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South State CenterState MOE Shows Even The Strong Need Scale To Thrive

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South State CenterState MOE Shows Even The Strong Need Scale To Thrive

The merger of equals between South State Corp. and CenterState Bank Corp. shows a growing push to achieve scale to combat earnings pressures and meet customer needs.

South State and CenterState are joining forces in another MOE driven by the desire to invest in technology. But the transaction stands out as both institutions felt the need to partner despite already operating on a strong footing, as we discuss in the latest "Street Talk" podcast.

South State and CenterState have earned their independence and boast young management teams that have demonstrated an ability to grow while producing attractive returns for shareholders. South State's returns on average assets and average equity in 2019 and 2018 were roughly in line with the median reported by peers — banks with between $10 billion and $50 billion in assets — but its shares have traded at a considerable premium to the SNL U.S. Bank and Thrift Index over the last year. CenterState shares have traded at a smaller premium, although its returns were notably higher than peers during the same time frame.

The two franchises arguably had a variety of strategic options and could have used their currencies to pursue additional acquisitions on their own. Their decision to partner underscores the slow-growth environment facing the industry and the fact that banks risk losing their competitive edge if they do not invest in digital channels.

When announcing the deal, the companies said they saw the banking business undergoing large changes and decided it was necessary to take action to provide a greater level of digital convenience to customers.

"Look, both companies were incredibly strong companies, standalone and individually," CenterState CEO John Corbett said on a conference call to discuss the MOE. But Corbett, who will be chief executive of the combined company, said he and South State CEO Robert Hill Jr. simply saw where the industry is heading. "If you have an opportunity to put the two best companies together, you take it before the opportunity passes you by. But clearly, digital is future."

There were similar motivations in other large MOEs announced last year, including the mergers of BB&T-SunTrustFirst Horizon National Corp.-IBERIABANK Corp. and Independent Bank Group Inc.-Texas Capital Bancshares Inc.

The urgency to act has grown as traditional banks have seen digital-only platforms grow retail deposits at a far faster clip in recent years. Many of those digital-only players attract customers with above-market rates, but some others like Chime have gained prominence by touting convenience and accounts with no fees. Big tech has encroached on traditional bank offerings even more recently, with Apple marketing a credit card and Google announcing plans to unveil a checking account this year through partnerships with Citigroup Inc. and Stanford FCU.

CenterState has produced strong returns in spite of growing competition but Corbett said South State has made greater progress on its digital transformation, with the company's COO Renee Brooks leading that effort. Brooks, who will become COO of the combined South State/CenterState franchise, touted efforts to modernize its offerings in a panel discussion in early December, noting that digital channels are responsible for 80% of new checking accounts opened at the bank.

"Without the channel, you could miss out," Brooks said at the event. "80% are brand-new customers coming to the bank. They wanted to open their account at 9 o'clock at night, and they couldn't find you online, then they're just going to go to the next bank."

The deal will also help the combined company drive earnings higher at a time when growth is hard to come by. South State and CenterState believe their MOE will be 20% accretive to earnings in 2021, offering a considerable boost to the bottom line.

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Virtually all banks have faced pressure on their net interest margins in recent quarters as the flat-to-inverted yield curve resulted in loan yields moving lower, while many in the industry struggled to report material decreases in deposit costs. While margins could stabilize soon, credit costs are unlikely to decline from current levels. And cost savings from deals can offer an attractive vehicle for growth, particularly when balanced against the prospect of producing above-average loan growth late in the cycle.

CenterState's Corbett had noted in July 2019 that the industry faced revenue headwinds, and deals could offer the easiest path to growth.

"So if we're going to get to growth in earnings per share, it may have to come on the expense side and 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," Corbett said at the time.

CenterState executives acknowledged on the call discussing the MOE that growth could be slower in the future. CenterState had maintained that it could grow 10% a year over a long period of time, even after acquiring National Commerce last year. However, the company noted that certain economies will allow for slower growth within its "credit box."

"And we think for the foreseeable future that a growth rate in mid-single digits is probably more realistic to expect," CenterState CFO Will Matthews said on the MOE call.

A more conservative growth outlook combined with the need to meet growing customer demands for digital offerings seems like it was enough to accelerate long-standing talks between South State and CenterState. Given that those issues likely are not unique to the two institutions, other banks might be more willing to move forward with any ongoing merger talks of their own.

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