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Edited Transcript of CSFL earnings conference call or presentation 31-Oct-18 6:00pm GMT

Q3 2018 CenterState Bank Corp Earnings Call

Davenport Nov 10, 2018 (Thomson StreetEvents) -- Edited Transcript of Centerstate Bank Corp earnings conference call or presentation Wednesday, October 31, 2018 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

* Jennifer L. Idell

CenterState Bank Corporation - Executive VP & CFO

* John C. Corbett

CenterState Bank Corporation - President, CEO & Director

* Stephen Dean Young

CenterState Bank Corporation - Executive VP & COO

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Conference Call Participants

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* Blair Craig Brantley

Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst

* Brady Matthew Gailey

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

* John Lawrence Rodis

FIG Partners, LLC, Research Division - Senior VP & Research Analyst

* Joseph Anthony Fenech

Hovde Group, LLC, Research Division - MD & Head of Research

* Michael Edward Rose

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

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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 Third Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the call over to Jennifer Idell. You may begin.

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Jennifer L. Idell, CenterState Bank Corporation - Executive VP & CFO [2]

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Thank you, Michelle. Thank you for joining the call this afternoon to discuss the company's third quarter financial results. Joining me in our presentation today include Ernie Pinner, Executive Chairman; John Corbett, President and CEO; and Steve Young, Chairman Operating Officer.

I would like to remind you that our comments made today may include forward-looking statements. Any of those statements made by any of us this afternoon are subject to the safe harbor rules. You can review the safe harbor language in detail found on Page 12 of our earnings release. As a reminder, you can find all of the documents that we discuss today on our website under the corporate profile tab of the Investor Relations section.

At this time, I'll turn the call over to Ernie Pinner to begin the presentation.

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

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Good afternoon. I'm going to play the absence card on you today. I've been out cheerleading so much this quarter for the team, I've lost my voice. So I'm going to sit back and let these great people tell you what a great quarter we had, which I believe, prompts us for a better quarter to come. So recognizing that today's Halloween, I'll say trick or treat, and turn this over to John.

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

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I don't know if Ernie has got laryngitis or he's got the bug, but my assistant Jill is in here, and she's got the bug. So if Jennifer, Steve and I start coughing in 20 minutes, you'll know the reason why. Thank you, Ernie, and good afternoon, everyone.

I'm pleased to report that during the third quarter, CenterState produced a net income of $38 million or $0.43 per diluted share. If you exclude merger cost, the net income improved to $45 million or $0.51 per diluted share. Compared to the same quarter in 2017, earnings per share has increased 42%. With merger cost excluded, the adjusted return on assets was 1.65%, the return on tangible common equity was approximately 20% and the efficiency ratio dropped to an all-time low of 50%.

On September 1, we closed on the acquisition of Charter Bank, and total assets at the end of the quarter grew to $12.3 billion. We've operated business lines in both Birmingham and Atlanta for nearly a decade with our correspondent banking and mortgage teams, but Charter represents our first traditional banking expansion into Georgia and Alabama. Charter's former President, Lee Washam is our new Regional President of Georgia and his leadership has been a great stabilizing force for us, and we're encouraged by the level of recruiting opportunities as we continue to invest in Atlanta.

We've scheduled the systems conversion for Charter in February, and we plan to see the cost savings materialize in the second quarter of next year. There's been a lot of investor focus this quarter on net interest margin, deposit betas and core revenue growth. If you exclude all loan accretion, we were pleased to see our core NIM improve 2 basis points last quarter to 3.88%. Not only has the core NIM expanded during the third quarter, it has also expanded 7 basis points since the same quarter last year. So our core NIM has benefited from the rate tightening cycle. And we continue to enjoy the flexibility of a liquid balance sheet with an 87% loan-to-deposit ratio.

In addition to a widening core NIM, we also enjoyed a strong increase in noninterest income of $4.5 million in the quarter, led by our correspondent banking team and our growing team of mortgage originators. Back in 2016, just after the Brexit vote, we laid out 3 goals to build a sustainable revenue and earnings stream: the first goal was to increase our loan-to-deposit ratio from 77% at that time, up to 85% by expanding our commercial lending team, and we have achieved that goal. The second goal was to make investments to build out our fee income lines of business to ensure that we had a balanced and diversified stream of revenue that would be sustainable at any point in an economic cycle. Our goal was to achieve fee income representing 1% of assets by building out our mortgage business, SBA, our interest rate swap business and by moving away from free checking. In the last year, if you include Harbor and Sunshine, we've increased fee income from 80 basis points of assets up to 96 basis points of assets this quarter, so we're almost at our goal of 1%. And then the third goal, back in 2016, was to continue to achieve cost savings through M&A and branch consolidations. And over the last 2 years, we've consolidated a total of 45 branches and increased our average deposits per branch along the way.

