South State Corporation (South State Bank) — FY 2017 Form 10-K
Reporting period: Year ended December 31, 2017; filed February 23, 2018. South State Corporation is a regional bank holding company headquartered in Columbia, South Carolina, operating across South Carolina, North Carolina, Georgia, and Virginia. The filing’s financial statements are audited and received an unqualified opinion. The company reported 2017 results against 2016, with major acquisitions affecting comparability.
Financial results and position
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Total assets at year-end | $14.47 billion | $8.90 billion |
| Loans, net of unearned income | $10.62 billion | $6.68 billion |
| Deposits | $11.53 billion | $7.33 billion |
| Shareholders’ equity | $2.31 billion | $1.13 billion |
| Net interest income | $409.0 million | $324.8 million |
| Net interest margin, taxable-equivalent | 4.15% | 4.22% |
| Net income | $87.6 million | $101.3 million |
| Diluted EPS | $2.93 | $4.18 |
| Provision for loan losses | $11.9 million | $6.8 million |
| Noninterest income | $149.1 million | $130.3 million |
| Noninterest expense | $377.4 million | $294.3 million |
| Operating cash flow | $197.9 million | $138.0 million |
- Earnings and margins: Net income available to common shareholders fell 13.6%; diluted EPS fell 29.9%, reflecting lower reported earnings and a substantially higher share count after stock-funded acquisitions. Net interest income increased 25.9%, primarily on larger average loan and securities balances, while the taxable-equivalent net interest margin declined 7 basis points. The efficiency ratio worsened to 67.07% from 64.16%; management’s adjusted, non-GAAP ratio was 59.2% versus 62.9%.
- Tax and unusual items: The 2017 income tax provision was $81.3 million, including a provisional, noncash $26.6 million charge to revalue deferred tax assets and liabilities following the Tax Cuts and Jobs Act. The effective tax rate was 48.13%; management said it would have been 32.40% excluding the revaluation. Fourth-quarter net income was $2.4 million, or $0.08 diluted EPS, with quarterly tax expense of $40.5 million.
- Cash flow: Cash from operations was $197.9 million; investing activities used $60.9 million and financing activities used $133.8 million. Cash and cash equivalents ended the year at $377.6 million, compared with $374.4 million. The cash-flow statement includes acquisition-related activity; acquisition consideration was primarily stock.
- Credit quality: Net charge-offs on non-acquired loans were 0.04% of average loans, down from 0.06%. Total nonperforming assets were $36.1 million, or 0.25% of assets, versus $38.6 million, or 0.43%. The allowance was $48.1 million across non-acquired and acquired credit-impaired loans; allowance coverage of non-acquired nonperforming loans was 293.0%.
- Capital and liquidity: The Bank was categorized as well capitalized. At year-end, consolidated CET1 was 11.59%, total risk-based capital 13.04%, and Tier 1 leverage 10.36%. The company reported $11.5 billion in deposits and $503.2 million in nondeposit borrowings in selected balance-sheet data; the balance sheet separately lists $286.9 million of federal funds purchased and repurchase agreements and $216.4 million of other borrowings. Management described liquidity as adequate, citing $516 million of federal funds lines, $364 million available at the Federal Reserve discount window, and a $1.9 billion FHLB facility, with $100.1 million of FHLB advances outstanding.
Material changes versus 2016
- Acquired Southeastern Bank Financial Corporation (SBFC) on January 3, 2017, for approximately $435.1 million, and Park Sterling Corporation (PSC) on November 30, 2017, for approximately $693.0 million. Both were stock-for-stock transactions. The acquisitions added significant loans, deposits, investment securities, branches, employees, and goodwill.
- Assets grew 62.5%, loans 58.9%, and deposits 57.2%. Acquisitions contributed approximately $3.7 billion of deposits at year-end; management also reported $546.9 million of legacy deposit growth. Non-acquired loans grew 23.9%.
- Shareholders’ equity more than doubled, primarily from $1.12 billion of common stock issued in the acquisitions. Shares outstanding increased from 24.2 million to 36.8 million.
- Net interest income rose $84.1 million, but interest expense also rose $8.7 million as acquired deposits carried higher rates and market rates increased. Acquired-loan yields declined 109 basis points.
- Noninterest expense rose 28.2%, including $44.5 million in merger and branch-consolidation expense (versus $8.1 million). Salaries and benefits increased $29.8 million, and full-time-equivalent employees rose to 2,719 from 2,055.
- Noninterest income increased 14.4%, helped by deposit fees and trust and investment services; mortgage banking income declined 12.6%. The FDIC loss-share agreements had been terminated in 2016, leaving the Bank responsible for future losses and recoveries on previously covered assets.
Outlook, risks, and contingencies
- Management projected a 2018 effective tax rate of 22%–23%, subject to refinement of the Tax Reform Act accounting and tax-return results. It expected additional PSC systems-conversion and integration costs in 2018 and anticipated further cost savings and synergies, without quantifying them.
- Beginning July 1, 2018, debit interchange-fee limits were expected to reduce bankcard-services income by about $8.5 million in the second half of 2018. The company estimated a $16 million reduction if the rules had applied for all of 2017.
- Crossing the $10 billion asset threshold brings heightened oversight, including annual stress testing, CFPB examination authority, and changes to FDIC assessments. The first required stress test was scheduled for December 31, 2018, with filing in July 2019. The company expected higher FDIC assessment costs.
- Management cited risks from real-estate and commercial lending concentrations, economic or local-market weakness, interest-rate and funding-cost changes, acquisition integration, competitive and technology pressures, cybersecurity, regulatory compliance, and litigation. Real estate was a primary or secondary component of collateral for approximately 82.2% of loans; commercial real estate loans were 227.3% of total risk-based capital.
- Interest-rate simulations indicated that a 200-basis-point increase over 12 months could raise net interest income by 5%, while a 200-basis-point decrease could reduce it by 5.9%, relative to a flat-rate base case. Results depend on model assumptions.
- CECL, scheduled to become effective in 2020, may require earlier or higher credit-loss allowances; the company was still assessing the impact. Legal matters were described as arising in the ordinary course, with no material pending proceeding identified by management.
- Management and the auditor concluded internal control over financial reporting was effective; however, the assessment and audit excluded PSC, which represented 23.2% of consolidated assets at year-end and 2.5% of 2017 revenue.
Most important facts for investors to verify
- How much of 2017 earnings decline reflects the one-time deferred-tax revaluation and merger costs, and how sustainable are adjusted earnings and efficiency improvements?
- Whether SBFC and PSC integration delivers the anticipated expense savings and revenue benefits, and how acquisition-related credit marks, goodwill, and provisional fair values develop.
- Whether loan growth—particularly in commercial real estate and construction—and rising nonacquired problem loans remain consistent with underwriting quality and allowance adequacy.
- The actual impact of the July 2018 interchange-fee limits, higher FDIC assessments, and other costs associated with the $10 billion regulatory threshold.
- Whether liquidity, funding costs, and capital remain sufficient as loans grow and acquired deposits reprice; review the maturity and terms of the $100 million FHLB advances and other borrowings.
- How the provisional tax accounting, expected 2018 tax rate, and CECL adoption affect reported results and capital.