FIRST FINANCIAL BANKSHARES INC quarterly report, Q3 FY2018

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First Financial Bankshares, Inc. — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018. Unaudited results; dollar amounts below are in millions unless stated otherwise. The company operates a full-service commercial bank primarily in Texas and reported 72 financial centers.

Financial performance and condition

  • Third quarter: Net earnings were $40.1 million, up from $29.4 million a year earlier; diluted EPS was $0.59 versus $0.44. Net interest income was $69.4 million, provision for loan losses $1.5 million, noninterest income $27.1 million, and noninterest expense $47.5 million.
  • First nine months: Net earnings were $112.2 million versus $84.2 million; diluted EPS was $1.65 versus $1.27. Net interest income was $202.5 million, provision for loan losses $3.9 million, noninterest income $77.0 million, and noninterest expense $142.4 million. Operating cash flow was $158.9 million, compared with $155.1 million in 2017; investing cash outflow was $185.1 million and financing cash outflow $146.7 million.
  • Margins and returns: Third-quarter net interest margin was 4.01%, up 7 basis points year over year; nine-month margin was 3.94%, down 7 basis points. Third-quarter return on average assets/equity was 2.10%/16.00%; nine-month figures were 1.97%/15.43%. Efficiency ratio was 48.12% for Q3 and 49.73% for the nine months, versus 48.71% and 49.22%, respectively.
  • Balance sheet at September 30: Total assets were $7.57 billion; loans held for investment were $3.87 billion, net of a $50.9 million allowance; available-for-sale securities were $3.14 billion. Deposits totaled $6.15 billion and borrowings $380.8 million. Shareholders’ equity was $995.7 million, or 13.15% of assets. Cash and cash equivalents were $199.5 million.
  • Capital and liquidity: Consolidated total risk-based capital, Tier 1, common equity Tier 1 and leverage ratios were 20.34%, 19.19%, 19.19% and 11.57%, respectively. The company reported $1.20 billion of available FHLB capacity, with no advances or letters of credit outstanding, and undrawn federal funds lines totaling $130 million. Management considered liquidity adequate and reported compliance with the Frost Bank credit covenants.

Material changes versus comparable periods

  • Results benefited from the January 1, 2018 acquisition of Commercial Bancshares/Commercial State Bank, which added Houston-area operations, loans and deposits. The company issued 1.29 million shares; acquisition goodwill was $31.6 million. Management identified the acquisition and lower corporate tax rates as key drivers of higher earnings.
  • The Tax Cuts and Jobs Act reduced the federal corporate rate from 35% to 21%. Reported effective tax rates were 15.73% for both the three- and nine-month 2018 periods, versus 23.84% and 23.10% in 2017. Excluding the tax adjustment, management stated Q3 net earnings would have been $34.88 million and nine-month earnings $98.13 million.
  • Loans held for investment grew $381.5 million from December 31, 2017, primarily due to the acquisition. Deposits increased $182.3 million over the same date, also primarily due to the acquisition. Compared with September 30, 2017, total loans and deposits were higher by about $394.8 million and $447.8 million, respectively.
  • Net interest income rose, supported by earning-asset growth and higher loan yields. Deposit interest expense increased to $4.3 million in Q3 from $2.2 million a year earlier as deposit rates rose. The company shifted its securities mix away from tax-exempt municipal securities toward taxable and mortgage-backed securities after the tax-rate reduction.
  • Available-for-sale securities had $54.5 million of gross unrealized losses at September 30, 2018, versus $12.5 million at year-end 2017. Accumulated other comprehensive loss was $28.0 million, compared with $26.8 million of accumulated other comprehensive earnings at year-end. Management attributed the securities losses primarily to interest rates, and did not consider them other-than-temporary.
  • Nonperforming assets rose to $26.9 million, or 0.69% of loans and foreclosed assets, from $20.1 million and 0.57% at year-end 2017. Nonaccrual loans were $25.6 million versus $17.7 million at year-end. The allowance was 1.31% of loans, down from 1.38% at year-end.

Outlook, commentary, risks and unusual items

  • The filing provides no specific earnings or revenue guidance. Management said it did not anticipate a significant change in its dividend policy; its long-term target is dividends of approximately 40% of annual net earnings, subject to capital and a 55% net-income covenant limit.
  • Management cited ongoing Federal Reserve rate increases and anticipated further increases in 2018 and 2019. Its September 30 interest-rate simulation projected net interest income changes over 12 months of +0.38% for a 100-basis-point rise, +0.40% for a 200-basis-point rise, and -2.06% for a 100-basis-point decline. The filing cautions that these are assumptions-based estimates, not forecasts.
  • Key stated risks include economic and Texas real-estate conditions, severe weather, oil and gas prices, interest-rate and funding changes, loan credit quality, securities valuation, regulatory or tax changes, competition, cyber and information-system risks, and acquisition integration. Hurricane Harvey-affected regions included $474.3 million of loans in the Conroe region and $399.1 million in Southeast Texas/Orange; management reported minimal losses to date and no identified credit-related municipal bond losses.
  • Q3 gains on securities sales were $0.1 million, down from $1.1 million a year earlier. Nine-month acquisition-related technology contract termination and conversion costs were $1.55 million. The company changed mortgage-loan sales to mandatory delivery and began using forward mortgage-backed securities to manage related rate exposure.
  • At September 30, the company reported $981.95 million of commercial commitments, including unfunded lines, credit commitments and standby letters of credit. The filing says many commitments are expected to expire undrawn. It reported no material pending legal proceedings and no material change in previously disclosed risk factors.

Important facts for investors to verify

  1. How much of earnings growth reflects the acquisition and tax-rate change versus ongoing organic performance; review the company’s stated tax-adjusted earnings figures.
  2. Whether loan growth and increased nonaccrual loans, particularly in real estate and commercial lending, lead to higher future provisions or charge-offs.
  3. How rising deposit costs, asset repricing and the changing securities mix affect net interest margin and funding needs.
  4. Whether unrealized securities losses remain interest-rate-related and whether any liquidity needs could require securities sales before recovery or maturity.
  5. Acquisition integration, the $31.6 million of goodwill, the $1.55 million of conversion costs, and the potential effects of the $10 billion asset threshold on interchange-fee economics.