Southstate Bank Corp quarterly report, Q2 FY2020

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South State Corporation — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. Figures are consolidated and unaudited; dollar amounts are in millions unless stated otherwise. Comparisons are substantially affected by the June 7 acquisition of CenterState Bank Corporation (CSFL) and adoption of CECL.

Business context and reporting period

South State is a regional bank holding company. The CSFL stock merger added a large banking operation: South State issued 37.3 million shares, with purchase consideration of approximately $2.26 billion. The company acquired approximately $12.9 billion of loans and assumed $15.6 billion of deposits. CSFL accounted for approximately 50% of consolidated assets at quarter-end. Purchase accounting remains preliminary, and CSFL’s standalone post-acquisition results were not practicable to report.

Financial performance and condition

  • Q2 earnings: Net loss of $84.9 million, or diluted loss per share of $1.96, versus net income of $41.5 million and diluted EPS of $1.17 in Q2 2019. For the first six months, net loss was $60.8 million, or $1.58 per diluted share, versus net income of $85.8 million, or $2.42 per diluted share, in 2019.
  • Revenue and net interest: Q2 net interest income was $162.6 million and noninterest income was $54.3 million, totaling $216.9 million, up from $164.8 million in Q2 2019. Six-month total revenue was $389.1 million versus $320.1 million. Q2 net interest margin was 3.23% on a non-taxable-equivalent basis and 3.24% taxable-equivalent, down from 3.80% and 3.82%, respectively, a year earlier.
  • Credit costs and operating expense: Q2 provision for loan losses was $151.5 million; this includes provision related to unfunded commitments. The income statement provision for loan losses was $151.5 million for Q2 and $188.0 million for the first half. Q2 noninterest expense was $175.1 million, up 60% year over year, including $40.3 million of merger and branch-consolidation expense. The efficiency ratio was 80.5%, versus 66.9% a year earlier.
  • Balance sheet and credit quality: Total assets were $37.7 billion, loans net of allowance were $25.1 billion, and deposits were $30.0 billion at June 30. The allowance for credit losses was $434.6 million, or 1.70% of loans, and covered nonperforming loans 3.53 times. Nonperforming assets were $142.0 million, or 0.56% of loans and repossessed assets; the company attributed much of the increase to CSFL and CECL-related classification changes. Annualized Q2 net charge-offs were reported as 0.00%.
  • Liquidity and debt: Cash and cash equivalents were $4.36 billion, including restricted cash. Six-month operating cash flow was $69.9 million; investing cash flow was positive $1.49 billion, largely reflecting acquisition proceeds, and financing cash flow was positive $2.11 billion. Reported funding included $362.3 million of federal funds purchased, $358.1 million of repurchase agreements, $389.2 million of corporate and subordinated debentures, and $700.1 million of other borrowings. Available FHLB capacity was approximately $2.1 billion; federal funds credit lines and Federal Reserve discount-window capacity were also available, with no balances outstanding on those facilities at quarter-end.
  • Capital: Consolidated CET1 and total risk-based capital ratios were 10.70% and 12.93%; the Bank’s were 11.00% and 11.75%. The filing states both remained above applicable minimums and the Bank remained well-capitalized. The company elected the five-year CECL regulatory capital transition.

Material changes versus comparable periods

  • Q2 net interest income rose 27.8% year over year, principally due to acquired balances and loan growth; lower interest rates reduced asset yields and the net interest margin.
  • Mortgage banking income rose to $18.4 million from $5.3 million, and correspondent banking and capital-markets income rose to $10.1 million from $0.9 million. Deposit-account fees declined, which management linked in part to pandemic-related changes in customer activity.
  • Credit provision and merger-related costs drove the swing from profit to loss. Management attributed the large provision to the COVID-19 economic forecast and the CECL accounting impact on acquired CSFL loans.
  • Compared with December 31, 2019, total assets, loans, deposits and shareholders’ equity increased substantially, primarily from the CSFL merger. The merger added $600.5 million of goodwill and $125.9 million of core deposit intangible assets.

Outlook, commentary, risks and unusual items

  • COVID-19 and credit: Management described the pandemic’s effects as evolving and uncertain. As of July 24, 2020, loan payment deferrals totaled $2.7 billion, or 11.6% of the loan portfolio. At June 30, lodging loans were $974 million, restaurant loans $505 million and retail commercial real estate loans $2.2 billion; management disclosed differing shares of each portfolio under deferral. The company originated approximately 19,500 PPP loans totaling $2.4 billion by June 30.
  • CECL and allowance uncertainty: CECL adoption on January 1 added $54.4 million to loan allowance, $6.4 million to reserves for unfunded commitments and reduced retained earnings by $44.8 million, net of tax effects. Management used separate credit-loss methodologies for legacy South State and acquired CSFL loans in Q2 and planned to consolidate them in the second half of 2020. Estimates depend on forecasts and management judgment.
  • Integration and cost actions: Management expected systems-conversion and other integration costs during 2020 and 2021, and said expected merger synergies were not reflected in pro forma results. A July 31 announcement detailed plans to close or consolidate 19 branches in November: estimated costs of $5.8 million, expected 2021 annual savings of $6.6 million, and an estimated $825,000 impact in 2020.
  • Other risks and contingencies: PPP-related litigation risk includes two lawsuits involving agent fees, with potential for additional claims; SBA guarantee eligibility and compliance remain uncertain. The company reported approximately $5.9 billion in commitments to extend credit and standby letters of credit, with a $21.1 million reserve for expected losses on unfunded commitments. Management did not expect ordinary-course legal matters to materially affect the financial statements. The previously disclosed SEC investigation involving CSFL was terminated without an enforcement action recommended.
  • Goodwill and controls: The company reported no goodwill impairment after its April 2020 annual test but said it would continue monitoring COVID-19 effects. Disclosure controls were deemed effective; however, the quarter-end evaluation excluded CSFL operations, and the company was still integrating CSFL into internal control processes.
  • Guidance: The filing provides no specific earnings or financial forecast. Management cautioned that interim results are not necessarily indicative of full-year results.

Important facts for investors to verify

  • How deferrals, borrower payment performance and exposure to lodging, restaurants and retail real estate develop after the disclosed dates.
  • Whether CECL assumptions, acquired-loan marks and the $434.6 million allowance remain adequate as economic forecasts change.
  • Actual merger and integration costs, branch-closure execution, and whether projected cost savings and synergies are achieved.
  • PPP loan forgiveness, SBA guarantee compliance, and any developments in PPP-related litigation or claims.
  • Post-merger capital, liquidity and deposit trends, including the effects of restricted cash, funding costs and acquired liabilities.