we are recruiting in all markets, and we are recruiting all the best bankers that we feel like are the best bankers that can be successful at CenterState. Some are part of the SunTrust BB&T team that everyone is talking about and asking about. And we're certainly focused on those as well because we think that's a unique opportunity, given the size and where those markets are relative to our markets. But we're focusing on all bankers in each of the markets, and we've had some success there. But we're also mindful of our own situation, the change that we're going through, the conversions that we're currently planning and about to embark on. So we're also paying a lot of attention to our backdoor. So that's a focus for us too.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [21]

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Okay. Thanks for all that color. One last one just on, I guess, kind of CECL maybe for Steve or Will. But obviously the loan loss reserves that are pretty low number, but the acquired loans have a reserve allocated to them. Could you just remind us what the all-in, kind of, credit mark is? And then what your expectations are, if you have any yet, for CECL pro forma basis?

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William E. Matthews, CenterState Bank Corporation - CFO [22]

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Yes, Mike, it's Will and Steve to elaborate. If you look on Page 6, the bottom on Page 6, we did have a footnote disclosure to our disclosure of the loan discount on our acquired portfolio. So at the bottom you'll see where total purchased loans is about just under $7 billion and principal balance, carrying balance is $6.8 billion and some change and total loan discount of about $145 million. About $71 million of that discount was attributable to PCI loans. And of that $71 million, as of our last cash where we forecast was about $28 million -- $27 million, $28 million of it was related to credit with the remainder of the other $44 million just [P&L]or rate type discount. And on CECL, I'm sorry, I forgot that part of the question. But yes, we expect to be able to give some guidance there, our plan is to do so with our third quarter call. We're on pace with our modeling and model validation, all that true stuff. But not yet at a point where we think it is information we are ready to disclose.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [23]

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Right. I'll just follow-up to Will's point on that disclosure on Page 6, which was new for us. We are disclosing, but there's a credit component, which if today, all things being equal but does not change, which it will over a period of cash flows, there will be roughly a $27 million reserve that will be created out of the PCI and the rest of it will continue to accrete, which is how it's modeled today.

Of course, we'll have a couple more recaps and that will change over the next couple of quarters. But that disclosure is there to try to help investors and analysts see the CECL impact on the PCI portfolio.

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Operator [24]

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And our next question comes from Michael Rose with Raymond James.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [25]

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Sorry, if I missed this, but as it relates to core NIM outlook for the rest of the year, does that include rate hikes, or excuse me, rate cuts?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [26]

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Yes. Michael, this is Steve. We have 4 -- We have, excuse me, 2 rate cuts in our outlook. And what our expectation last quarter was 3.95% to 4.05% was our expectation at the core NIM for the remainder of 2019. We have changed that with the new environment and with the 2 rates cuts that's kind of dramatically happened in the last quarter to 3.90% to 4% range. So we moved the range down 5 basis points. You'll recall this quarter, our core NIM was 4.01%, but we expect -- in our forecast today, we expect 2 rate cuts.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [27]

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Okay. So couple of basis points for every cut. I guess what would make you -- what are the drivers that would make you come in towards the top end relative to the bottom end of that range? I'm sure it's a myriad of things, but we'd just love to hear your thoughts.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [28]

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Sure. A couple of things. First of all, would be kind of our loan-to-deposit ratio, do 1 lever. Today it's 89%. We're comfortable taking that up a little bit further. We're not going to take it greater than 92%, 93% or so. But that is a particular lever for that as well as the moderation of deposit costs. And I think what we're seeing in our markets is, at least in our last management ALCO about a week ago, is that the pressure is still there. Although, we are hearing from many of these calls and others that the pressure might moderate. So my guess is that pressure doesn't moderate a lot in the third quarter, but maybe by the fourth quarter, if they do a rate cut or 2, you would start seeing that kind of moderate down.

If you looked at our balance sheet in our disclosures to the 10-K, we have a pretty neutral balance sheet, but understand any time you have a neutral balance sheet that, when they move rates quickly, you have to catch up a little bit, so there's some catch up that probably would happen in the first quarter or 2.

