SouthState Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

SouthState Corporation is a financial holding company operating in the Southeastern US, primarily engaged in providing commercial and retail banking services, as well as wealth management services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

SouthState operates a network of over 230 branches in Florida, Alabama, Georgia, North Carolina, South Carolina, and Virginia. The company’s main business activities include offering retail and commercial lending solutions, treasury and related services, and wealth management options.

Business Overview:

  • Revenue Distribution: SSB generates its revenues primarily through three main channels:
    1. Net interest income (NII): Driven by the difference between the interest earned on loans and other earning assets and interest paid out on deposits and other funding liabilities.

NII constitutes the bulk of revenue for traditional banks and is more reliable and less volatile than other streams. 2. Fee and Commission income: This includes banking service charges, trust fees, brokerage commissions, and revenues from other similar services. 3. Trading Income: In addition to those two segments, the company earns some revenue via various market-based and proprietary trading activities. This income stream can be volatile because it depends on the market conditions.

  • Industry Trends: The banking sector in the U.S. is currently facing both opportunities and challenges.
    • On one hand, interest rates increases create better yields and hence higher net interest income for the banks.
    • On another hand, banks face an ever-increasing regulation, a rapidly changing technological landscape, and aggressive competition from traditional and new players (FinTech).
  • Margins: The bank’s profitability is primarily measured by its net interest margin (NIM), which stood at 3.5% during the recent quarter (10-Q). NIM reflects the difference between the interest earned on loans and other earning assets and the interest paid out on deposit. This number is not particularly high for the industry and shows a significant dependency on higher interest rates.
  • Competitive Landscape: SSB operates in the highly competitive banking sector in the Southeast region of U.S. It faces competition from larger national banks, regional banks, community banks, and non-banking fintech firms. Competition exists in both the loan and deposits market.
  • What Makes the Company Different: SSB’s primary differentiation comes from its customer service focus and local knowledge. It prides itself on having a strong community presence and intimate customer relationships. Although these may appear strong, its financial strength as a mid-sized bank are more comparable to other peers.
  • Recent News:

Merger Concerns and Shareholder Vote: * SouthState and Independent Bank Group Inc. (IBTX) agreed to combine, a deal expected to close in 2024. However, at a recent conference call, after the latest earnings report, a shareholder asked about potential downside if this merger does not complete (and he gave the reason that IBTX’s shares have struggled and are trading at discounts). The management said that if the merger did not work out, they would consider other opportunities to generate additional shareholder value, including M&A opportunities, implying that the merger is not required for them to thrive. There are concerns if IBTX shareholders will approve the merger, or if this merger is priced appropriately. It should also be noted that SouthState has given guarantees regarding the stock price, and they might be liable for extra payments should that price fall.

Economic Outlook: * The Federal Reserve has increased the interest rates aggressively to fight against inflation. This could benefit the bank’s earnings, however, it is also likely to dampen the loan demand if the economy slows down. * SouthState is seeing the positive effect of this rising rate environment on its net interest margins. The company’s management has noted that they expect to see a NIM above 4% in the near term. * However, they have also noted that it becomes very difficult to predict interest rate levels from here.

  • Earnings Call Highlights:
    • Management highlighted that the bank is continuing to work on their CRE (Commercial Real Estate) portfolio and trying to reduce risk.
  • Management expects a slight increase in the charge-offs for 2023, which is a metric for bad loans. * They also see an upcoming slowdown in the economy and are ready to adjust their business model according to that. * The company is aiming for a loan growth of 5-10% in the near term.
  • Key Operational Details:
    • The Company has been improving its core banking, by using modern technology to provide better services and improve internal systems, including AI technology in some of their segments.
    • Management stated that the company is doing well in the areas where they have a big presence (Florida, for example). However, they also believe the company’s growth rate in areas where they have a smaller presence can do better. Thus, their growth strategy is focusing on growing in areas where they are already having operations and expanding into new geographies.

