GREAT SOUTHERN BANCORP, INC. quarterly report, Q1 FY2019

Great Southern Bancorp, Inc. — Q1 2019 Form 10-Q

Business context and period. Great Southern is a one-bank holding company operating primarily through Great Southern Bank, serving customers mainly in the Midwest and originating commercial loans in several other markets. This unaudited report covers the three months ended March 31, 2019; balance-sheet comparisons are with December 31, 2018.

Financial performance and position

Metric	Q1 2019 / March 31, 2019	Comparable period / Dec. 31, 2018
Net income	$17.6 million; diluted EPS $1.23	$13.5 million; diluted EPS $0.95 in Q1 2018
Net interest income	$44.6 million	$39.4 million in Q1 2018
Net interest margin	4.06%	3.93% in Q1 2018
Total assets	$4.78 billion	$4.68 billion
Net loans	$4.05 billion	$3.99 billion
Deposits	$3.96 billion	$3.73 billion
Stockholders’ equity	$543.6 million; 11.4% of assets	$532.0 million; 11.4% of assets
Cash and cash equivalents	$206.1 million	$202.7 million

• Interest income rose 22.3% to $57.4 million; interest expense increased 71.3% to $12.8 million, largely as deposit costs rose. Non-interest income was $7.5 million and non-interest expense $28.5 million. The efficiency ratio improved to 54.74% from 61.05%.
• Operating cash flow was $29.8 million; investing activities used $88.2 million and financing activities provided $61.8 million. Cash increased $3.3 million during the quarter.
• At quarter-end, short-term borrowings and other interest-bearing liabilities were $22.2 million, reverse-repurchase obligations were $118.6 million, subordinated debentures were $25.8 million and subordinated notes were $74.0 million net of issuance costs. No FHLBank advances were outstanding.
• Bank regulatory capital ratios were 12.5% CET1, 12.5% Tier 1, 13.4% total capital and 12.1% Tier 1 leverage; the Bank reported that it was well capitalized. Tangible common equity to tangible assets was 11.21%.
• The allowance for loan losses was $38.7 million. Non-performing assets excluding FDIC-acquired assets were $10.3 million, or 0.22% of assets; non-performing loans were $4.6 million. Potential problem loans increased to $5.1 million from $3.3 million.

Material changes versus comparable periods

• Net income increased 30.8% year over year, chiefly reflecting $5.2 million higher net interest income and $0.5 million higher non-interest income, partly offset by higher taxes and expenses.
• Average loan yield rose to 5.42% from 4.84%, while deposit costs increased; net interest margin improved 13 basis points. Management attributed margin gains partly to higher loan and investment yields, with higher funding costs a partial offset.
• Net loans increased $61.3 million from year-end, but gross loans excluding FDIC-acquired loans and loans held for sale declined $11.4 million. Commercial construction, commercial real estate and multifamily lending grew; consumer auto balances fell.
• Deposits grew $231.1 million, including increases in transaction accounts and certificates of deposit. Brokered deposits, including CDARS purchased funds, rose to $400.8 million from $326.9 million.
• Short-term borrowings and other interest-bearing liabilities fell $170.5 million, primarily because $178.0 million of overnight FHLBank borrowings outstanding at year-end were repaid. Securities sold under reverse repurchase agreements increased $13.3 million.

Outlook, management commentary, risks and unusual items

• No specific earnings or revenue guidance was provided. Management expected an effective tax rate of approximately 17.5%–19.0% in future years. Its interest-rate models indicated rising rates generally benefit net interest income and falling rates generally hurt it, with limited modeled impact in the first 12 months and potentially greater effects over 12–36 months.
• Management said it expects to recognize $1.7 million of remaining acquired-loan accretable yield during the rest of 2019; the remaining adjustment was $2.8 million at March 31. Q1 accretion contributed $1.5 million to net interest income and 13 basis points to margin. Future cash-flow estimates for acquired loans may change.
• The Company ceased indirect automobile lending effective March 31, 2019, citing competition and challenges to long-term profitability. It will continue servicing existing loans; the indirect portfolio was approximately $180–$184 million at quarter-end, with management expecting much of it to run off over two to four years. The Company also consolidated its Fayetteville, Arkansas branch into Rogers in April 2019.
• A $400 million interest-rate swap hedging floating-rate loans generated $513,000 of Q1 loan interest income and an after-tax $5.8 million gain in other comprehensive income. The swap could reduce loan interest income if one-month LIBOR exceeds its fixed receipt rate of 3.018%.
• Other income included $677,000 of gains from sales or recoveries of assets acquired in FDIC-assisted transactions. Management considered available-for-sale securities’ unrealized losses temporary and reported no other-than-temporary impairment in the quarter.
• Lease accounting adoption on January 1, 2019 recognized a $9.3 million right-of-use asset and $9.3 million lease liability; management reported no material income-statement impact.
• Key risks cited include credit losses and collateral values, economic and real-estate conditions, interest-rate movements, deposit competition and access to brokered deposits or other funding, regulatory changes, cybersecurity, litigation and competition. Management said no material risk-factor changes had occurred since the 2018 Form 10-K. It also stated disclosure controls were effective and there were no material changes to internal control over financial reporting.
• The Company was implementing the expected-credit-loss standard for adoption in Q1 2020. Management expected a one-time allowance adjustment but could not estimate its size or overall financial-statement impact.

Important facts for investors to verify

• Whether deposit growth—particularly higher-cost time and brokered deposits—can support loan and securities funding without materially pressuring margins.
• Credit performance in commercial real estate/construction and consumer auto, including the increase in potential problem loans and the adequacy of the allowance.
• The future contribution and collectability of FDIC-acquired loan pools, including the timing and sustainability of accretable-yield income.
• The runoff, credit quality and earnings effects of the discontinued indirect auto portfolio.
• The 2020 expected-credit-loss adoption impact, and the sensitivity of earnings to rates, the $400 million hedge and changing funding costs.
• The sustainability of the $1.07 per-share Q1 dividend declared, which included a $0.75 special dividend; the declared amount equaled 87% of diluted Q1 EPS.