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William E. Matthews, CenterState Bank Corporation - CFO [29]

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And the other component, Michael, I would add that's hard -- part of it, of course, is prepayment risk on your loan book, and whether some of those things pay off sooner than your modeling would indicate. That of course would be a downside risk on loans that are priced above where their replacement would be today.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [30]

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But you would say, we were really pleased when we put the 2 companies together. But this is the first time this cycle that we had a core NIM above 4%. So if you think about how, John mentioned in the course of the last 3 years, when we had Brexit that we had a NIM in probably in the 370 range, and we have moved it up, levered it up to around a 4% NIM with a great core deposit base. So I like our position as well if anything.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [31]

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Okay. That's very helpful. I wanted to ask about the correspondent business, obviously, good quarter. Just remind us again, my understanding is obviously, if rates are moving or there is some volatility that, that business will do better. But if you can just remind us, what is the optimal environment for that business?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [32]

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Sure. There's really 3 types of business that we do there: we do fixed income; we do interest rate swaps; and then, three, we do payments. The payment business is pretty steady under any scenario, so I'll stop talking about that.

Fixed income generally does a little bit better in the low rate environment, but typically, when a low rate environment comes, you get a little more steep yield curve, and that's typically when fixed income does better. So we saw an improvement in the second quarter in fixed income, although not a dramatic improvement, just because -- although rates fell, it was under a flat curve environment. Where we really saw a huge improvement was in our interest rate swap business, and that's when you have a flat yield curve, that business really takes off. And that business has been building, it's not -- it's only rate dependent -- it's certainly dependent upon curve, but new customers as well. So the interest rate swap business does really well in a flat curve environment. And as you kind of look at it going forward, you would expect, as far as we can see right now, it appears that we're in a flat rate curve environment for a little bit longer, for sure.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [33]

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So as I think about it, if we do get a rate cut or 2, and the curve were actually to steepen, the fixed income piece might do a little bit better but the swap income might come off a little bit?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [34]

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Yes. I'd say that's exactly right. They probably offset each other but at a higher level than we are -- we have been over the last year or so.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [35]

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Understood. And maybe just one final one for me, just on the loan growth outlook for the rest of the year. That was end of second quarter to the end of fourth quarter, all-in on a period-end basis?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [36]

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Yes.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [37]

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Low to mid-single-digit growth?

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William E. Matthews, CenterState Bank Corporation - CFO [38]

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Yes, annualized.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [39]

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Yes, annualized.

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Operator [40]

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And our next question comes from Stephen Scouten with Sandler O'Neill.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [41]

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I want to get some clarification on some of the commentary. You know, John, I felt like your commentary at the beginning was fairly cautious, and maybe leading me to believe that share repurchases could be a bigger part of what you guys are doing and maybe loan growth would slow. But then it sounds like, especially in Richard's commentary, that 3Q growth does look attractive to you all? And that there do seem to be ample opportunities here. So I'm just wondering if you can kind of help me reconcile those 2 statements? Or if it's just growth now but cautiousness as we look out further?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [42]

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Yes. I think it's really when we capture this analysis of looking at the deal flow, the deals we didn't do. So we did $864 million of production, and there were $700 million on deals we passed on. So we looked $1.560 billion during the quarter and we passed on 45%. And so from an activity standpoint, from a pipeline standpoint, the market is still very active. So this is just really where discipline comes in.

