Business context and reporting period
Southside Bancshares, Inc. is a Texas bank holding company. This unaudited Form 10-Q covers the quarter ended March 31, 2012; comparisons are primarily with the quarter ended March 31, 2011 and, for balance-sheet items, December 31, 2011. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q1 2012 | Comparison |
|---|---|---|
| Net interest income | $24.0 | Up 7.8% year over year |
| Provision for loan losses | $3.1 | Up from $2.1 |
| Noninterest income | $10.8 | Up 12.2%; included $6.0 securities-sale gain |
| Noninterest expense | $18.5 | Down 1.1% |
| Net income attributable to Southside | $10.1 | Up from $8.4; diluted EPS $0.58 vs. $0.49 |
| Net interest margin | 3.52% | 3.55% prior-year quarter |
| Return on average assets / equity | 1.26% / 15.34% | 1.12% / 15.65% prior-year quarter |
| Operating cash flow | $26.7 | $22.2 prior-year quarter |
Interest income declined 0.6% to $31.7 million, but interest expense fell 20.0% to $7.7 million as funding costs decreased. The reported effective tax rate rose to 23.4% from 16.2%, primarily because tax-exempt income represented a smaller share of taxable income. Comprehensive income was $3.6 million, down from $12.5 million, reflecting a $6.6 million after-tax other comprehensive loss, mainly from securities valuation changes and reclassification of realized gains.
At March 31, total assets were $3.217 billion, down from $3.304 billion at year-end. Loans were $1.141 billion, up 4.9% from year-end; net loans were $1.121 billion. Deposits were $2.310 billion, down $11.2 million. Cash and cash equivalents were $46.2 million. Shareholders’ equity was $259.9 million, or 8.1% of assets.
Total FHLB advances were $453.5 million, down $169.1 million from year-end; long-term debt was $60.3 million. The bank reported capital ratios above “well-capitalized” thresholds: total risk-based capital 21.18%, Tier 1 risk-based capital 19.92%, and Tier 1 leverage 8.85%. Management said the company met applicable capital requirements. Liquidity included approximately $635.1 million of additional potential FHLB funding against unpledged securities; short-term cash, deposits, and investments with maturities or repricing within a year equaled 15.2% of assets, versus 19.0% at year-end.
Material changes, outlook, and risks
- Securities repositioning: The company sold all $647.8 million of securities previously carried at fair value through income, recording a $0.5 million sale loss, to reduce earnings volatility. It also sold lower-yielding or longer-duration securities and reinvested selectively, recognizing $6.0 million in available-for-sale gains. Securities were 55.2% of assets at quarter-end, compared with 61.0% at year-end. Management anticipated increasing the portfolio in Q2 toward a level similar to the combined portfolio at December 31, 2011, but said purchases depend on acceptable risk-return opportunities. It cautioned that Q1 securities gains may not recur.
- Loans and credit quality: Loans grew mainly through 1–4 family residential lending, up $43.5 million from year-end. Nonperforming assets increased 5.5% sequentially to $13.9 million, but were 19.1% below March 2011. Nonaccrual loans were $11.1 million; the allowance was $20.1 million, or 1.76% of loans. Net charge-offs declined to $1.5 million from $3.1 million a year earlier. Management considered the allowance adequate while noting that economic or borrower conditions could require future adjustments.
- Impaired trust preferred securities and funding-option charges: Pooled trust preferred securities had $2.8 million amortized cost and $0.658 million fair value; the company recorded an additional $0.141 million credit impairment in earnings. Valuation depended on management cash-flow assumptions and illiquid-market inputs. A further $0.472 million impairment charge was recorded on FHLB advance option fees; $1.6 million remained on the balance sheet and could be expensed if commitments are not exercised or become further impaired.
- Funding and market risk: The company uses FHLB advances and securities as part of its balance-sheet strategy. It cited risks from interest rates and yield-curve changes, mortgage prepayments, securities values, credit quality, liquidity, and wholesale-funding costs. Its modeled 12-month net interest income response to immediate rate changes was +2.86% for +100 basis points, +1.90% for +200, -2.39% for -100, and -3.76% for -200, relative to the base case; results depend on assumptions and may differ from actual outcomes.
- Controls and legal matters: Management concluded disclosure controls were ineffective at quarter-end because of material weaknesses in securities price verification and evaluation of FHLB advance-option impairment. Controls had been enhanced, but management lacked sufficient evidence of sustained operating effectiveness and continued testing and remediation. Routine litigation was not considered material by management. No material risk-factor changes from the prior Form 10-K were reported.
- Other corporate action: The board declared a 5% stock dividend, payable May 9, 2012, to shareholders of record April 18. Southside Bank became a direct wholly owned subsidiary following a February 2012 internal merger. No numerical earnings guidance was provided.
Most important facts for investors to verify
- Whether the disclosed control weaknesses are fully remediated and independently tested, especially controls over securities pricing and FHLB option impairment.
- Whether the $6.0 million securities gain and the planned Q2 portfolio rebuilding are sustainable without adding undue interest-rate, valuation, or liquidity risk.
- How credit quality evolves: nonperforming assets rose sequentially, while net charge-offs improved year over year; review allowance adequacy and loan growth by category.
- Whether trust preferred security cash-flow assumptions and illiquid fair values remain supportable, and whether further impairment is required.
- Whether lower funding costs and capital strength can offset ongoing loan-yield pressure, changing deposit mix, and possible future FHLB option-fee charges.