So we're encouraged by the positive revenue trends in the last year. Fee income is up about 16 basis points on assets and core NIM is up about 2 basis points on assets for total core revenue growth of 18 basis points on assets when you include Harbor and Sunshine. And Steve can give you some more color on the revenue composition and forecast. Loan production, however, was seasonally softer in the third quarter at $485 million, compared to record loan production of $622 million in the second quarter. We had a number of loan closings get pushed into the fourth quarter, so we expect loan production and growth to pick back up in the fourth quarter and into 2019.

And now I'll turn it over to Steve, for a deeper dive into our revenue.

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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 out on the third quarter revenue results as well as our updated expectation for both balance sheet and revenue for the remainder of 2018 and into 2019.

First of all, total revenue increased $5.8 million from the prior quarter, here are some of the components: reported net interest margin decreased 20 basis points to 4.31% this quarter from 4.51% in the second quarter, but was higher than our guidance of 4.15% to 4.25%. As you will recall, net interest margin was positively affected during the previous quarter due to a large prepayment on 1 PCI relationship of approximately $4 million during the quarter. If you exclude that 1 large prepayment, which represented 18 basis point of net interest margin in the previous quarter, the reported net interest margin would be stable. As John also mentioned, excluding all loan accretion on acquired loans, net interest margin increased 2 basis points to 3.88% this quarter versus 3.86% from the previous quarter and also increased 7 basis points from the third quarter in 2017. This upward trend has continued even with the effects of our purchase of lower core NIM banks that we purchased this year.

During the quarter, we are also pleased that our total originated loan portfolio yield increased 10 basis points, while new funded loan production yields increased 33 basis points to 5.08%. Investment securities and Fed funds combined yields increased 8 basis points for the quarter. In addition, most of the Charter investment security book was sold at close and remained uninvested at September 30.

Finally, as it relates to margin, total deposit cost including DDA increased 9 basis points from the prior quarter to 42 basis points, mainly due to the repricing of CDs in a higher rate environment, along with the impact of higher Charter costs of deposits for 1 month. Total deposit beta for the quarter including noninterest bearing DDA was 36%. Total deposit costs including DDA are up 25 basis points from the bottom-end rates since September 15, which represents a 13% beta. Total noninterest-bearing deposits represent 33% of total deposits on September 30.

Now moving to noninterest income. Noninterest income as a percent of average assets increased significantly from 87 basis points in the second quarter to 96 basis points in the third quarter, and closer to our stated goal of 1% average assets by the fourth quarter of this year. The $4.5 million increase in the quarter was primarily due to the increase in correspondent banking revenue, mortgage banking revenue, gain on sale of deposits and the 1 month effective Charter Bank on the quarter. I'll explain these in further detail. Correspondent banking revenue increased $1.2 million from the prior quarter and $1.1 million from the prior year quarter, mainly due to the higher interest rate swap revenue. Our interest rate swap program in the third quarter marked a 16% increase in notional volume as well as an increase of 14 more client banks using the product than in the second quarter. Interest rates swap revenue is strong as it continues to be a tailwind in this flat yield curve environment.

Mortgage banking. Mortgage banking noninterest income increased approximately $600,000 from the prior quarter, but also increased $2.8 million from the third quarter of last year. New loan origination was a record $173 million compared to $153 million in the second quarter and only $46 million in the third quarter of last year.

In addition, we announced, during the quarter, a lift out of the secondary mortgage origination team and related pipeline from State Bank. No premium was paid. Also during the quarter, we recorded 1 month of noninterest income from Charter Bank, which added approximately $1.6 million. As you might recall, Charter was doing approximately $5 million per quarter in noninterest income. Lastly, we sold a $25 million deposit branch to a Community Bank correspondent client for a $600,000 premium recognized this quarter.

