Stock Yards Bancorp, Inc. — Q1 2017 Form 10-Q
Business context and period. Regional banking and wealth-management company reporting unaudited results for the three months ended March 31, 2017, compared with Q1 2016. Balance-sheet comparisons are with December 31, 2016. Amounts below are in U.S. dollars; financial statement amounts are generally shown in millions.
Financial performance and condition
- Earnings: Net income was $10.8 million, up 9.7% from $9.8 million. Diluted EPS rose to $0.47 from $0.44. Growth reflected higher net interest and fee income and a lower effective tax rate, partly offset by higher expenses and loan-loss provision. The $1.0 million benefit from the adoption of ASU 2016-09 materially reduced Q1 2017 income tax expense.
- Revenue and margins: Net interest income was $25.2 million, up 7.3%; on a tax-equivalent basis it was $25.4 million, up 7.2%. Net interest margin improved to 3.63% from 3.56%; net interest spread was 3.53% versus 3.49%. Non-interest income increased 7.1% to $10.8 million, led by wealth management and trust fees, which rose 10.5% to $5.1 million. Non-interest income was 30.0% of total revenue.
- Expenses and returns: Non-interest expense increased 8.2% to $21.1 million, including higher compensation and technology costs. The reported efficiency ratio worsened to 58.5% from 57.9%; adjusted for tax-credit partnership amortization, it was 56.8% versus 54.9%. Annualized return on average assets was 1.46% and return on average equity was 13.78%, compared with 1.40% and 13.52%.
- Cash flow: Operating cash flow was $15.6 million versus $17.6 million in Q1 2016. Investing activities provided $47.2 million, compared with $61.6 million used in the prior-year quarter, including a $32.2 million net decrease in loans. Financing activities used $21.3 million, including $4.3 million of dividends and $38.3 million of net repayments of repurchase agreements and federal funds purchased. Cash and cash equivalents increased $41.5 million during the quarter to $89.5 million.
- Balance sheet and funding: Total assets were $3.03 billion, essentially flat from year-end. Loans fell 1.4% to $2.27 billion, primarily from anticipated commercial real estate payoffs; average loans were up year over year. Deposits increased 0.9% to $2.54 billion. Stockholders’ equity rose to $319.7 million. Short-term borrowings declined to $76.7 million from $115.0 million; FHLB advances were $50.8 million. Cash and short-term investments totaled $89.5 million; the company reported $200.8 million of unpledged securities and $500.1 million of available FHLB credit.
- Credit quality: The allowance for loan losses was $24.5 million, or 1.08% of period-end loans, versus $24.0 million and 1.04% at year-end. Q1 provision was $0.9 million, up from $0.5 million; net charge-offs were $0.4 million. Non-performing loans were $6.1 million, or 0.27% of loans, and non-performing assets were $10.1 million, or 0.33% of assets, both down from year-end. No loans were over 90 days past due and still accruing at quarter-end.
- Capital and shareholder returns: Consolidated total risk-based capital was 13.49%, common equity Tier 1 was 12.51%, and leverage was 10.64%. The tangible common equity ratio was 10.48%, up from 10.26% at year-end. The quarterly dividend was $0.19 per share. The 44,838 shares reported as purchased during the quarter were withheld for taxes on equity awards, not purchases under a publicly announced repurchase plan.
Material changes and management commentary
- Average earning assets increased 6.2% year over year, with loan growth supporting net interest income; higher rates and balances on money-market deposits and other funding partly offset the benefit.
- Trust assets under management increased 15.7% year over year to $2.61 billion. Management was optimistic about continued 2017 growth in wealth management and trust, while noting market volatility could affect short-term results.
- Management increased the qualitative loan-loss allocation after noting a slight rise in past-due loans and potential exposure in one classified-loan pool. It also extended the historical loss look-back period from 24 to 28 quarters to better capture a full economic cycle. Management described asset-quality metrics as exceptionally strong.
- Q1 2017’s effective tax rate fell to 22.6% from 27.2%, largely because ASU 2016-09 requires excess share-based-compensation tax benefits to flow through earnings; the quarter included a $1.0 million tax benefit. The year-over-year earnings comparison therefore includes this accounting-driven benefit.
- Management reported no specific earnings or financial targets in the provided filing text. Results for the quarter are not necessarily indicative of full-year results.
Risks, contingencies, and unusual items
- Controls: Disclosure controls and procedures were not effective as of March 31, 2017 because of a material weakness identified in the 2016 Form 10-K. Remediation began during the quarter, including changes to control design, performance and documentation, and added internal loan-review staffing. Management said the changes still need to demonstrate effectiveness over time; it nevertheless stated that the interim financial statements fairly present the company’s results and condition in all material respects.
- Credit and off-balance-sheet exposure: Commitments to extend credit totaled $651.2 million, including $14.1 million of standby letters of credit; the company accrued $350,000 for inherent risks in unfunded commitments. Commitments are not necessarily expected to be fully drawn. Five consumer mortgage loans totaling $639,000 were in formal foreclosure proceedings.
- Legal matters: Pending claims and proceedings were reported in the ordinary course of business. Management, after consulting counsel, did not expect a material adverse effect on financial position or results.
- Interest-rate sensitivity: The simulation estimated net interest income would increase 0.50% for a 100-basis-point rise and 1.10% for a 200-basis-point rise, but fall 3.77% for a 100-basis-point decline. Management cautioned that the model indicates trends, not actual expected results; a 200-basis-point decline was deemed not reasonably possible at then-current rates.
- Other sensitivities: Securities had $803,000 of net unrealized losses at quarter-end; management attributed losses to interest-rate changes and said it did not intend, and was not likely to be required, to sell before recovery. Future CECL adoption was expected to significantly affect credit-loss accounting, but the company was still evaluating the impact. Economic conditions, competition, regulation, interest rates, customer liquidity and market volatility were identified as risks.
Important facts for investors to verify
- Whether earnings growth persists excluding the $1.0 million ASU 2016-09 tax benefit, and how future share-award tax effects affect the tax rate.
- Whether loan growth resumes after Q1 payoffs, particularly in commercial real estate, and whether the increased provision and qualitative reserve assumptions prove adequate.
- Whether expense growth, especially compensation and technology costs, moderates and improves the efficiency ratio.
- Progress and evidence of sustained remediation of the material weakness in disclosure controls and procedures.
- Deposit stability, liquidity needs, and the effect of rate changes on funding costs and net interest income.
- Implementation plans and eventual quantified effects of CECL and other pending accounting standards.