South State Corporation (South State Bank Corp.) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; balance-sheet comparisons are principally to December 31, 2018 and June 30, 2018. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless stated otherwise.
Business context and reporting period
South State is a South Carolina bank holding company providing commercial and consumer banking, mortgage, trust and investment services. At June 30, 2019, it reported $15.7 billion in assets and 2,544 full-time equivalent employees. The company continues to pursue organic growth supplemented by selected acquisitions. Minis & Co. was merged into South State Advisory effective January 1, 2019.
Financial results and key metrics
- Q2 earnings: Net income was $41.5 million, up 2.5% from $40.5 million a year earlier. Diluted EPS was $1.17 versus $1.09; basic EPS was $1.18 versus $1.10. The share count declined, partly reflecting repurchases.
- First-half earnings: Net income was $85.8 million versus $82.8 million; diluted EPS was $2.42 versus $2.24.
- Interest income and margin: Q2 interest income rose to $150.0 million from $141.7 million, but interest expense increased to $22.8 million from $12.2 million. Net interest income fell 1.8% to $127.2 million from $129.6 million. The non-tax-equivalent net interest margin declined 32 basis points year over year to 3.80%; the taxable-equivalent margin was 3.82%, down from 4.14%.
- Noninterest income and expense: Q2 noninterest income was $37.6 million, broadly flat year over year. Noninterest expense was $109.4 million versus $110.5 million and included a $9.5 million pension-plan termination charge. For the first half, noninterest income fell 10.8% to $69.7 million, while expense declined 7.3% to $207.6 million.
- Margins and returns: Q2 efficiency ratio was 66.9%, compared with 65.6% a year earlier and 63.2% in Q1 2019. Annualized return on average assets was 1.08%; return on average equity was 6.98%.
- Loans and credit: Net loans were $11.17 billion at quarter-end. Total loans, excluding loans held for sale and net of deferred fees and costs, were $11.23 billion. Non-acquired loans grew 19.8% year over year to $8.62 billion; acquired loans continued to run off and were 23.2% of the portfolio versus 33.5% a year earlier. Q2 provision for loan losses was $3.7 million, down from $4.5 million. Non-acquired annualized net charge-offs were 0.02%; the allowance was 0.62% of non-acquired loans and covered non-acquired nonperforming loans 3.43 times.
- Liquidity and funding: Cash and cash equivalents were $852.0 million, compared with $409.0 million at year-end 2018. Deposits were $11.92 billion, up $275.3 million since year-end. Other borrowings rose to $816.4 million from $266.1 million, including $700.1 million of FHLB advances. The company reported $723.3 million of remaining availability on its $1.7 billion FHLB facility and no outstanding federal funds credit-line or discount-window advances.
- Capital and equity: Shareholders’ equity was $2.37 billion. Consolidated CET1, Tier 1, total risk-based capital and leverage ratios were 11.58%, 12.56%, 13.07% and 9.99%, respectively. The Bank and Company exceeded minimum regulatory requirements and qualified as well-capitalized. Equity-to-assets was 15.14%, down from 16.12% a year earlier.
- Cash flows, first half: Operating cash flow was $100.3 million, versus $160.2 million in 2018; investing used $401.1 million versus $167.2 million; financing provided $743.9 million versus $26.3 million. Cash increased $443.0 million. Financing included $700.0 million of FHLB advances, $82.1 million of share repurchases and $27.5 million of dividends.
Material changes versus comparable periods
- Higher loan and securities interest income was outweighed by a $10.6 million increase in Q2 interest expense. Management attributed funding-cost pressure to higher deposit rates, competition for deposits and increased borrowings.
- Organic non-acquired loan growth was strong, while acquired loans declined through paydowns, charge-offs, foreclosures and renewals into the non-acquired portfolio.
- Deposit-account fees fell $3.9 million in Q2 and $8.6 million in the first half, principally because the Durbin Amendment interchange-fee cap applied to the Bank beginning July 1, 2018.
- Q2 expense benefited from lower merger-related costs than in 2018, partly offset by the pension termination charge and higher salaries and benefits.
- Accumulated other comprehensive income improved from a $24.9 million loss at year-end to a $1.5 million gain, mainly reflecting higher fair values of available-for-sale securities, partly offset by cash-flow hedge losses.
- The company repurchased 1,141,200 shares under its buyback plan in the first half for $80.1 million. A further 594,400 shares were repurchased in July for $44.6 million.
Outlook, management commentary, risks and unusual items
- Cost initiatives: The company scheduled 13 branch closures in 2019; all but one had closed by the end of Q2. Management estimated annual savings of $13.0 million and a net 2019 impact of approximately $10.0 million, with $2.5 million of savings realized in Q2 and a further $6.4 million expected in Q3 and Q4. These are expectations, not formal earnings guidance.
- Pension termination: The $9.5 million Q2 pre-tax, non-cash charge comprised $7.7 million reclassified from accumulated other comprehensive income and a $1.8 million pension-plan asset write-off. Plan distributions were expected to be completed by Q3 2019.
- Credit outlook and CECL: Management characterized asset quality as solid and stable, while noting that allowance estimates involve judgment and may change with economic conditions. The company was implementing CECL, expected to adopt in Q1 2020, but said it could not yet reasonably estimate the impact.
- Concentrations: Reported credit concentrations included $1.3 billion of loans to lessors of nonresidential buildings, $586.5 million to lessors of residential buildings and $554.3 million in hotel and motel loans. Commercial real estate loans were 227.4% of Bank risk-based capital, below the cited 300% regulatory guideline.
- Other risks and contingencies: Commitments to extend credit and standby letters of credit totaled $2.8 billion; management did not anticipate material losses. Management said pending or threatened litigation was not expected to materially affect financial position or results. The filing identifies interest-rate, liquidity, credit, competition, cybersecurity, regulatory, integration and economic risks. No material changes to previously disclosed risk factors or market-risk disclosures were reported.
- Unusual items and sensitivity: Q2 securities gains included a gain on Visa Class B shares; first-half securities gains also reflected Visa share sales, partly offset by losses on sales of lower-yielding securities. The company reported a $14.3 million cash-flow hedge liability related to FHLB advances. It also adopted lease accounting in 2019, recording $84.5 million of right-of-use assets and $85.0 million of lease liabilities at June 30.
- Guidance: The filing provides cost-savings expectations but no comprehensive earnings, revenue or margin guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether loan growth, deposit retention and funding costs sustain net interest income and margin amid deposit competition and greater use of FHLB funding.
- Whether announced branch and cost savings are realized on schedule and offset by ongoing operating costs.
- Credit trends, including acquired-loan charge-offs, nonperforming assets, commercial real estate concentrations and the adequacy of the allowance.
- The eventual CECL adoption effect on provisions, capital and retained earnings; the filing does not provide a clear estimate.
- Effects of share repurchases and dividends on capital ratios, alongside the company’s substantial buyback authorization.
- Whether Visa-related securities gains and other portfolio transactions affect comparisons of recurring earnings.