Now moving on to 2018 and '19 balance sheet revenue guidance. Loan growth is expected to increase at a rate of upper single digits for the remainder of 2018 and '19, while deposits are continuing to expect to increase in mid-single digits. Net interest margin. With a loan-to-deposit ratio of 87%, we have flexibility to improve our core margins without raising the cost of deposits too quickly. Based on our forecast, we reiterate our net interest margin guidance of 4.15% to 4.25% for the remainder of 2018 and '19, which is the same guidance from last quarter.

Noninterest income. As we mentioned before, noninterest income is now 96 basis points of average assets versus 87 in the second quarter, but we believe there's further upside from here based on the following updates: as it relates to mortgage guidance, we have 60 -- we now have 60 retail mortgage originators at September 30 versus 35 at June 30. Our mortgage group has produced $420 million through September 30 and is expected to exceed our production goal of $600 million for 2018.

Turning toward 2019. We're expecting approximately $1 billion of production, which is consistent with the current number of originators and our prior goals and forecast. The next update is related to Charter. Charter is accretive to us from a noninterest income standpoint and adds approximately $20 million per year or 1.2% of average assets. We saw only 1 month of their noninterest income in the third quarter, but we'll see the full benefit in the fourth quarter and following. Finally, with these updates, we reiterate our guidance from a year ago to bring our noninterest income to average assets to 1%, this year, fourth quarter.

With that, I will turn the call over to Jennifer to discuss noninterest expense, allowance for loan losses and taxes for the third quarter as well as the guidance.

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Jennifer L. Idell, CenterState Bank Corporation - Executive VP & CFO [6]

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Thank you, Steve. First, noninterest expense. On the call, last quarter, we guided noninterest expense in the third quarter to be $63 million to $64 million. This included the full realization of Harbor cost saves since the integration was completed in the second quarter. The Harbor cost saves have been fully realized and noninterest expense came in at $63 million as expected before the addition of Charter Bank. Charter Bank has noninterest expense -- a noninterest expense run rate of approximately $12 million per quarter. So since we closed on September 1, there was 1 month or $4 million of additional expense in the quarter resulting in $67 million of noninterest expense before merger costs. Merger costs related to Charter Bank recorded in the quarter were $10 million. Looking forward to the fourth quarter, Charter noninterest expense will be carried for the full quarter at approximately $12 million in addition to the run rate of $63 million, resulting in noninterest expense of approximately $75 million, and this does include variable compensation related to the revenue lines of business. Looking forward into 2019, we continue to expect cost saves from Charter to be fully realized in the second quarter after the conversion of the core systems.

Next, provision expense and the allowance for loan loss. Credit quality continues to trend positively. The company recorded $1.95 million of provision expense against the originated portfolio, which is within the range of previous guidance. As we forecast loan growth and credit for the fourth quarter, we anticipate provision expense to be approximately $2 million to $2.5 million.

And finally, the effective tax rate. The company's effective tax rate in the third quarter was 23.5%, which is in line with previous guidance. We anticipate the fourth quarter effective tax rate to be consistent with the third quarter, between 23% and 24%. Thank you.

This concludes our discussion of the third quarter results. We are happy to answer any questions you may have at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Brady Gailey of KBW.

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

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I was surprised to see the new production loan yield up 33 basis points linked quarter. Could you just give a little more color on that? I'm not sure if you had more fixed rate closings or what. But just a little more color on that magnitude of an increase.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [3]

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Sure, Brady. This is Steve. The production was weighted in the previous quarter. We had about, I want to say, around $50 million to $60 million of municipal production, which is lower yield better credit stuff. And so the quarter really was a difference in, sort of, the types of production this quarter versus last quarter and so the lower credit spreads in the second quarter versus the third quarter. That would be, kind of, a high level view. The way we do net loan pricing is we price it off the curve, so our -- I think our fixed rate, I don't have it in front of me, but I want to say that our average life on new production was maybe in that 3.5 to 4 range versus previous quarters, maybe down to 2.5 to 3. But for us, we price off the curve, so we [get a rate rock] off of that, based on the curve and yields moved up this quarter.

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

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All right. And then on the flip side, on the cost of total deposits, I mean, you've all had a very low deposit beta cycle to date. But I mean, if you look at the 3 quarters in 2018, the total cost of deposits, it was up 2 basis points in 1Q, then 7, then 9 in 3Q. So it feels like it's continuing to go up. Maybe just an update on deposit competition and pricing in Florida and Atlanta. And do you expect to see the cost of deposits increase at an increasing rate, kind of, from here on out?

