Southside Bancshares, Inc. — 2011 Form 10-K
Business context and reporting period. Community-focused Texas bank holding company headquartered in Tyler, with banking, trust, brokerage and consumer-finance activities. This annual report covers the fiscal year ended December 31, 2011; comparisons are primarily with 2010. The filing was signed March 26, 2012.
Financial performance and condition
| Metric | 2011 | 2010 / change |
|---|---|---|
| Total assets | $3.304 billion | $3.000 billion; up 10.1% |
| Total loans | $1.087 billion | $1.078 billion; up 0.9% |
| Total deposits | $2.322 billion | $2.134 billion; up 8.8% |
| Net income attributable to Southside Bancshares | $39.1 million | $39.1 million; up 0.1% |
| Diluted EPS | $2.38 | $2.37 |
| Net interest income | $95.4 million reported; $105.6 million taxable-equivalent | Reported: $86.1 million |
| Net interest margin / spread | 3.60% / 3.34% | 3.39% / 3.07% |
| Provision for loan losses | $7.5 million | $13.7 million |
| Net charge-offs | $9.7 million; 0.92% of average loans | $12.9 million; 1.25% |
| Nonperforming assets | $13.2 million; 0.40% of assets | $17.7 million; 0.59% |
| Shareholders’ equity | $258.9 million; 7.8% of assets | $214.5 million; 7.1% |
| Cash dividends per share | $0.90 | $0.85 |
Interest expense fell 21.4% to $35.6 million, more than offsetting a slight decline in total interest income. Noninterest income fell 30.5% to $35.3 million, principally reflecting lower realized gains on available-for-sale securities ($11.8 million versus $25.8 million in 2010). Noninterest expense rose 1.4% to $72.3 million.
Net cash provided by operating activities was $73.6 million; investing activities used $341.3 million and financing activities provided $231.9 million. Cash and cash equivalents fell $35.8 million to $43.2 million. The securities portfolio was approximately $2.01 billion at year-end, substantially larger than loans.
Year-end borrowings included $622.5 million of FHLB advances and $60.3 million of long-term debt, principally junior subordinated debentures. Long-term obligations were $321.0 million; short-term obligations were $365.0 million. The bank reported strong regulatory capital: total risk-based capital ratio 21.52%, Tier 1 risk-based 20.26%, and Tier 1 leverage 8.29%; it was categorized as well capitalized.
Liquidity sources included cash and short-term investments equal to 19.0% of assets, securities, FHLB borrowing capacity of approximately $664 million against unpledged collateral, and three $15 million federal-funds lines. These resources coexist with significant wholesale funding and deposit-maturity exposure.
Material changes versus the prior comparable period
- Net interest income and margin improved as lower funding costs outweighed weaker loan yields. Average interest-earning asset yield declined to 4.82% from 5.01%, while average funding cost declined to 1.48% from 1.94%.
- Credit indicators improved: nonaccrual loans fell to $10.3 million from $14.5 million, and the allowance declined to $18.5 million from $20.7 million, or 1.71% of loans versus 1.92%.
- Mortgage-backed and related securities drove asset growth. The securities portfolio increased about 21%; loans grew only modestly. Noninterest-bearing deposits rose to $505.6 million from $423.3 million.
- FHLB advances increased to $622.5 million from $562.6 million, while the mix shifted: short-term advances increased and long-term advances declined. Brokered CDs totaled $163.8 million, or 7.1% of deposits.
- Equity rose 20.7%, supported by earnings and a $21.0 million increase in accumulated other comprehensive income, partly offset by $14.7 million of cash dividends and the $2.8 million equity impact of buying out SFG’s noncontrolling interest.
- Return on average assets decreased to 1.25% from 1.30%; return on average equity decreased to 16.20% from 17.98%.
Outlook, commentary, risks and unusual items
- Management described local markets as partially stabilized but still affected by housing weakness and unemployment. It noted forecasts for U.S. growth in 2012 but cautioned that recovery could be uneven; the filing gives no specific earnings or revenue guidance.
- In 2011, the company recorded an $8.9 million impairment of fees paid for $200 million of future FHLB advance commitments; $2.0 million remained on the balance sheet at year-end. Further impairment or non-exercise could result in additional expense.
- The company held $647.8 million of mortgage-backed securities carried at fair value through income at year-end. After year-end it began selling these securities to reduce potential earnings volatility; less than $30 million remained by March 8, 2012. The portfolio generated a $6.7 million fair-value gain in 2011.
- Pooled trust preferred securities had $2.9 million amortized cost and estimated fair value of about $499,000. Management reported a $3.1 million cumulative credit impairment and relied on Level 3 valuation inputs because of illiquidity; no further earnings write-down was recorded in 2011.
- Accounting errors led to restatement of the first three quarters of 2011 and revisions to 2010 comparative statements. The errors involved securities classification/pricing and failure to timely assess impairment of FHLB option fees. Restated nine-month 2011 net income attributable to the company was $29.6 million, about $0.3 million below originally reported.
- Management and the auditor concluded that internal control over financial reporting was ineffective at December 31, 2011 because of material weaknesses in security price verification and FHLB option-fee impairment controls. Management described remediation steps begun after year-end; remediation was not yet established as complete. The auditor nevertheless gave an unqualified opinion on the consolidated financial statements.
- Key exposures include real-estate collateral and local Texas economic conditions, medical-sector lending, subprime automobile loans through SFG ($68.4 million at year-end), mortgage prepayments, interest-rate and securities fair-value volatility, and reliance on FHLB and brokered funding. Management estimated net interest income would decline 1.60% and 3.59% under immediate +100 and +200 basis-point shocks, respectively, and 2.16% and 1.95% under -100 and -200 basis-point shocks.
- Legal proceedings were described as arising in the ordinary course; management believed they were not material. Regulatory change, including implementation of Dodd-Frank and anticipated capital-rule changes, could raise compliance costs or affect operations.
- Other developments: Southside acquired the remaining 50% of SFG for $4.8 million in July 2011; Southside Securities began broker-dealer operations; and the CEO transition to Sam Dawson took effect January 5, 2012.
Important facts for investors to verify
- Review the amended 2011 quarterly filings and revised 2010 figures; reconcile the securities accounting changes and the $8.9 million FHLB-option impairment to reported earnings.
- Track whether the disclosed material weaknesses are remediated, and assess the reliability of security valuations and impairment judgments in subsequent filings.
- Monitor the size, mix, valuation and realized results of the mortgage-backed securities portfolio, including the post-year-end sales and any effects on income or equity.
- Assess credit trends and reserve adequacy, particularly real-estate and medical exposures, SFG subprime auto loans, and changes in nonperforming assets and charge-offs.
- Evaluate deposit stability, public-fund and brokered-CD concentrations, FHLB borrowing levels and maturities, and the company’s ability to maintain liquidity and capital under stress.
- Confirm future dividend capacity, which depends on earnings, regulatory restrictions and subsidiary dividends; the filing provides no assurance that the 2011 dividend level will continue.