If we're willing to only do a 75% loan to value and a competitor will do 80%, is this really the time of the cycle to go outside of loan policy? So I think what Richard is saying is, there's plenty of activity, plenty of things to look that, our lenders are busy. But this is the hard part of the cycle where you've got to make tough, forward-looking choices, not to take on late cycle risk. We're perfectly -- we've always said, Stephen, that we're trying to build the company to grow organically 10% a year through a cycle; faster the first half of the cycle, slower the back half of the cycle. So if we want to grow 8%, 9%, that would be fine as long as it's within our credit appetite. But if we're not growing -- let's say we continue to grow loans at a low to mid-single-digit range, our TCE is rapidly marching up. So we ended the quarter at 10%, a few quarters, you're looking at 11%. There's a point here where we need to deploy the capital, and we can either do it in dividends, M&A, loan growth or buybacks. And this is really the first quarter, the second quarter we really got active in the buyback piece. So in a slow growth environment, we're growing capital, that's an option that we plan to utilize on a quarter-by-quarter basis, based upon the market.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [43]

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Perfect. Really helpful. And then just as I think about some of the, maybe longer-term macro risks you spoke to and just that those are increasing at least slightly today and you begin to monitor them more closely. Is there anything specifically you guys are seeing from a credit perspective that gives you pause? Any segments, any sectors or geographies or otherwise that -- kind of you're starting to get more cautious on now?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [44]

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It's no different than what we've said the last couple of years. We are cautious on multifamily, hotels, Miami. Those are some things we've said repeatedly, but I think what we're seeing right now is more macro risk. I mean think about what happened to the stock market in December. That was a shock to the system and to business sentiment. The consumer seems to be doing fine, but the business sentiment seems a little more cautious. And when we talk about late cycle risk, for us as bank managers it's a little different than investors. Investors have the optionality to make a sell decision in a day. Any loan decision that we make we're planning on living with for the next 5 years. So I'm not saying we're at the end of the cycle, but we're clearly late cycle and we're trying to be forward looking and looking at every decision we make as a 3- to 5-year risk.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [45]

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Yes and I would just add based on John's commentary and Richard's that, there -- our payoffs were elevated this quarter, about $100 million versus last quarter, and some of the underlying trends in there, which were interesting was that we had several business owners who -- some of the top payouts that actually sold their businesses not just their projects, which means they're derisking as well, and that's probably lessons learned from the last cycle. So you kind of have a portion of the best borrows you want to be around, are selling out to go -- to just be more cautious as well. So that's who we want to align with.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [46]

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Yes. I mean some of these are multigenerational businesses, been clients of ours for a long, long time and they just punched out and said they're going to go on the sidelines.

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William E. Matthews, CenterState Bank Corporation - CFO [47]

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One last clarifying point, Steven. I think we ought to make is that of the $700 million or so in loans that we -- that didn't fit within our box, it wasn't that the other people were doing crazy stuff. It's just one or more combinations of factors that didn't fit within our underwriting parameters and we chose not to deviate. But it wasn't like this is wild stuff going on.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [48]

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No. There really wasn't. There was no real pattern in terms of the metrics or the craziness or any particular competitor. And again, this was the first time we've really gathered this information. So we think it will be helpful going forward. It will be more helpful after we've been able to gather it for 2, 3, 4 quarters consistently, so we know exactly what we're looking at. But it really wasn't anything -- and another thing, these were not transactions for the most part, or opportunities, excuse me, for the most part that were appealed by folks in the field, which gives us the feeling that we're not shrinking our credit box as much as these opportunities were just a little bit more of a stretch than we were willing to do, and we didn't feel like at this point in time, in the cycle was the right time to try to find a way to stretch.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [49]

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Makes sense. And maybe one last one for me. If we try to kind of isolate how you expect interest-bearing deposit costs to react to these potential rate cuts, especially as we get 3 or 4 potentially, what the forward curve implies today. How do think, on a quarterly basis for each 25 basis point hike, does interest-bearing deposit cost might perform. If you pegged a beta to it, on the way back down or can you just give us some color on how you're thinking about it?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [50]

