Business context and reporting period
Stock Yards Bancorp, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2019. The Louisville-based regional bank operates in the Louisville, Indianapolis and Cincinnati markets, with Commercial Banking and Wealth Management & Trust (WM&T) segments.
On May 1, 2019, Bancorp acquired King Bancorp and King Southern Bank for $28 million in cash, extending its footprint into Nelson County, Kentucky. King brought approximately $192 million of assets, including $164 million of loans and $126 million of deposits. The acquisition contributed $1.6 million of revenue for the quarter and first half; management expects it to be accretive to quarterly operating results going forward.
Financial performance and condition
Amounts below are in millions, except per-share data, percentages and where noted.
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net interest income | $30.8 | $28.7 | $60.4 | $56.0 |
| Non-interest income | $12.3 | $11.4 | $23.3 | $22.3 |
| Net income | $16.5 | $13.6 | $32.2 | $27.0 |
| Diluted EPS | $0.72 | $0.59 | $1.40 | $1.17 |
| Net interest margin, tax-equivalent | 3.81% | 3.88% | 3.85% | 3.84% |
- Second-quarter net income increased 21.8% year over year; first-half net income rose 19.3%. Annualized Q2 return on average assets was 1.93% and return on average equity was 17.40%.
- First-half net interest income grew 7.9%, primarily from loan growth and higher asset yields. Higher deposit costs and a shift toward interest-bearing deposits pressured the Q2 margin; the first-half margin was nearly unchanged year over year.
- First-half non-interest income rose 4.4%. WM&T revenue increased 2.4% and assets under management reached $3.07 billion, up 7.6% from June 2018. Debit and credit card income grew 22.4% and treasury management fees grew 9.2%.
- Non-interest expense increased 15.0% in Q2 and 11.4% in the first half. First-half expenses included about $1.3 million of King acquisition-related costs; the reported efficiency ratio was 57.36%, compared with 54.98% a year earlier.
- Total assets were $3.46 billion at June 30, up $160.9 million from year-end 2018. Loans were $2.76 billion, up $215.7 million, including $160.5 million acquired from King. Legacy loan growth was $51.6 million, or 2.0%, in the first half.
- Deposits totaled $2.88 billion, up 3.2% from year-end. Cash and cash equivalents fell $82.9 million to $116.0 million as liquidity funded loan growth and the acquisition. First-half operating cash flow was $21.9 million, versus $36.1 million in 2018; investing cash use was $35.7 million and financing cash use was $69.1 million.
- FHLB advances totaled $84.3 million, versus $48.2 million at year-end, including advances assumed from King. The company reported $484 million of available FHLB credit and $105 million of available correspondent-bank federal funds lines. The Bank was categorized as well-capitalized; Bancorp’s consolidated total risk-based capital ratio was 12.67% and leverage ratio was 10.91%.
- Stockholders’ equity was $389.4 million, up 6.2% from year-end. GAAP equity to assets was 11.24%; tangible common equity to tangible assets, a non-GAAP measure, was 10.85%, down from 11.05% at year-end, with the decline attributed to the King acquisition.
Material changes, outlook and risks
- Tax effects: Kentucky tax law changes generated state tax benefits of $1.3 million in Q1 and $2.4 million in Q2, or approximately $3.8 million in the first half ($0.16 per diluted share). These benefits drove the first-half effective tax rate down to 8.2% from 18.7% and Q2’s rate to 5.9% from 18.9%. Management expects an unfavorable tax impact of about $200,000 annually beginning in 2021 from the transition to Kentucky corporate income tax.
- Credit quality: The allowance was $26.4 million, or 0.96% of loans, at June 30. First-half provision was $0.6 million versus $2.0 million a year earlier, and net recoveries were $282,000. Non-performing loans were $3.9 million, up from $3.4 million at year-end but below $7.4 million in June 2018. Classified loan balances increased $23.4 million in the first half, concentrated in OAEM loans; management said two affected commercial relationships were well-secured.
- Interest-rate exposure: Management cited possible margin pressure from an inverted yield curve and falling rates. Its June simulation estimated net interest income changes of -10.14% and -1.37% under rate declines of 200 and 100 basis points, and +3.01% and +6.03% under increases of 100 and 200 basis points. Following the Federal Reserve’s late-July 25-basis-point rate cut, Bancorp intended to reduce deposit rates to offset lost revenue, while noting that future cuts could still hurt margin.
- Acquisition and unusual items: King-related transaction charges were approximately $1.3 million, including nearly $900,000 of legal and professional costs and $437,000 of severance and retention costs. Purchase accounting remains preliminary. Bancorp expected to sell three acquired branch buildings in Q3 while retaining customer relationships. A $176,000 card-processor activity incentive and other items also affected non-interest income.
- Other risks and commitments: Forward-looking risks include local and general economic conditions, competition, regulation, interest rates, customer liquidity and credit conditions. Off-balance-sheet commitments to extend credit totaled $1.10 billion; these are contractual maximums and not necessarily expected cash requirements. Management said pending legal matters were not expected to have a material adverse effect. CECL was scheduled for adoption January 1, 2020, with a one-time cumulative adjustment expected; the amount was not specified.
- Capital actions: Bancorp declared dividends of $0.25 per share in Q1 and $0.26 in Q2, repurchased $5.8 million of shares in the first half, and authorized a new program for up to 1 million shares. The company also redeemed approximately $3.6 million of acquired trust-preferred securities in June.
Most important facts for investors to verify
- How much of earnings growth reflects recurring operating performance versus the $3.8 million of Kentucky tax benefits and acquisition-related costs.
- King’s post-acquisition contribution, final purchase-price allocation, expected synergies and planned branch-building sales.
- Whether loan growth, funding costs and deposit mix support net interest margin after the Federal Reserve rate cut.
- Trends in classified and non-performing loans, allowance adequacy and the effect of the expanded historical loss look-back period.
- The eventual CECL allowance and capital impact, and the realization of the reported liquidity and capital buffers.
- Execution of the share repurchase authorization, while balancing dividends, acquisition integration and capital needs.