Southside Bancshares, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited consolidated results; dollar amounts below are in millions unless noted. Southside is a Texas bank holding company operating through Southside Bank and subsidiaries.
Financial performance and position
- Q3 earnings: Net income attributable to Southside was $8.6 million, versus $8.6 million in Q3 2011; diluted EPS was $0.50 in both periods. Nine-month attributable net income was $26.5 million, down from $29.6 million, and diluted EPS fell to $1.53 from $1.71.
- Revenue and margins: For the first nine months, net interest income was $68.5 million, down 3.2%; total interest income fell 8.8% to $89.6 million, while interest expense declined 23.2% to $21.1 million. Net interest margin was 3.31%, versus 3.65% a year earlier. Q3 net interest margin was 3.22%, versus 3.60%.
- Noninterest items and expenses: Nine-month noninterest income rose 4.9% to $29.4 million, including $13.6 million of gains on available-for-sale securities. Noninterest expense increased 3.9% to $56.7 million. Nine-month pretax income was $32.7 million, down from $38.9 million.
- Loans and credit: Loans were $1.222 billion, up 12.4% from year-end 2011, led by 1–4 family residential lending. The allowance for loan losses was $20.8 million, or 1.71% of loans; nine-month provision was $8.5 million. Net charge-offs were $6.2 million, down from $8.0 million in the comparable period.
- Asset quality: Nonperforming assets rose to $15.8 million from $13.2 million at year-end; nonaccrual loans were $11.9 million and restructured loans $2.9 million. Management attributed the increase mainly to two commercial loans and higher nonperforming SFG loans. Allowance coverage was 175.5% of nonaccrual loans.
- Balance sheet and liquidity: Total assets were $3.221 billion, compared with $3.304 billion at December 31, 2011. Deposits were $2.302 billion, slightly below $2.322 billion. Cash and cash equivalents increased to $132.0 million from $43.2 million. Short-term liquid investments were 17.4% of assets, versus 19.0% at year-end; the Bank reported about $256.9 million of additional FHLB borrowing capacity using unpledged securities.
- Debt and capital: FHLB advances totaled $533.2 million, down from $622.5 million at year-end; long-term debt was $60.3 million. Shareholders’ equity was $276.6 million, or 8.6% of assets. At September 30, consolidated total risk-based capital was 23.11%, Tier 1 risk-based capital 21.85%, and Tier 1 leverage 9.03%; the Bank met applicable capital requirements.
- Cash flow: Nine-month operating cash flow was $60.6 million and investing cash flow was positive $148.3 million, compared with negative $238.7 million in 2011. Financing used $120.2 million, and cash increased by $88.7 million to $132.0 million. Securities purchases and sales, loan growth, and FHLB advance activity drove substantial investing and financing flows.
Material changes and management commentary
- Lower market rates and faster mortgage-backed securities prepayments reduced securities yields and income, more than offsetting growth in average earning assets and loans. Management said competitive loan pricing may continue to pressure loan yields and profitability.
- The company sold all securities carried at fair value through income during Q1 2012, recognizing a $0.5 million loss; it held none at September 30. It also restructured the securities portfolio, selling primarily longer-duration municipal and more prepayment-sensitive mortgage-backed securities and reinvesting mainly in shorter-duration municipal securities.
- The company recorded $13.6 million in nine-month gains on available-for-sale securities. Management cautioned that these gains may not recur at the same level. FHLB advance option impairment charges were $2.0 million for the nine months, and the remaining option fees were fully impaired.
- Management described continued use of FHLB funding and securities as part of its balance-sheet strategy, while noting interest-rate, prepayment, liquidity, and credit risks. It said near-term securities-led asset growth was uncertain in the low-rate environment and that it would reassess asset and funding choices as conditions change. No numerical earnings guidance was provided.
- Liquidity and interest-rate simulations projected that immediate rate increases of 100 and 200 basis points would raise modeled 12-month net interest income by 1.04% and 0.58%, respectively; decreases of 100 and 200 basis points would reduce it by 2.79% and 3.07%. These are model estimates, not forecasts, and depend on management assumptions.
- Management reported that disclosure controls were effective as of September 30 and that previously identified material weaknesses involving securities price verification and FHLB option impairment controls had been remediated after added procedures, staffing, and technology. The company cautioned that it cannot assure remediation is complete or that additional deficiencies will not be identified. The filing also recounts prior-period restatements related to those control issues.
- The company applied to regulators in October to open a second full-service Austin branch in Q1 2013. Litigation in the normal course was not considered material by management.
Risks and contingencies
- The pooled trust preferred securities had $2.7 million amortized cost and $0.7 million estimated fair value. Management’s impairment analysis estimated a $3.3 million cumulative credit impairment and a $2.0 million noncredit impairment in other comprehensive income at September 30. The valuation uses significant unobservable inputs and depends on default, deferral, and recovery assumptions; an additional $0.181 million impairment was recognized in earnings during the first nine months.
- Outstanding unused credit commitments were $142.7 million and standby letters of credit were $6.0 million. These are contingent exposures and do not necessarily represent expected cash outflows. Management believed normal-course litigation would not materially affect financial position, results, or liquidity.
- Key stated risks include economic and real-estate conditions in Texas and other markets, borrower credit deterioration, interest rates and yield-curve changes, mortgage prepayments, liquidity and wholesale-funding costs, securities valuations, regulatory changes including Dodd-Frank, and the adequacy of estimates and controls.
Important facts for investors to verify
- Whether loan growth—particularly residential, commercial, and SFG lending—can be maintained without further deterioration in nonperforming assets, charge-offs, or required provisions.
- Whether net interest margin stabilizes as securities yields decline, prepayments remain elevated, and competitive loan pricing continues.
- Whether securities-sale gains and FHLB option impairment charges materially affect reported earnings in future periods, and how portfolio repositioning changes interest-rate and prepayment exposure.
- Whether the TRUP valuation and impairment assumptions remain supportable as underlying issuer credit conditions and market liquidity change.
- Whether the disclosed remediation of prior material weaknesses remains effective, particularly for securities pricing and impairment reviews.
- Whether deposits, FHLB borrowing capacity, and capital remain adequate to support loan growth, commitments, dividends, and other funding needs.