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Sure. And we have models around all of this and it's based on the a lot of assumptions. The one comment I would make is our betas on the way up have been pretty low. So you would expect you're betas are back on the way down are going to be reasonably low because there's a lot of core deposits in there. We do want to make sure that when we cut deposit rates, which we're actively looking at relative to deposit cost that we don't cut the core customer. Because at the end of the day, our core deposit base is the foundation of our bank and it is a very quality low cost one. So we don't want to be shortsighted in moving too fast and cutting out some of the things that we've built over the past 2 decades. But I would say that if you think about the betas going down, so obviously those checking accounts aren't going to move very much. The money markets are going to be probably one that moves a little faster on the way down, the CDs are going to be 100% correlated within the first 6 or 9 months. Our CD bucket is pretty short, our average life is probably around 6 to 7 months. So those would be 100% correlated to the rate movement and with CDs. The money markets will be roughly between 40% and 50% beta. So as you kind of think about each one of those structures, you could see -- once we get Fed rate cuts for maybe a quarter or so, you'll still see deposit costs increase for the next quarter or so. But once we get back into the system and start actually decreasing many of these costs, you'll probably see 3 or 4 basis points on that margin -- on the cut side, on the deposit cut side. But that's just an estimate based on a lot of assumptions [as the real] marketplace.

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Operator [51]

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And our next question comes from Tyler Stafford with Stephens.

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Tyler Stafford, Stephens Inc., Research Division - MD [52]

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I want to start on fee income and specifically just the mortgage business. Do you have what the amount of mortgage loans sold during the quarter were?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [53]

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It would be 416 x 63%, whatever that was. I don't have it right in front of me but we can...

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Tyler Stafford, Stephens Inc., Research Division - MD [54]

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Okay. I can do that math. So lots of inputs, I guess over the last several quarters, with the addition of the estate bank team, NCOM this quarter and just obviously the lower rates and the added volume that the mortgage market is producing for you guys. Can you just give us a sense for how to think on a sustainable kind of annual production level? If there is a target amount of total mortgage production that you want to sell each year? Just given all the puts-and-takes on it, just how to think about that from an annual kind of big picture perspective.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [55]

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It's a good question. Kind of a target secondary portfolio is around 70% sold, 30% portfolio. Of course, that will change in the various environments. Like for instance, what you seeing now is an inverted yield curve, so therefore you would expect that the pipeline is closed this quarter. Probably has a little more bend towards the secondary versus portfolio just because it's cheaper from a secondary perspective, since the 30-year rates are hovering around 4%. As you think about our targets for that business, we're looking at -- I think we said it early in the year, with NCOM we're looking at around $1.5 billion of production and back to 70% of that would be our target to sell. So if you do that math and being on sale, that would kind of get you -- and from -- and from an annual basis. And then of course you're going to have puts and takes relative to the refinances or yield curve steepens or what have you. Is that helpful?

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Tyler Stafford, Stephens Inc., Research Division - MD [56]

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Yes. $1.5 billion on an annual basis is kind of a rough approximate, is that the number that you said?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [57]

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Yes.

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Tyler Stafford, Stephens Inc., Research Division - MD [58]

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Okay. Perfect. Just thinking about the deposit trends you saw this quarter, can you just talk about I guess legacy CenterState and legacy National Commerce, just what you saw from both a pricing and kind of product growth trend perspective during the quarter?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [59]

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Tyler, this is Steve again. As I mentioned in my prepared remarks, the deposit costs went up 4 basis points if you kind of normalize National Commerce and CenterState. As of the first quarter, I think our cost to deposits, if you put us together was 66 basis points. This quarter it's 70 basis points. So it was up 4 basis points. But if you looked at our interest-bearing liabilities, which would include all our federal home loan bank advances, trust preferred and so on, our interest-bearing liability costs were only up 1 basis point. And the reason for that was we saw an opportunity late in the first quarter to move some of our Federal Home Loan Bank, pay those off and go to brokered CDs. So what happened was our deposit costs went up a little because there a funding advantage to doing brokered CDs, which shows up in deposit cost versus the Federal Home Loan Bank advances would show up in interest and liability. So as we look at it, total funding was up a basis point for the quarter. Having said that, where we see the most pressure is on the money market side of the house. I think that's where we're seeing any pressure at all. The rest of CD pressures are maybe still there, but we're not a big CD shop, so I don't think there's a ton of pressure. But money market is probably the biggest pressure point.

