SOUTHSIDE BANCSHARES INC quarterly report, Q2 FY2020

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Southside Bancshares, Inc. — Q2 2020 Form 10-Q

Business context and reporting period. Texas-based bank holding company reporting unaudited results for the quarter and six months ended June 30, 2020. The period was materially affected by COVID-19, lower interest rates, CECL adoption and participation in the Paycheck Protection Program (PPP). Amounts below are in U.S. dollars; financial statement amounts are converted to millions unless otherwise stated.

Financial performance and position

  • Q2 earnings: Net income was $21.6 million, up 15.8% year over year; diluted EPS was $0.65 versus $0.55. Net interest income rose 9.6% to $47.3 million. Noninterest income increased 8.3% to $12.2 million, including $2.7 million of securities-sale gains. Total provision for credit losses was $5.2 million, versus $2.5 million a year earlier.
  • First-half earnings: Net income was $25.5 million, down 31.8%; diluted EPS was $0.76 versus $1.11. Net interest income increased 9.2% to $92.0 million, but provision for credit losses rose to $30.5 million from $1.6 million. Noninterest income increased 33.2% to $27.7 million, largely reflecting $8.2 million of securities-sale gains.
  • Margins and operating costs: Net interest margin on a fully taxable-equivalent (FTE) basis was 3.02% for both Q2 and the first half, compared with 3.17% and 3.12%, respectively, in 2019. Q2 noninterest expense was $29.9 million, up 0.5%; first-half expense was $60.4 million, up 1.8%. First-half effective tax rate was 11.4%, versus 15.2%.
  • Balance sheet at June 30: Assets were $7.33 billion, up 8.6% from year-end 2019. Loans totaled $3.85 billion, up 8.0%; deposits were $5.07 billion, up 7.8%. Securities totaled approximately $2.80 billion, up 12.3%. Noninterest-bearing deposits increased $358.1 million.
  • Credit quality: Allowance for loan losses was $59.9 million, or 1.55% of loans, versus $24.8 million, or 0.69%, at year-end. Nonperforming assets were $17.6 million, or 0.24% of assets, versus $17.4 million, or 0.26%. Nonaccrual loans were $5.6 million, or 0.15% of loans.
  • Cash flow and liquidity: First-half operating cash flow was $17.5 million, down from $34.8 million; investing cash outflow was $534.5 million and financing cash inflow was $507.1 million. Cash and cash equivalents were $100.8 million, down from $110.7 million at year-end. Management reported approximately $980.9 million of additional FHLB borrowing capacity and $757 million of additional Federal Reserve discount-window capacity.
  • Debt and capital: FHLB borrowings were $1.09 billion, up from $972.7 million at year-end; other borrowings were $71.3 million. Long-term subordinated and trust-preferred debt totaled $158.9 million. Shareholders’ equity was $817.6 million, or 11.2% of assets. Consolidated CET1 ratio was 13.68%; management said the company and bank met applicable capital requirements. The company elected regulatory relief to defer CECL’s capital impact, which benefited the reported CET1 ratio by 36 basis points.
  • Dividends and repurchases: Cash dividends were $0.31 per share in Q2 and $0.62 for the first half. The company repurchased $25.8 million of common stock in the first half.

Material changes versus comparable periods

  • Q2 net income improved year over year, principally because interest expense fell by $6.3 million and noninterest income rose; higher credit-loss provision and lower interest income partly offset those benefits.
  • First-half net income declined sharply, primarily because provision for credit losses increased by $28.9 million, driven by CECL and COVID-related economic assumptions.
  • Interest expense fell as funding costs declined following Federal Reserve rate cuts, while yields on earning assets also decreased. FTE net interest margin narrowed year over year.
  • Loan growth included $308.4 million of PPP loans at quarter-end. Commercial real estate loans also increased, while construction and residential loan balances declined from year-end.
  • Available-for-sale securities’ unrealized gains contributed to a $38.8 million increase in first-half other comprehensive income, net of tax. AOCI rose to $43.0 million from $4.2 million at year-end.

Outlook, management commentary and risks

  • Management said COVID-19’s full financial impact and duration could not be reasonably estimated. It warned of potential further credit-loss reserves, borrower modifications, liquidity pressure, reduced dividends and staffing challenges. No quantified earnings guidance was provided.
  • Through June 30, the company processed approximately $308 million of approved PPP loans. By July 28, it had granted payment deferrals, generally for up to three months, on $302.5 million of outstanding loans, including $229.2 million of commercial real estate loans.
  • Management expected prolonged low interest rates to pressure net interest income, margins, borrowing costs and profitability for the remainder of 2020. Its interest-rate simulation estimated next-12-month net interest income changes of +1.17% under a 100-basis-point increase, -0.35% under a 200-basis-point increase, -2.19% under a 100-basis-point decrease and -4.41% under a 200-basis-point decrease, relative to its base case. These are modeled estimates, not guidance.
  • COVID-sensitive sectors identified by the company totaled $543.8 million, or 14.12% of loans; this included retail commercial real estate, retail goods and services, hotels, food services, and arts and recreation. Oil and gas loans were $118.5 million, or 3.08% of loans; classified oil and gas loans were $7.6 million.
  • Other key risks include deterioration in Texas and broader economic conditions, collateral-value declines, interest-rate and securities-prepayment risk, wholesale-funding reliance, cybersecurity and remote-work exposure, and uncertainty in CECL estimates. The company reported $832.3 million in commitments to extend credit and standby letters of credit. Management did not expect ordinary-course litigation to materially affect financial position, results or liquidity.
  • Unusual items included CECL adoption on January 1, which reduced opening retained earnings by $7.8 million after tax, and a pension-plan freeze effective December 31, 2020, with a $6.0 million reduction to AOCI primarily related to a lower discount rate. The company also repurchased $25.8 million of shares during the first half.

Important facts for investors to verify

  • Whether borrower performance, payment deferrals and the economic outlook require further increases in the allowance for credit losses; review CECL assumptions and subsequent asset-quality disclosures.
  • How PPP loan forgiveness, repayment and runoff affect loan growth, deposits, interest income and future comparisons.
  • Whether lower funding costs can offset continued pressure on earning-asset yields and FTE net interest margin.
  • Liquidity and funding developments, including FHLB and discount-window usage, securities availability and the level and cost of brokered deposits.
  • Capital and shareholder-return decisions, including the effects of CECL regulatory relief, buybacks and the board’s discretion over future dividends.
  • Exposure and credit trends in commercial real estate, COVID-sensitive industries and oil and gas, as well as the impact of securities valuation changes on AOCI and equity.