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

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Sure, Brady. This is Steve, again. As we model from a forecasting perspective and clearly, whenever you model, doesn't mean it's right, it's just how we model it and we've historically looked at it. We've typically looked at, on our deposit base, around a 30% beta, between 30% and 35%, when you run the math out. And so last quarter, I think, the total deposit beta was 28%, this quarter it was 36%. Now that included 1 month of Charter in there, which, I think, their cost to deposits was at around 58 basis points versus our 42. So it moves it a little bit. So I'd say that, from our modeling perspective, we would expect somewhere in that 7 to 10 basis points for every 25 basis points would be, kind of, consistent with our modeling. As far as guidance in the future, it's just hard to tell, but I don't think it's accelerating from here. But that's how we model it.

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

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All right. And then the last one for John. I mean, I'd hate to ask about additional M&A. I know you guys have barely closed Charter. But as you look forward, and you wait another quarter or so and Charter -- the cost saves have realized and you all are operating nicely, how do you think about additional M&A? I mean, is it still going to be just bank-focused? Would you consider any, sort of, non-bank M&A? And then now -- you used to really just be a Florida bank, now you have a presence in Atlanta. So how do you think about, kind of, Florida versus M&A outside of Florida?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [7]

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Yes. Sure, Brady. As far as the non-bank M&A goes, we've been approached by a number of folks to look at specialty finance lines of business, and we've turned those away at this point in the real estate cycle or the economic cycle. We really don't want to get involved in any kind of lending platform that's not in our geography that we would perceive to be higher risk. But as far as our traditional M&A strategy, really nothing's changed. We continue to look to double down on existing markets, get deeper market penetration and look for cost savings through branch overlap. Our preferred markets would be the metro markets that we're currently in, so Orlando, Tampa and Jacksonville is what we've been saying and now we can add Atlanta to that mix. Those would be the markets that we would prefer to be in.

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Operator [8]

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Our next question comes from Michael Young of SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [9]

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I wanted to just start with the acquired loans for the first time, I think, have exceeded the originated loans on the balance sheet at this point with the, kind of, recent deals closed. Can you just talk about your expectations for those balances? How much of that do you expect to kind of re-underwrite and stick around versus how much you think might run off, maybe over the next year and how much you're kind of replacing from originated loan growth?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [10]

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Yes. This is John, Michael. That mix can change pretty rapidly. I mean, normally -- Jennifer, correct me if I'm wrong, but normally, we model our loan average life to be about 4 or 5 years, so we look for about 20% of it to run off. And if you look at the rate that we're originating loans, I think, if you just looked at that originated loan portfolio, I think, our originated loan growth was close to 29% or 30% this quarter. So I think, the mix changes fairly rapidly. We feel like we're in a good place in the economic cycle. So as we look at these loans that we've acquired and that we've marked, we're trying to do a scrub right now and just see what the long-term fit is of some of these clients, because if we're going to exit, now would be a good time in the cycle to exit. But that's a one by one equation. But I look for that mix of originated and acquired to change pretty rapidly in the next couple of years if we're generating, I think, this year's a little over $2 billion, $2.2 billion of loan origination, so you could see how that changes pretty quickly.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [11]

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Michael, just to further comment, we, of course, subset that between the acquired loans and the PCI loans. And typically, PCI loans are loans in PCI for a reason, but I wouldn't expect those to grow or go anywhere, but out over time. But the acquired loans are loans that we deem to be good relationships, generally. And that's how we look at them.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [12]

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Okay. So a net basis, you don't expect necessarily a higher level pay downs or anything next year. And I'm just trying to understand the, kind of, high single-digit guide, if that's incorporating some pretty high pay downs or if that's assuming more of a, kind of, steady-state environment going forward into '19?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [13]

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Yes, I'd say that's a steady-state environment. We have not identified a large tranche of any of these acquired loans that we are trying to exit. We underwrote these clients and they're similar type banks to us. So there's no unique class of loans that are a line of business we're looking to exit. So I'd say steady state.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [14]

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Okay. Perfect. And then just on the NIM guide, I understand that, kind of, remaining at this similar level. Obviously, the benefit from purchase accounting accretion has been pretty high here. Do you have any, kind of, outlook for that? And maybe any underlying assumptions on rate hikes going into next year that's, kind of, included in the NIM guide at this point?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [15]

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Sure, Michael, it's Steve. In our outgo forecast, we have built in 3 rate hikes between now and the end of next year, which, I think, is generally what the market is showing. But relative to -- I think from a core NIM perspective, excluding all core -- excluding all accretion, our NIM this quarter was 3.88%. So we don't see any huge move one way or the other. It was up 7 basis points year-over-year. It's hard to know, honestly, from a forecasting perspective. But if you, kind of, look at it and think core NIM runs between 3.85% and 3.95% next year and then accretion is between 30 and 40 basis point next year that, kind of, gets you to your 4.15% and 4.25% guidance level.

