Business context and reporting period
South State Corporation, a regional bank holding company operating mainly in South Carolina, North Carolina and Georgia, filed this audited Form 10-K for the fiscal year ended December 31, 2016. It reported 116 financial centers and approximately $8.9 billion in year-end assets. The filing includes unaudited fourth-quarter results. The January 3, 2017 Southeastern acquisition is a subsequent event and is not included in 2016 year-end balances.
Financial performance and condition
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net income available to common shareholders | $101.3 million | $99.5 million | +1.8% |
| Diluted EPS | $4.18 | $4.11 | +1.7% |
| Net interest income | $324.8 million | $327.8 million | -0.9% |
| Taxable-equivalent net interest margin | 4.22% | 4.58% | -36 bps |
| Noninterest income | $130.3 million | $115.6 million | +12.8% |
| Noninterest expense | $294.3 million | $287.1 million | +2.5% |
| Provision for loan losses | $6.8 million | $5.9 million | +$1.0 million |
| Return on average assets | 1.16% | 1.21% | -5 bps |
| Efficiency ratio | 64.16% | 64.19% | Nearly unchanged |
- Fourth-quarter 2016 net income was $24.2 million and diluted EPS was $1.00, versus $25.5 million and $1.05 in fourth-quarter 2015.
- Year-end assets were $8.90 billion, loans net of unearned income were $6.68 billion, deposits were $7.33 billion, and shareholders’ equity was $1.13 billion. Loans grew 11.3% and deposits 3.3% from year-end 2015.
- Noninterest income growth was led by deposit-account fees, which rose $8.4 million. Lower loan yields and declining acquired-loan balances weighed on net interest income; lower funding costs partly offset that pressure.
- Operating cash flow was $138.0 million, compared with $186.9 million in 2015. Investing activities used $690.9 million, principally reflecting net loan growth; financing activities provided $231.6 million. Cash and cash equivalents fell $321.3 million to $374.4 million.
- Year-end total risk-based capital was 13.04%, Tier 1 leverage was 9.88%, and tangible common equity to tangible assets was 8.88%. The Bank was classified as well capitalized.
- Year-end nondeposit borrowings were $369.1 million: $313.8 million of federal funds purchased and repurchase agreements and $55.4 million of other borrowings, principally subordinated debt. The filing reports $55.4 million of long-term debt obligations.
- Liquidity resources included $471 million in federal funds credit lines, $176.3 million available at the Federal Reserve discount window and an approximately $1.3 billion FHLB facility; outstanding FHLB advances were $123,000. Management said liquidity was adequate.
Material changes versus prior period
- Non-acquired loans increased $1.0 billion, or 24.2%, while acquired loans declined $344.5 million, or 19.3%. Noninterest-bearing deposits increased $222.6 million; certificates of deposit declined $219.8 million.
- Asset quality improved: total nonperforming assets fell to $38.6 million from $53.7 million, and net charge-offs on non-acquired loans declined to 0.06% of average loans from 0.09%. The allowance for non-acquired loan losses was $37.0 million, or 0.71% of those loans.
- Net interest margin continued to compress, down 36 basis points in 2016 after a 22-basis-point decline in 2015. Average yields on non-acquired and acquired loans fell 16 and 33 basis points, respectively.
- Cash dividends increased to $1.21 per share from $0.98; the payout ratio rose to 28.91% from 23.84%. Book value per share rose to $46.82 from $43.84.
- Cash and cash equivalents declined from $695.8 million at year-end 2015. Total assets increased 4.0%, while average assets increased 6.3%.
Outlook, management commentary, risks and unusual items
- No numerical earnings or growth guidance is provided. Management said it expected improvement in local economic conditions and business activity to continue in 2017 and described capital and liquidity as supportive of organic growth and strategic opportunities.
- On January 3, 2017, the Company completed its $435.1 million acquisition of Southeastern Banking Financial Corporation, issuing 4,978,338 shares. Southeastern had approximately $1.8 billion in assets, $1.5 billion in deposits and $1.1 billion in loans at December 31, 2016. Purchase accounting was incomplete at filing; the merger took the Company above $10 billion in assets.
- The Bank terminated all FDIC loss-share agreements effective June 23, 2016. It paid $2.3 million to the FDIC and recorded a $4.4 million pretax charge, including the remaining indemnification-asset write-off. The Bank now bears the full future losses and recoveries on previously covered assets.
- Crossing $10 billion in assets brings heightened oversight, including stress-testing and consumer-protection requirements. The filing estimates debit-card interchange revenue could decline by approximately $15 million annually beginning July 2018; 2016 bankcard services income was $40.1 million.
- Key risks include real-estate and commercial credit concentration, loan-growth-related reserve needs, interest-rate and margin sensitivity, acquisition integration, increased regulatory and compliance costs, cybersecurity and operational disruptions, and deposit or wholesale-funding pressures. Approximately 76.2% of loans had real estate as a primary or secondary component of collateral; commercial real estate loans equaled 149.4% of risk-based capital.
- Investment securities had $8.6 million of gross unrealized losses at year-end, principally associated with higher interest rates. Management said it did not intend, and was not more likely than not required, to sell the securities before recovery; no 2016 OTTI charge was recorded.
- Management and the independent auditor concluded internal control over financial reporting was effective. The auditor issued unqualified opinions on the financial statements and internal controls. Management reported no pending or threatened litigation expected to have a material effect.
Most important facts for investors to verify
- Whether post-merger integration, purchase accounting, costs and expected benefits for Southeastern align with management’s plans.
- The actual timing and financial effect of the $10 billion asset threshold requirements, especially the estimated interchange-income reduction and related compliance expenses.
- Whether rapid non-acquired loan growth—particularly in commercial real estate and construction—continues without weakening credit quality or requiring materially higher provisions.
- Whether margin compression stabilizes as rates and funding costs change, and whether cash generation and liquidity remain adequate as loan growth continues.
- Whether the termination of FDIC loss sharing, unrealized securities losses and goodwill assumptions result in additional charges or capital pressure.