SIMMONS FIRST NATIONAL CORP annual report, FY2013

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Business context and reporting period

Simmons First National Corporation filed this Form 10-K for the fiscal year ended December 31, 2013. The Arkansas-based financial holding company operated community banks in Arkansas, Missouri and Kansas, with 131 financial centers. At year-end it reported $4.38 billion in assets, $2.40 billion in loans, $3.70 billion in deposits and $403.8 million in stockholders’ equity.

The major strategic event was the November 25, 2013 acquisition of Metropolitan National Bank for $53.6 million in cash. Metropolitan added about $884 million of assets at acquisition and materially increased the company’s scale. The filing also includes subsequent events announced in March 2014.

Key financial metrics

  • Earnings: Net income was $23.2 million, down 16.1% from $27.7 million in 2012. Diluted EPS was $1.42 versus $1.64. Management’s non-GAAP core earnings were $27.6 million, or $1.69 per diluted share, up from $26.9 million, or $1.59, in 2012.
  • Interest income and margin: GAAP net interest income rose 15.3% to $130.9 million. On a fully taxable-equivalent basis, net interest income increased 14.9% to $135.8 million and net interest margin improved to 4.21% from 3.93%.
  • Other income and expenses: Non-interest income fell 16.0% to $40.6 million; non-interest expense rose 14.5% to $134.8 million. The efficiency ratio increased to 71.28% from 70.17%, indicating weaker operating efficiency.
  • Cash flow: Operating activities provided $36.1 million; investing activities provided $8.4 million; financing activities used $42.9 million. Cash and cash equivalents ended the year at $539.4 million, compared with $537.8 million a year earlier.
  • Loans and credit quality: Total loans increased 25.1% to $2.40 billion, including $369 million of acquired loans; legacy loans grew 7.0%. The allowance for loan losses was $27.4 million, or 1.57% of total loans. Non-performing loans were 0.53% of loans, down from 0.74%; net charge-offs were 0.27% of average loans.
  • Non-performing assets: Non-performing assets were 1.69% of period-end assets, up from 1.29%. The increase was largely associated with $42.9 million of non-covered foreclosed assets acquired with Metropolitan; non-performing loans themselves declined.
  • Debt and liquidity: Total debt, including subordinated debentures, was $137.7 million, versus $110.1 million. This included $46.0 million of unsecured correspondent-bank notes used partly to fund Metropolitan, at a floating 3.25% rate and due by December 2016. Cash, trading and available-for-sale securities, and mortgage loans held for sale equaled 17.6% of assets, down from 21.6%. Management said liquidity remained strong; approximately $520.8 million of additional FHLB advances was available.
  • Capital and shareholder returns: The company reported a 9.22% Tier 1 leverage ratio and a 14.10% total risk-based capital ratio; subsidiary banks were classified as well capitalized. Book value per share was $24.89 and tangible book value per share was $19.10. Dividends were $0.84 per share for 2013; the company announced an increase to $0.22 quarterly beginning in 2014.

Material changes versus the prior comparable period

  • Assets rose by about $856 million to $4.38 billion, primarily reflecting the Metropolitan acquisition. Deposits grew 28.7% to $3.70 billion, including approximately $850 million associated with Metropolitan.
  • Net interest income benefited from acquired-loan growth and lower funding costs. Legacy-loan yields declined 30 basis points, however, reducing legacy-loan interest income by $1.8 million.
  • Reported net income and EPS fell, while core earnings and core EPS increased. The difference largely reflects acquisition and other nonrecurring items in both years.
  • Fourth-quarter net income was $3.8 million, compared with $8.0 million in fourth-quarter 2012. Fourth-quarter non-interest income declined to $7.7 million from $14.7 million, while non-interest expense rose to $41.7 million from $32.2 million, including elevated acquisition-related costs.
  • Non-performing loans improved, but total non-performing assets increased because of acquired foreclosed property. The allowance-to-non-performing-loans ratio rose to 297.9% from 231.6%.
  • Equity-to-assets declined to 9.21% from 11.51%, mainly because acquisition-related asset growth outpaced equity growth. Tangible common equity to tangible assets fell to 7.23% from 9.87%.
  • The company repurchased 419,564 shares at a weighted average price of $25.89 during 2013, then suspended repurchases in August in anticipation of the Metropolitan acquisition.

Outlook, commentary, risks and unusual items

  • Management said it would focus on improving core operating income, organic lending and selective acquisitions, with traditional bank acquisitions expected to become a greater focus as FDIC-assisted opportunities diminish.
  • The company planned to complete Metropolitan’s systems conversion in March 2014 and close 27 overlapping branches. It also announced consolidation of its six smaller subsidiary banks into the lead bank during 2014, citing regulatory burden, cost reduction and operational efficiency.
  • A March 2014 shelf registration, if declared effective, would permit offerings of up to $200 million of securities. The filing does not specify whether or when an offering will occur.
  • Acquisition-related items were significant: 2013 included $6.4 million of pre-tax Metropolitan merger costs, and the filing reports after-tax costs of about $4.0 million. Metropolitan purchase accounting remained preliminary, with potential adjustments as fair values and tax positions were finalized.
  • Changes in expected cash flows from acquired loan pools increased 2013 interest income by $18.9 million and reduced non-interest income by $18.1 million, a net pre-tax benefit of about $0.8 million. Management estimated a similar net addition of about $0.8 million in 2014, subject to revised cash-flow estimates.
  • Interest-rate simulation indicated that a 100-basis-point rate decline would reduce estimated next-12-month net interest income by 10.16%; 100- and 200-basis-point increases were estimated to raise it by 0.22% and 1.35%. Management cautioned that model assumptions are uncertain and actual results may differ materially.
  • Principal risks include regional economic and real-estate conditions, concentration in Arkansas, Missouri and Kansas, credit-card losses, acquisition integration and valuation, interest-rate movements, regulatory and compliance costs, and the accuracy of loan-loss and acquired-asset estimates. Management identified Northwest Arkansas as a comparatively challenged loan market.
  • The investment portfolio had $16.5 million of gross unrealized losses on held-to-maturity securities, which management attributed primarily to interest-rate increases and considered temporary. The filing reports no material adverse effect expected from pending legal proceedings, most of which involve loan foreclosures.
  • Basel III rules were scheduled to take effect beginning January 1, 2015. Management believed the company and its banks would meet the fully phased-in requirements based on December 2013 positions. The filing also reported an unqualified audit opinion and effective internal controls, while excluding Metropolitan from the year-end internal-control assessment as a current-year acquisition.

Important facts for investors to verify

  1. Whether Metropolitan integration, branch closures and the planned bank-charter consolidations deliver expected cost savings without disrupting customers or revenue.
  2. How much future earnings depend on acquired-loan accretion and FDIC indemnification adjustments, and how those estimates change as loan-pool cash flows are reassessed.
  3. Whether underlying credit quality remains sound after including Metropolitan’s acquired loans and foreclosed assets; distinguish acquired problem assets from changes in the legacy portfolio.
  4. Whether deposit growth, funding costs, tangible capital and regulatory capital remain adequate as the enlarged balance sheet is absorbed and Basel III requirements phase in.
  5. Whether operating expenses normalize after acquisition costs and whether the efficiency ratio improves; compare GAAP results with management’s non-GAAP core measures.
  6. The effectiveness and pricing of any capital raised under the $200 million shelf registration, and the effect on existing shareholders if securities are issued.
  7. The assumptions behind the allowance for loan losses, held-to-maturity securities’ unrealized losses, acquired-asset valuations and interest-rate sensitivity estimates.