Financial Analysis:

  • Profitability: The company’s profitability, measured by both return on invested capital (ROIC) and economic profit (economic profit = NOPLAT-WACC*Invested Capital), has not been impressive. The company hasn’t produced attractive ROICs and it only produces a marginal economic profit. However, there has been improvement over the previous few years in both these metrics.
    • ROIC has shown a lot of variation over the years and hasn’t been above 10%. This indicates that while the bank may be showing good results, it might not be efficient in its operations.
    • However, it must be noted that the banking industry is such that it can be profitable even with negative economic profit. That profitability and value is mostly driven by the bank’s spread, loan volume, and loan growth.
  • Balance Sheet:
    • The company’s balance sheet is somewhat complex due to the number of nonoperating items they have. However, the debt to equity and debt to market capitalization ratios are in line with the banking industry.
    • The company’s main assets include loans, available-for-sale securities and investment securities, which add up to around $51B.
    • The company’s liabilities are primarily composed of deposits ($40.8B) and borrowings ($6.4B), with an equity of $4.5B.
  • Growth: Although the company has seen some positive growth, it is hard to determine whether this growth will persist. Also, it is important to note the company has been very active in M&A, so there might be some one-time effects.
  • Capital: The company continues to exceed regulatory capital requirements. For the quarter ending September 2022, the Tier 1 Capital Ratio stood at 10.55%, which is well above the 6% required by law.
  • Capital Allocation: The bank’s managers plan to deploy cash for various purposes including reinvesting in the business by loan growth, dividends, and opportunistic share repurchases.

Moat Assessment (2/5):

A moat in investing is a structural competitive advantage of a business that will protect it from competition, allowing it to sustain higher returns over a long period of time.

  • Intangible Assets: SSB benefits to some extent from its brand recognition within its operating geography but its brand is not a national brand, and it can easily be duplicated by other community banks. Also, they have some technology-based services but they are not unique in nature. Thus, we do not see strong intangible asset moats here.

  • Switching Costs: Switching costs are somewhat high because customers are unwilling to switch over from the bank due to switching costs, the hassle of moving all the banking information and procedures. However, these switching costs are not unique to SSB and are common in other community banks, making this a weak moat.

  • Network Effects: Given its nature as a regional bank, it does not have network effects. Other regional or community banks can take away business by giving same or better offerings, so this is not a source of a moat.

  • Cost Advantages: The bank has not displayed any cost advantage, compared to its peers. Its profit margins are reasonable, but aren’t exceptional. Its operations aren’t unique and can be copied by other competitors. For a traditional bank, cost advantages are hard to achieve.

Therefore, I would give a moat rating of 2/5. It is a combination of some small barriers and advantages due to switching cost, and their local network.

Risks to Moat and Business Resilience:

  • Regional Competiton: As a bank with a regional presence, a local economic slowdown in the Southeast region could negatively impact its ability to grow its loan portfolio and could also cause it to have credit losses.
  • Interest Rate Sensitivity: The bank’s earnings and profitability highly depend on the interest rate, so changes in interest rates are likely to cause swings in performance.
  • Regulatory Risks: The company is subjected to a variety of banking regulations, which can impose certain restrictions or additional costs to the business.
  • Merger Integration Risks: Given the planned merger with IBTX, the process may not go as planned and might negatively impact the financial performance.
  • Economic Downturn: Like all banks, a strong recession could impact the loan and deposit portfolio, which may cause large losses.

Given these risks, the resilience of the business is questionable, though its solid regional presence and good balance sheet should help it survive downturns. The risks are common to all the banking industry.

Understandability (2/5):

While the core banking operations are relatively simple to understand, analyzing a bank’s financial statements, especially for a company undergoing acquisition, can be difficult and time consuming. The following elements make the company a complex one to understand:

  • A large number of assets that are categorized as non-operating.
  • Complex financial statements with a high number of lines, footnotes, and accounting practices specific to banks.
  • The company is also undergoing acquisition, and so understanding its operations requires understanding the merging business too.
  • The company faces a highly regulated industry.

Due to these factors, the business is not very easy to understand and requires a considerable amount of skill to value.

Balance Sheet Health (4/5):

  • The company has a reasonable leverage.
  • The assets are primarily comprised of loans, which are traditionally risky and susceptible to changes in the economy, the bank’s capital and liquidity ratios are adequate.
    • Their capital position has improved over the previous years.
  • Though the bank does hold some non-marketable securities, their composition has improved over the last years.
  • The company has a large amount of deposits and the company is taking steps to grow the deposits more.
  • Given the overall factors, the bank’s financial health is good.

Due to its overall financial strength, I would rate it 4/5 for balance sheet health.