Stock Yards Bancorp, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with 2016. Stock Yards Bancorp is a bank holding company whose business is substantially conducted through Stock Yards Bank & Trust. It operates 37 branches in the Louisville, Indianapolis and Cincinnati markets, with commercial and personal banking and wealth management and trust services.
Financial performance and condition
- Revenue: Total revenue was approximately $148.7 million, up about 6% from 2016. Net interest income rose 6.5% to $103.6 million; non-interest income grew 3.6% to $45.1 million. Tax-equivalent net interest margin was 3.63%, compared with 3.59%.
- Profit: Net income was $38.0 million, down 7.3% from $41.0 million. Diluted EPS declined to $1.66 from $1.80. Results included a one-time, non-cash $5.9 million tax expense ($0.25 per diluted share) to remeasure deferred tax assets after tax reform. The 2017 effective tax rate was 31.1%, versus 27.1%.
- Costs and returns: Non-interest expense increased 11.6% to $91.0 million, including higher personnel, technology and tax-credit partnership costs. The efficiency ratio rose to 60.9% from 57.6% (56.1% versus 54.4% excluding tax-credit partnership amortization and impairment). Return on average assets was 1.25% and return on average equity 11.61%; management said the tax remeasurement reduced these ratios by 0.20 and 1.81 percentage points, respectively.
- Loans and credit: Loans increased 4.5% to $2.410 billion. The allowance was $24.9 million, or 1.03% of loans, versus 1.04% a year earlier. Non-performing loans were $7.4 million (0.31% of loans), up from $6.7 million (0.29%); net charge-offs remained 0.07% of average loans. Management described credit quality as historically strong but expects metrics to normalize over time. Potential problem loans totaled $17.9 million, up from $9.3 million.
- Balance sheet and capital: Assets were $3.240 billion, up 6.6%; deposits were $2.578 billion, up 2.3%; stockholders’ equity was $333.6 million, up 6.3%. Common equity Tier 1 capital was 12.57%, total risk-based capital 13.52%, and leverage 10.70%. The company reported that it met applicable well-capitalized requirements.
- Liquidity, funding and debt: Cash and cash equivalents were $139.2 million, versus $48.0 million. Available-for-sale securities totaled $574.5 million, with $190 million unpledged. Core deposits were 99% of deposits, and the company had no brokered deposits. Year-end borrowings included $161.4 million of federal funds purchased and $49.5 million of FHLB advances; repurchase agreements were $70.5 million. The federal funds purchased balance included a $150 million FHLB cash-management advance that matured in early January 2018.
- Cash flow: Operating activities provided $53.7 million, investing activities used $114.7 million, and financing activities provided $152.3 million. Cash and cash equivalents increased $91.3 million during the year. These figures reflect bank balance-sheet funding and investment flows, not a conventional corporate free-cash-flow measure.
- Shareholder distributions: Dividends declared rose to $0.80 per share from $0.72; the basic-EPS payout ratio was 47.34%. The company had no active repurchase program; fourth-quarter share purchases were employee tax withholdings.
Material changes versus 2016
- Revenue increased on loan growth, higher asset yields and higher wealth-management fees, while net income fell because expenses and taxes rose, including the deferred-tax remeasurement charge.
- Interest expense increased 47% to $7.2 million as deposit and borrowing costs rose. Average loan balances grew 6.7%; year-end loans grew 4.5% amid elevated repayments and payoffs.
- Wealth management and trust revenue rose 7% to $20.5 million; assets under management increased 12% to $2.8 billion. Mortgage banking revenue declined 17.3% to $3.2 million.
- Non-performing loans edged higher, although non-performing assets declined to $10.0 million from $11.7 million, aided in part by lower foreclosed property.
- Operating cash flow declined from $63.3 million. Year-end cash rose substantially, partly reflecting seasonal deposits and short-term investments.
Outlook, commentary and risks
- Management expected a 2018 effective tax rate of approximately 17%, modestly higher net interest margin, and loan growth greater than 2017. It also identified deposit gathering, credit quality, technology investment and wealth-management client retention as priorities. Tax-credit partnership participation was expected to be lower because investment opportunities were reduced.
- Rate exposure remains important: the year-end simulation estimated net interest income would decline 2.90% for an immediate 200-basis-point increase and 4.83% for a 200-basis-point decrease. Management cautioned that competitive loan pricing and rising deposit rates could constrain margin improvement.
- Funding risk includes concentrated commercial relationships: approximately 40% of deposits were in accounts with balances of $500,000 or more. Management cited higher-cost alternative funding if significant balances leave.
- Other principal risks include local economic and real-estate conditions, borrower losses, stock-market declines affecting wealth-management fees, competition, cybersecurity and third-party technology dependence, regulation, and changing customer behavior. About 44% of non-interest income came from wealth management and trust services, whose fees are largely tied to market values.
- CECL was expected to require a potentially significant increase in the allowance; the company could not quantify the effect and expected a one-time cumulative adjustment in first-quarter 2020. The company also expected about $11 million of lease assets and liabilities upon adoption of the new lease standard.
- Legal proceedings were described as arising in the ordinary course; management, after consulting counsel, did not expect a material adverse effect. A $266,000 accrual was recorded for estimated losses from certain administrative proceedings. A prior material weakness concerning loan-grade review controls was reported remediated in fourth-quarter 2017. The auditor gave unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of 2017’s earnings decline reflects the one-time $5.9 million tax charge, and whether the anticipated 2018 tax rate and tax-credit benefits are achievable.
- Whether deposit costs rise faster than loan yields, given the reported interest-rate sensitivity and concentration in large commercial deposit accounts.
- Whether potential problem loans and non-performing loans develop into higher charge-offs or provisions, and whether the allowance remains adequate as credit conditions normalize.
- How the $150 million short-term FHLB advance was repaid or refinanced after its January 2018 maturity, and how seasonal excess deposits and liquidity evolve.
- The sensitivity of wealth-management revenue to market declines and the sustainability of loan growth, expense growth and the efficiency ratio.
- The eventual CECL transition impact, including the allowance and equity adjustment, as well as completion of provisional tax-reform accounting.