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Operator [16]

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Our next question comes from Michael Rose of Raymond James.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD, Equity Research [17]

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So I just wanted to talk about mortgage for a second. So obviously, some good progress here and you guys are picking up the team from Cadence. So just wanted to get a sense. I think you talked about $1 billion of mortgage production. Does that include Cadence? And then as you think about the expenses that you laid out for the fourth quarter, Jennifer, does that include bringing on those folks?

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

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So I'll start with those questions, Michael. So yes, the guidance includes the origination team that we got from Cadence. And of course, we're actively recruiting, as we mentioned. I mean, we had 35 originators at the June 30. At the end of September, we had 60, I would guess. Based on the pipeline, we'll probably have 65 by the end of the year, is my guess. Our average retail producer does somewhere in the $15 million to $17 million range and that's where your retail guidance is. So it's potential that we could add a little bit more on that relative to wholesale, there'll be a little bit of that, but that's a lower margin business. But I think the guidance of about $1 billion is probably about right. As it relates to expense guidance, what we do around here, generally, is we reallocate expenses and that's what we're doing here. And within Jennifer's guidance is part of that related to the mortgage ramp up.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD, Equity Research [19]

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Okay, that's very helpful. And then maybe following up on the question around loan growth. I guess, if I split it into maybe expectations, not the remixing, but, I guess, what you would expect from core CenterState and then core Charter and how we should think about that. John, you've mentioned several times that you guys have pulled back a little bit, where later cycle you clearly could grow faster. Is there any difference in expectations for what you've acquired with Charter in terms of the growth rate versus what you guys are expecting at core CenterState?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [20]

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Yes. Thank you, Michael. The Charter franchise, in some respects, mirrors CenterState in that half of it is metro in Atlanta and half of it's nonmetro where there's some great sticky deposits. So I think we modeled -- when we did that deal and we announced it, we modeled that they would be at about 5% loan growth for the first year. And then as we recruit more and more people in Atlanta, it would migrate to our normal 10% growth rate, which is, kind of, how we construct the company. So I don't look for -- maybe a small slowdown, because of Charter in the first year, but not a long-term slowdown.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD, Equity Research [21]

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Okay. That's helpful. Maybe last one for me. So Brady asked the M&A question, I'll ask the buyback question. Yes, your stock, clearly at a discount to peers on an earnings basis, at least, as it stood as of yesterday. You guys have 3 million shares, I think, in authorization. I guess, what are your thoughts here once [year in, year] out, the Charter deal is closed and might you be in the market here in the near term?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [22]

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Yes. Michael, we consider ourselves active capital managers, I mean, that's our job. And we utilize capital management through M&A quite a bit and through our dividend and we've got a buyback plan in place, as you mentioned of 3 million shares. So I'll just tell you that, that's a daily constant evaluation of buyback versus M&A versus organic growth and we like having that flexibility. And we intend to respond when the market gives us opportunity. Unfortunately, when the market was really dropping a couple of weeks ago, we were in this lockout period. So that tends to be the way it works in life.

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Operator [23]

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Our next question comes from Stephen Scouten of Sandler O'Neill.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [24]

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I'm curious, I just wanted to make sure I'm understanding the guidance correctly. The 8% to 10% growth, is that truly net growth or are you thinking about that in some ways of, like, organic versus acquired runoff or anything like that? Because if I were to backout, I think, maybe, the Charter loans, I was getting more like 1% to 2% growth from the current quarter net. So I want to make sure I'm not thinking about it the wrong way.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [25]

