Business context and reporting period
Southside Bancshares, Inc. is a Texas bank holding company. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010. Unless stated otherwise, financial amounts below are in millions of dollars.
Southside’s balance-sheet strategy combines loans with substantial holdings of securities, funded by customer deposits and FHLB advances. On July 15, 2011, it acquired the remaining 50% of Southside Financial Group (SFG) for $4.8 million, bringing ownership to 100%; SFG was already consolidated.
Financial performance and position
| Metric | Q3 2011 / September 30, 2011 | Comparable period / prior year-end |
|---|---|---|
| Net income attributable to Southside | $11.5 million; $0.70 per diluted share | Q3 2010: $11.0 million; $0.67 per share |
| Nine-month net income attributable to Southside | $29.9 million; $1.82 per diluted share | Nine months 2010: $31.9 million; $1.93 per share |
| Net interest income | Q3: $24.0 million; nine months: $70.8 million | Q3 2010: $21.3 million; nine months 2010: $63.7 million |
| Net interest margin | Q3: 3.61% | Q3 2010: 3.35% |
| Provision for loan losses | Q3: $1.5 million; nine months: $5.5 million | Q3 2010: $3.2 million; nine months 2010: $9.3 million |
| Noninterest income | Q3: $10.3 million; nine months: $28.5 million | Q3 2010: $14.7 million; nine months 2010: $42.2 million |
| Noninterest expense | Q3: $17.7 million; nine months: $54.5 million | Q3 2010: $17.7 million; nine months 2010: $53.1 million |
| Operating cash flow | Nine months: $56.7 million | Nine months 2010: $43.8 million |
- Balance sheet: Total assets were $3.21 billion, up from $3.00 billion at year-end 2010. Deposits rose to $2.29 billion from $2.13 billion; gross loans declined to $1.04 billion from $1.08 billion.
- Funding and liquidity: Cash and cash equivalents were $47.1 million, down from $79.1 million. FHLB advances totaled $562.7 million, compared with $562.6 million at year-end; long-term debt was $60.3 million. Management reported $606.3 million of additional potential FHLB funding against unpledged securities. Investing activities used $238.7 million and financing activities provided $150.1 million during the nine months.
- Credit quality: Allowance for loan losses was $18.2 million, or 1.75% of loans. Nine-month net charge-offs were $8.0 million, down from $10.5 million in 2010. Nonperforming assets were $13.2 million, or 0.41% of assets, versus $18.7 million, or 0.62%, at year-end 2010. Nonaccrual loans were $10.6 million.
- Capital: Shareholders’ equity was $258.1 million, 8.0% of assets, compared with $214.3 million and 7.1% at year-end. At September 30, consolidated total risk-based capital was 22.59%, Tier 1 risk-based capital 21.33%, and Tier 1 leverage 8.92%. The company stated it met applicable capital requirements.
- Cash dividends: $0.18 per share for Q3 and $0.52 per share for the nine months; the company also declared a 5% stock dividend in 2011.
Material changes versus comparable periods
- Q3 net income attributable to Southside increased 4.2%, while nine-month net income declined 6.5%. For the nine months, lower securities-sale gains outweighed improvement in net interest income and lower credit-loss provisioning.
- Nine-month net interest income increased 11.2%, primarily because interest expense fell 21.2% as funding costs declined. The Q3 net interest margin rose 26 basis points year over year. Management noted that lower market rates reduced loan and securities yields.
- Nine-month noninterest income fell 32.6%, primarily because securities gains declined to $9.7 million from $23.0 million. Q3 securities gains were $3.9 million versus $8.0 million a year earlier. Management cautioned that this level of gains may not continue.
- Management grew the securities portfolio during Q3 and restructured holdings, selling selected lower-coupon or longer-duration securities and buying primarily shorter-duration municipal and higher-coupon, less prepayment-sensitive mortgage-backed securities. Securities were 61.0% of assets at September 30, versus 55.5% at year-end.
- Net unrealized gains on securities contributed to a $24.1 million nine-month increase in accumulated other comprehensive income. This was a significant component of the increase in equity.
- Loans declined 3.5% from year-end, led by lower individual, construction, and commercial balances; municipal and 1–4 family residential loans increased. Management cited limited availability of auto-loan pools and a $6.2 million SFG loan sale among reasons for the decline in individual loans.
Outlook, risks, contingencies and unusual items
- Outlook: The filing provides no numerical earnings or revenue guidance. Management said loan growth could improve as local economic conditions recover, but also described competitive pressure on loan pricing. It may grow or shrink the balance sheet depending on the relative economics of assets and funding.
- Interest-rate and securities risks: The securities-heavy strategy is exposed to yield-curve changes, prepayments, spread volatility, and market-value changes that can affect earnings and equity. Management’s interest-rate simulations projected positive 12-month net-interest-income variances under both modeled rate increases and decreases, but results depend on assumptions and may differ from actual outcomes.
- Trust preferred securities: Pooled trust preferred securities had $2.9 million amortized cost and $947,000 estimated fair value. Management identified an estimated $3.1 million credit impairment and $2.0 million noncredit impairment recorded in other comprehensive income, with no additional earnings write-down in the first nine months of 2011. Valuation relies on Level 3 assumptions and cash-flow modeling because of market illiquidity.
- Funding commitments: The company had purchased options for $200 million of future FHLB advances and paid $11.0 million in fees, recorded in other assets. The fees may be expensed if management concludes exercise is no longer probable. Brokered CDs totaled $166.3 million; management cited higher potential funding costs and limited customer loyalty as risks.
- Off-balance-sheet exposure: Unused commitments to extend credit were $128.3 million and standby letters of credit were $5.9 million at September 30. Commitments may not be fully drawn. Management said ordinary-course litigation was not expected to materially affect financial position, results, or liquidity.
- Regulatory and other risks: The filing cites economic and real-estate conditions, borrower credit, interest rates, liquidity, competition, regulatory changes including Dodd-Frank, and the accuracy of loan-loss and fair-value estimates. Management said Dodd-Frank compliance may increase costs. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether lower nonperforming assets and charge-offs persist, and whether the $18.2 million allowance remains adequate as portfolio conditions change.
- How the securities portfolio’s size, duration, prepayment exposure, unrealized gains, and Level 3 trust preferred valuations evolve, particularly if interest rates or market liquidity change.
- Whether reported earnings remain supported by recurring net interest income rather than securities-sale gains, and how competitive loan pricing affects margins.
- How the company funds growth and manages FHLB advances, brokered CDs, future advance options, and associated fees and collateral requirements.
- Whether SFG’s automobile-loan performance, loan-pool availability, and integration under full ownership affect credit costs or growth.
- Any changes to capital ratios, dividend capacity, regulatory requirements, or disclosed legal and off-balance-sheet exposures.