South State Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The filing is for South State Corporation and its consolidated subsidiary, South State Bank. Results are not necessarily indicative of full-year performance.
Business context and financial performance
- The company is a regional banking organization headquartered in Columbia, South Carolina. At quarter-end, it reported $14.5 billion in assets and 2,640 full-time equivalent employees.
- Q3 revenue (net interest income plus noninterest income) was $160.3 million, versus $134.1 million a year earlier. Net income was $47.1 million, up 34.3%; diluted EPS was $1.28, versus $1.19. The effective tax rate fell to 17.26% from 33.53%, chiefly reflecting federal tax reform and related tax benefits.
- First nine months: Net interest income was $386.8 million, noninterest income $110.1 million, and net income $129.9 million, compared with $296.7 million, $103.3 million, and $85.1 million, respectively, in 2017. Diluted EPS was $3.52 versus $2.90.
- Net interest margin: Q3 non-tax-equivalent margin was 4.02%, down 4 basis points year over year and 10 basis points sequentially. Tax-equivalent margin was 4.04%, down 7 basis points year over year. Higher funding costs and a smaller acquired-loan balance pressured margins.
- Costs and efficiency: Q3 noninterest expense rose 26.5% to $100.3 million, largely due to the Park Sterling acquisition. The efficiency ratio was 62.3%, versus 58.8% a year earlier; it improved from 65.6% in Q2 2018.
- Cash flows: Nine-month operating cash flow was $223.8 million; investing activities used $222.5 million and financing activities used $71.6 million. Cash and cash equivalents ended at $307.3 million, down from $377.6 million at December 31, 2017.
Balance sheet, liquidity and capital
- Total assets were $14.5 billion; net loans were $10.9 billion and deposits were $11.6 billion at September 30, 2018. Loans grew 32.0% year over year, reflecting the Park Sterling acquisition and 22.1% growth in non-acquired loans. Deposits rose 28.2% year over year, also substantially reflecting the acquisition.
- Borrowings included $279.7 million of federal funds purchased and repurchase agreements and $115.9 million of other borrowings. The company repaid $425.0 million of borrowings and received $325.0 million of FHLB advances during the first nine months.
- Management described liquidity as adequate. Available sources included $556 million of federal funds lines, $378.3 million of Federal Reserve Discount Window capacity, and a $1.9 billion FHLB facility; there were no federal funds line or Discount Window advances outstanding at quarter-end.
- Consolidated capital ratios were 12.30% CET1, 13.31% Tier 1 risk-based, 13.80% total risk-based, and 10.82% Tier 1 leverage. The company said it and the Bank exceeded applicable minimums and qualified as well capitalized.
- Shareholders’ equity was $2.37 billion. Accumulated other comprehensive loss widened to $44.5 million, mainly due to unrealized losses on available-for-sale securities as interest rates rose.
Material changes and asset quality
- The November 2017 Park Sterling acquisition expanded the company’s footprint and contributed substantially to year-over-year balance-sheet and earnings growth. Q3 included $4.5 million of merger-related expense; nine-month expense was $29.9 million. Management did not expect material Park Sterling merger expense in Q4 2018.
- Q3 loan interest income increased $36.3 million year over year, while interest expense increased $11.2 million. The company cited acquired balances, organic loan growth, and higher interest rates. Deposit costs rose as acquired deposits carried higher rates and market rates increased.
- Non-acquired nonperforming assets were $18.5 million, compared with $19.2 million a year earlier. Total nonperforming assets, including acquired assets, were $38.6 million. Q3 annualized net charge-offs on non-acquired loans were 0.07%, versus 0.04% in Q3 2017. The non-acquired allowance was 0.66% of those loans.
- Available-for-sale securities had $48.8 million of gross unrealized losses at quarter-end, up from $12.8 million at December 31, 2017. Management said the securities continued to perform as scheduled and did not consider them other-than-temporarily impaired, but noted future impairment or sale conclusions could change.
Outlook, risks and unusual items
- The filing provides no formal earnings or revenue guidance. Management expected a similar Q4 decline in bankcard service income following the Durbin Amendment interchange-fee cap, effective for the company July 1, 2018. It estimated a $4.8 million pretax Q3 reduction from the cap and a $3.7 million after-tax effect.
- Management cited rising funding costs, interest-rate and liquidity risk, credit quality, acquisition integration, regulatory and compliance costs, cybersecurity, and the effects of exceeding $10 billion in assets as material risk areas. The $10 billion threshold increased FDIC assessment costs and triggered the interchange-fee cap.
- Loan commitments and standby letters of credit totaled $2.9 billion; management did not anticipate material losses from them. The company reported ordinary-course legal matters and did not expect them to materially affect its financial statements.
- Lease accounting adoption was expected to add approximately $76 million of right-of-use assets and lease liabilities based on quarter-end balances. The company could not yet reasonably estimate the impact of the forthcoming CECL credit-loss standard.
- After quarter-end, the company began repurchasing shares. By the filing date it had repurchased 351,200 shares at an average $65.69 per share, for $23.1 million, with authorization for up to 548,800 additional shares.
- The company adopted the new revenue standard retrospectively; the principal presentation change was netting debit-card network costs against related fees. Management said the adoption did not materially change revenue recognition or financial results.
Important facts for investors to verify
- How much future earnings growth is organic versus attributable to Park Sterling, and whether merger cost savings persist after integration.
- Whether deposit pricing and funding costs continue to rise faster than asset yields, and the resulting effect on net interest margin.
- Trends in nonperforming loans, charge-offs, acquired-loan cash-flow estimates, and allowance adequacy as lending expands.
- Whether the securities portfolio’s unrealized losses recover or lead to sales or impairment charges, and the potential effect on equity.
- The realized impact of the Durbin Amendment, increased regulatory costs, planned share repurchases, and adoption of lease and CECL accounting standards.