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No, you're thinking about the right way. I mean, we think about building the company to grow everything good in the company 10% a year through a cycle. Typically, our goal would be to grow a little faster the first half of the cycle and then as we work in the back half, it might -- some of that growth rate may slowdown. But when we're talking about growth rates, we're talking about all-in the entire loan portfolio, not dividing it out. I mean, this quarter, the production was down. What you'll find in Florida, is the third quarter is always our seasonally slowest quarter of the year. If you look back to last year at this time, the company only grew loans 3%. And then in the fourth quarter, we jumped right back up last year to 8%. So it's a seasonally slow quarter for us in Florida. And we had some cases where, in this quarter, we had some loan closings we thought would close, but they were bigger commercial loans and they got pushed into the fourth quarter. So our guidance of upper single digits is all-in.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [26]

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Okay. That's very helpful. And can you maybe give some commentary on what you're seeing. I know you're only a month in full bore in Atlanta, I suppose, but can you give some commentary on what you're seeing in terms of the loan demand, the team that you have here and, kind of, what your plans are at this stage for, I guess, the remainder of this year and next year? And how do you think that demand dynamic could play out?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [27]

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Yes. We've got a great team with Charter up there today, and it's a very stable team, as I mentioned. And President of that bank, Lee, is continuing to be our leader up there in Georgia. So I would characterize it as steady right now. I think, I looked, and I've got it right here, I think, we're anticipating $50 million to $60 million of loan production in the fourth quarter from Charter. But our plan longer-term would be to really focus a lot of our hiring efforts in the metro markets that I mentioned earlier, and that includes Atlanta as well as Orlando, Tampa and Jacksonville. So we're not done investing. Jennifer talked about remixing some of those expense base and a lot of that will be in commercial RMs in Atlanta, Orlando, Tampa and Jacksonville.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [28]

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Perfect. John, and then maybe my last question would be around that correspondent banking teams. Steve, I know, you mentioned maybe 14 new banking clients and some improvements on the swap business. Do you think that could lead to a materially higher run rate in terms of what that business could deliver? Or are we still, kind of, in that $30-ish, kind of, million a year revenue run rate?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [29]

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Sure, Stephen. Yes, that's right. We've been running -- it's been reasonably consistent between $7 million and $8 million a quarter, which is back to your $30 million range. What we've seen is the interest rate swap business, it was a record quarter and the pipeline is a record quarter for us. The question -- so I guess, generally, we would say that it would be higher than $30 million from here. The negatives in that business, so the fixed income business, it's very challenging right now. But if we just get a little pickup from fixed income, it's been pretty muted, but if we get a little pick up, that should really bolster the entire business. Hopefully that's helpful.

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Operator [30]

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(Operator Instructions) Our next question comes from John Rodis of FIG Partners.

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John Lawrence Rodis, FIG Partners, LLC, Research Division - Senior VP & Research Analyst [31]

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Steve or Jennifer, maybe. Just on the operating expenses, you said $63 million core for the fourth quarter and is that into the -- into 2019 too?

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Jennifer L. Idell, CenterState Bank Corporation - Executive VP & CFO [32]

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So in 2019, we're expecting an efficiency ratio to remain around 50%. So we have anticipated Charter cost saves that are going to happen in the second quarter since we have the conversion in the first quarter. So you would expect that ratio to, kind of, drop down a little bit below 50%. But we're continuing to invest in the fee income lines of business to optimize return on assets, return on equity and these investments obviously result in additional variable comps. So in my comments, I mentioned $63 million after you get past the cost saved of Charter, that'll add about $8 million. So you're in $71 million, $72 million range. However, we want to continue that, because we're going to have continual variable comp that's increasing with the increased revenue line. So that's why we're, still in 2019, estimating a 50% efficiency ratio.

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John Lawrence Rodis, FIG Partners, LLC, Research Division - Senior VP & Research Analyst [33]

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Okay. And then Steve, I think, you, sort of, talked about the new hires on the mortgage side. You said some of those expenses could be offset with savings at other places. Is that correct?

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

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Yes. That's right. So back to the overall guidance, I think, as Jennifer is working towards the fourth quarter of $75 million, that's included the hires that we've made in there, it's included in there. If we can move the guidance, if we took the mortgage production from $1 billion to $1.5 billion, which I'm not suggesting we are, but if we did, certainly that would move the variable comp up as well.

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John Lawrence Rodis, FIG Partners, LLC, Research Division - Senior VP & Research Analyst [35]

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Okay. Fair enough. And then Steve, one other question for you just on the securities portfolio. I think, you said you sold off what Charter had. And would your expectations right now with the yield curve where it is just, sort of, keep the securities portfolio relatively flat?

