Great Southern Bancorp, Inc. — Q3 2014 Form 10-Q
Business context and period. Regional bank holding company operating through Great Southern Bank, with lending and deposit operations primarily across Missouri, Iowa, Kansas, Minnesota, Nebraska and Arkansas, plus commercial loan offices in Texas and Oklahoma. Unaudited results cover the three and nine months ended September 30, 2014; balance-sheet comparisons are with December 31, 2013. Amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Interest income | $47.6 | $43.0 | $134.3 | $133.9 |
| Net interest income | $44.1 | $38.5 | $122.0 | $119.1 |
| Provision for loan losses | $0.9 | $2.7 | $4.1 | $14.6 |
| Net income | $11.6 | $8.4 | $31.5 | $25.1 |
| Net income available to common shareholders | $11.4 | $8.3 | $31.0 | $24.6 |
| Diluted earnings per common share | $0.83 | $0.61 | $2.25 | $1.80 |
| Net interest margin | 4.91% | 4.64% | 4.75% | 4.60% |
| Efficiency ratio | 64.07% | 66.40% | 66.25% | 62.89% |
For Q3, non-interest income was $1.8 million and non-interest expense was $29.4 million. For the nine-month period, those figures were $13.3 million and $89.7 million, respectively. The reported 2013 comparisons were retrospectively adjusted for an accounting presentation change that moved affordable-housing investment amortization from non-interest expense to income-tax expense, with no effect on net income.
- Balance sheet at September 30: Total assets were $3.91 billion, up 9.8% from year-end; net loans were $2.92 billion, up 19.8%; deposits were $3.07 billion, up 9.4%; and stockholders’ equity was $409.1 million, versus $380.7 million at year-end.
- Funding and debt: FHLB advances were $190.7 million, versus $126.8 million at year-end; customer reverse-repurchase agreements were $171.8 million, versus $135.0 million; subordinated debentures were $30.9 million. The $50 million structured repurchase agreement was repaid in June. The company also repaid $80 million of FHLB advances during the nine months.
- Liquidity: Cash and cash equivalents were $221.4 million. Management reported available secured lines of $491.2 million at the FHLB and $545.3 million at the Federal Reserve, plus $84.5 million in unpledged securities. Operating cash flow was $34.0 million, investing cash flow was $107.0 million, and financing activities used $147.5 million in the first nine months.
- Capital: Company tangible common equity to total assets was 8.8%. The Bank’s Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 12.0%, 13.3% and 9.4%, respectively; management reported the Bank and holding company as well capitalized under then-current requirements.
Material changes and unusual items
- Valley Bank acquisition completed June 20, 2014. It added deposits and loans; the company recorded a preliminary $10.8 million bargain-purchase gain. Acquired Valley loans had a $152.5 million carrying value at September 30. System conversion was completed October 24, after quarter-end.
- Loan growth reflected the Valley and Boulevard transactions and organic originations. Excluding acquired covered and non-covered loans and mortgage loans held for sale, loans increased $367.7 million from year-end. Available-for-sale securities declined $130.1 million, partly as securities were sold and proceeds used to fund lending.
- Nine-month earnings benefited from lower loan-loss provisions and the Valley acquisition gain, but were partly offset by $7.4 million in one-time borrowing prepayment penalties and acquisition-related costs. Valley-related non-interest expenses were approximately $2.9 million for the nine months.
- Q3 net income increased 37.3% year over year; nine-month net income increased 25.6%. Lower provisions, increased net interest income and higher non-interest income were key contributors. Nine-month non-interest expense rose 13.8%.
- Reported acquired-loan cash-flow adjustments contributed $3.9 million to pre-tax income in the nine months: $25.8 million added to interest income was substantially offset by $21.9 million of lower non-interest income. Management expected a further $7.2 million of interest income and $6.0 million of negative non-interest income effect from remaining adjustments in the remainder of 2014; additional revisions remained possible.
- Asset quality improved on reported legacy measures: non-performing assets, excluding FDIC-covered and acquired non-covered assets, were $47.1 million, or 1.21% of assets, versus $62.3 million, or 1.75%, at year-end. Non-performing loans were $12.0 million; troubled debt restructurings were $52.1 million, down from $54.1 million. Total other real estate owned was $43.8 million. The allowance was $38.1 million; its ratio to loans excluding FDIC-covered loans was 1.43%.
Outlook, commentary and risks
- Management said 2014 provision expense and net charge-offs would likely remain below 2013 levels, while cautioning that credit costs are difficult to predict and could rise if economic conditions deteriorate or estimates change.
- Management expected the effective tax rate typically to be 20%–25%, subject to tax-credit use, tax-exempt income and pre-tax earnings. No formal earnings or revenue guidance was provided.
- Management described improving regional employment and commercial real estate conditions, but noted housing affordability, tight inventories, lending competition and uncertain future loan demand. Interest-rate risk remains significant; most identified prime-based adjustable-rate loans were at contractual floors, which may constrain upside when rates rise and can increase refinancing risk.
- Deposit competition and reliance on brokered deposits and FHLB advances are funding risks. Brokered deposits were $150 million, up from $50 million at year-end. Approximately $80 million of Valley internet-bulletin-board deposits had been withdrawn by September 30.
- FDIC loss-sharing coverage on non-single-family TeamBank loans ended March 31, 2014, and coverage on non-single-family Vantus loans ended September 30, 2014. Future losses on those portfolios are no longer covered; the respective remaining loan carrying values were $28.3 million and $23.5 million. Other acquired-asset cash flows and FDIC indemnification estimates remain judgment-sensitive.
- Basel III capital requirements were scheduled to begin taking effect January 1, 2015. The filing also identifies economic, credit, interest-rate, regulatory, acquisition-integration, liquidity, litigation and competition risks.
- A certified class-action case alleges the Bank’s automated overdraft fees violate Missouri usury law. Management said it could not determine the probability of a material adverse outcome or reasonably estimate a potential loss. Management otherwise believed pending and threatened litigation would not materially adversely affect the company.
Most important facts for investors to verify
- How much of earnings and net interest margin depends on acquired-loan accretion and related FDIC indemnification adjustments, and how estimates may change.
- Final Valley acquisition accounting and integration results, including whether the preliminary $10.8 million gain changes and whether expected cost savings are realized.
- Credit performance, allowance adequacy, troubled debt restructurings and foreclosed-asset valuations, especially as FDIC coverage expires on acquired portfolios.
- Deposit stability, brokered-funding dependence, available borrowing capacity and the effect of deposit pricing competition on funding costs.
- Capital and dividend capacity under new regulatory rules, the SBLF preferred-stock terms and any constraints on repurchases or distributions.
- Developments in the overdraft-fee class action and the company’s ability to manage interest-rate exposure, including loans at rate floors.