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William E. Matthews, CenterState Bank Corporation - CFO [60]

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And Tyler, just to clarify that. As Steve said, that 1 basis point and 4 basis points, respectively, those were excluded in the effect of the NCOM merger.

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Tyler Stafford, Stephens Inc., Research Division - MD [61]

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Okay. Got it. And then just lastly for me, just given the NCOM deal did close, I guess, 90 days ago or so. Any interest in or what's your interest in M&A or appetite for M&A at this point?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [62]

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Tyler, it's John. Really it's no different than what we've communicated earlier, 2019 is kind of a heads down integration year to make sure that we get all the pieces put together correctly. Having said that, though, the industry is facing revenue headwinds. We've got an inverted yield curve, growth is potentially slow. So if we're going to get to growth and earnings per share, it may have to come on the expense side if there's no better way to do that than through M&A. So we are entertaining and having discussions, but we're thinking about what to do in 2020. And one of our goals is to continue to grow the franchise in markets where there's great demographics, great population in migration. Our first choice would be to be in the markets we're currently in; in Florida, in Georgia and in Atlanta. If we had to leave these markets, in order to replicate the kind of population in migration, if you went east, it's got to be the Carolinas. If you went west, you'd have to go over to Texas to keep the same kind of demographic profile. But that's sort of our thinking, but heads down in 2019 and planning for 2020.

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Tyler Stafford, Stephens Inc., Research Division - MD [63]

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So John, Texas at a certain point would not be too far west for you?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [64]

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You know it feels kind of far west, but if you look at how larger banks have built their franchise and the markets that they've gone to, if you went west from Atlanta, every one of them goes to Texas, they normally don't stop along the way. So that's -- not saying that's something that we're going to do, but that's just the demographic reality of the matter. It's really to the east, if you head up 85, if you get to go to Greenville, Charlotte, Charleston, those kind of markets are very attractive similar to ours. But if you go west, you've really got to go all the way to Texas in order to have a similar demographic profile.

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Operator [65]

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And our next question comes from John Rodis with Janney Montgomery.

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John Lawrence Rodis, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [66]

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Just a little different question. I had seen the other day a 13F filing out of Regions Financial, that they had bought some stock, like a little bit over 1% stock in CenterState's. Just curious, have you had any conversation with them, just about what that position is?

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William E. Matthews, CenterState Bank Corporation - CFO [67]

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John, it's Will. I'll short circuit that. That is Regions' Trust Department and it's a shareholder or group of shareholders that were large National Commerce shareowners that have their shares in a trust in Regions' Trust Department. We had the same question at National Commerce over the years as well.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [68]

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So it's not Regions.

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John Lawrence Rodis, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [69]

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I thought that might be the case but I just wanted to get it out there.

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Operator [70]

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We have a follow-up from Michael Young with SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [71]

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Just on the M&A commentary. If you went into another new market, in the past you've wanted to go with a little bit of scale. Is that kind of the way you're thinking about it this time? Or does the fact that we're late cycle make you want to make smaller bets? Just trying to kind of size up how you're thinking about that.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [72]

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Yes. Michael, it's John. I think we're more interested in the quality of the loan book than the size of the institution. The reality is, if you look at a chessboard today, there are not as many smaller opportunities as there were over the past 5 years. we really built the company doing $500 million to billion dollars deals. We've always said, 10% of our size to a third is kind of ideal, but we have to play within the realities of the chessboard and there aren't as many smaller opportunities out there.

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Operator [73]

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And I'm showing no further questions. I'd like to turn the call back to Mr. John Corbett for any closing remarks.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [74]

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Okay [Kevin]. Thank you for calling in today and thank you for your interest in CenterState. We're planning to attend a number of investor conferences in the third quarter. We'll be at the KBW Conference in New York next week and then in September, The Stephens Conference in Little Rock and Raymond James in Chicago. So we hope to see many of you there. In the meantime, if you have any questions, feel free to reach out to any of us and have a great afternoon.

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Operator [75]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.