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

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We -- I think the Charter securities portfolio was a couple of hundred million. I think we sold it off. And we had a fairly robust Fed funds balance at the end of the quarter, somewhere around $500 million, I want to say. We're averaging in some of that over the next quarter or 2. Rates have moved. The 5-year part of the curve when we closed Charter was somewhere in the 2.80% range and -- or maybe 2.70% range, now it's around 3%. So we think it's an attractive time to average in. So we won't -- I don't think it makes major changes to your model one way or the other. But we'll certainly be opportunistic.

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John Lawrence Rodis, FIG Partners, LLC, Research Division - Senior VP & Research Analyst [37]

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Okay. So -- but you could see it grow $100 million, $200 million, I guess?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [38]

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Right, that's right, yes.

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Operator [39]

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Our next question comes from Joe Fenech of Hovde Group.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - MD & Head of Research [40]

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You had mentioned that deposit costs were up 9 bps linked quarter with Charter. I apologize if I missed this earlier, but what would that have been -- what would they have been up without Charter? And how did beta change specifically for the legacy book this quarter from last?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [41]

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Sure, Joe. It's Steve. It's affected probably about 1 basis point or so. So if you do the math on that, it would've been up 8 basis points versus 7 last quarter, somewhere in there.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - MD & Head of Research [42]

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Okay. So no material impact?

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [43]

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No.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - MD & Head of Research [44]

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Okay. And then, John, sort of a bigger picture question for you. When you guys have bucked the trend as an acquisitive company, I'd say, whose stock still tends to go up when you announced deals, others haven't been nearly as fortunate, especially this year. Aside from the very high prices may be paid for some of these deals, which is an obvious reason why maybe why some have struggled. Is there some other common characteristic that you're seeing in these deals that isn't working out that you will look to avoid maybe as you move forward with your M&A strategy? Not asking you to comment on any specific deals, just some general thoughts if you have any on that?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [45]

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Yes. I wouldn't want to comment on any particular deal. But as I think about our strategy, it's really the same strategy. I mean, if you look back over, gosh, 8 or 9 deals, you'll see that the operating metrics in the box that we operate in is pretty consistent. We're normally less than 2 or 3-year earn back. We're normally mid-single-digit accretion. We're normally looking for a lot of cost saves through branch consolidation. So I think that approach is working well for us over the last 3 to 4 years. And to the extent that there is partners out there that fit that mold, we'll stick to our knitting with that. And the last piece is just it's easier to stick to your knitting if -- when you're working with these potential partners, it's a negotiated situation versus a bid situation. And I want to say if I look back, our last, probably 4 acquisitions were all negotiated, where we went in and, kind of, gave that guidance of those metrics on the initial conversation and then just worked with that partner to back into those metrics.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - MD & Head of Research [46]

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So maybe a combination of the marginal buyer, whereas 5 years ago, you were still doing -- staying within the box, maybe that marginal buyer is now going outside? And then also maybe some of the work you guy did years ago in, sort of, laying the groundwork with lot of these banks that you thought you might want to buy down the road. Combination of those 2 things, kind of, keeps you out of the penalty box if some of these other guys acquire or seem to be flipping into?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [47]

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Yes. We don't engage with folks that have a flipper mentality. We want to partner with folks that have an ownership mentality and a lot of -- as you just pointed out, Joe, a lot of these relationships are relationships that go back 5, 10, 15 years. And that gives us a great deal of comfort that the integrations are going to will go well, that we're going to retain the revenue producers and that we're going to have rational, reasonable negotiating partners.

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Operator [48]

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Our next question comes from Blair Brantley of Brean Capital.

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Blair Craig Brantley, Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst [49]

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Just a couple of quick questions. One on, kind of, the non-purchase loan growth. Can you just, kind of, talk about where you saw the -- some strength this quarter and where the -- and how the pipelines are looking?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [50]

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Yes. This is John. Let me see here. For the last quarter, where we saw the greatest production, we had 33% was nonowner-occupied commercial real estate, 19% was owner occupied, 10% was C&I and 24% was residential. So it was pretty balanced and diversified growth. As far as the markets where we were growing, most of it was along the I-4 corridor or the Orlando, Tampa, Lakeland markets. And then we did get some good production down in the Palm Beach, Broward County markets as well.

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Blair Craig Brantley, Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst [51]

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Okay. And then in terms of pipeline, how do they compare versus going into 2019.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [52]

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Yes. The pipeline was down slightly moving into the fourth quarter. But I was talking with our bank President, Mark Thompson, yesterday and the pipeline has grown about 15% since the beginning of the quarter. So within the fourth quarter, we've seen a nice ramp. So we were feeling more bullish about the fourth quarter production growth than we did in the third.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [53]

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And Blair, this is Steve. One other thing to think about is, there is production and there is the funding rate. And the last quarter, our funding rate was around 66%, which was the lowest we've had in a long time. So I think ultimately, if those funding rates get back up to more normalized, I think, we should be fine.

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Blair Craig Brantley, Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst [54]

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Okay. And then on -- with fee income, I just -- what was the SBA impact this quarter? And just any thoughts given, kind of, where some -- the gains have, kind of, pulled back some recently?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [55]

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Sure. I think on the --

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [56]

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Yes, this is Steve. Mark Bryant, who leads our program there, I think, we did about $1 million in fee revenue there, which was pretty consistent with first quarter and second quarter. And ultimately, I think, a year ago, we didn't have very much at all, I don't have in front of me.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [57]

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$250,000 a year ago. This quarter was around $1.20 million.

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Stephen Dean Young, CenterState Bank Corporation - Executive VP & COO [58]

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Yes, and I think, we're on pace to do about $50 million of production in that business. And the hope is that next year, we can maybe make that $75 million or $80 million as we continue to grow.

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Blair Craig Brantley, Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst [59]

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Okay. But no concerns about, kind of, the pull back in some of those premiums as of late?

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [60]

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I don't think it's -- back to when you're ramping a business, it's, kind of, like mortgage. A lot of people are talking about the gains on sale, margins and so on, like that. Actually, our gain on sale margin and mortgage actually expanded a little bit to 2.92% versus 2.80% the prior quarter. And I think it's just because we don't have -- we're starting from a low base and so when you start from a low base, your stats are probably not as accurate. But as you start getting more data -- same thing with SBA, the premiums are coming down, but we didn't have a big enough shop to begin with and we're ramping production. So I think that's, kind of, the 2 offsets.

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Operator [61]

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Our next question is a follow-up from Michael Young of SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [62]

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Just one quick modeling question on the Durbin impact and maybe any other $10 billion asset-related impacts going into next year? If you could just comment on those?

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Jennifer L. Idell, CenterState Bank Corporation - Executive VP & CFO [63]

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Sure, Michael. This is Jennifer. So we had modeled, back when we did Harbor, a $7 million impact to the total company and we included that in the modeling that we did when we purchased Harbor. Subsequently, Charter came on board. And we talked about this on the Charter acquisition call, where they had a very low estimated Durbin impact of about $250,000, because of the way that they handled their interchange income. And so we're still refreshing those numbers as we continue to get more data, but we continue to believe that that's the impact that we'll have, it's a little over $7 million from a Durbin perspective. We also have about a -- back at this point about a year ago, we estimated about $2 million FDIC insurance premium. We continue again to update that model, but don't see a lot of changes in that as we forecast that. So the change really comes in about $1 million we had from a DFAST perspective. And with DFAST no longer being an issue, we will still have a little bit of increase. We've already invested in an updated AON model, but that was very minimal cost and capital stress testing, kind of, person, if you will, but not to the level of the DFAST. So that $1 million is going to be significantly less. So in all in all, it was $10 million pretax. We still think the $7 million and the $2 million is good. And then probably maybe about half of that $1 million from a DFAST perspective. So I would say that the original estimations are still in line.

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

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And then the Durbin kicks in, Jennifer, third quarter of next year, correct? July 1?

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Jennifer L. Idell, CenterState Bank Corporation - Executive VP & CFO [65]

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That's correct.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [66]

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Will be half a year?

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Jennifer L. Idell, CenterState Bank Corporation - Executive VP & CFO [67]

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Half a year of that $7,250,000.

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Operator [68]

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There are no further questions. I'd like to turn the call back over to John Corbett for any closing remarks.

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John C. Corbett, CenterState Bank Corporation - President, CEO & Director [69]

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All right, Michelle. Thank you for calling in today and your continued interest in our company. Steve and I are going to be attending the Sandler Conference in Palm Beach next week, and look forward to seeing a number of you there. This concludes our call. Have a good day.

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Operator [70]

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