First Financial Bankshares, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. The Texas-based financial holding company operates a full-service commercial bank, trust and asset-management businesses, and related subsidiaries. It had 69 financial centers across Texas. This unaudited filing covers the quarter and nine months ended September 30, 2017; balance-sheet comparisons are principally to September 30, 2016 and December 31, 2016. Dollar amounts below are in millions unless noted.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $59.7 | $56.7 | $175.8 | $170.3 |
| Provision for loan losses | $1.4 | $3.8 | $5.1 | $8.2 |
| Noninterest income | $24.3 | $22.2 | $68.7 | $63.4 |
| Noninterest expense | $44.0 | $42.0 | $129.9 | $123.8 |
| Net earnings | $29.4 | $25.6 | $84.2 | $78.1 |
| Diluted EPS | $0.44 | $0.39 | $1.27 | $1.18 |
- Growth and returns: Net earnings increased 14.7% year over year in Q3 and 7.8% for the nine months. Q3 return on average assets was 1.65% and return on average equity 12.95%; nine-month figures were 1.62% and 12.88%, respectively.
- Margins and efficiency: Tax-equivalent net interest margin was 3.94% in Q3, down 10 basis points year over year, and 4.01% for nine months, down 9 basis points. Management attributed margin pressure largely to the prolonged low-rate environment. Efficiency ratio was 48.71% in Q3 versus 49.33%; nine-month ratio was 49.22% versus 49.09%.
- Balance-sheet growth: Total assets were $7.01 billion, up 4.8% from September 2016. Loans held for investment were $3.47 billion, up 4.0% year over year and $114.9 million from year-end 2016; real estate loans drove most of the year-to-date increase. Deposits were $5.70 billion, up 8.8% year over year. Available-for-sale securities totaled $2.89 billion.
- Credit quality: Nonperforming assets were $22.1 million, or 0.63% of loans and foreclosed assets, compared with $34.9 million and 1.04% a year earlier. Nonaccrual loans declined to $18.8 million from $33.7 million. The allowance was $47.9 million, or 1.37% of held-for-investment loans, versus $45.3 million and 1.34% a year earlier. Net charge-offs were 0.10% of average loans annualized in Q3 versus 0.43%.
- Cash flow and liquidity: For nine months, operating cash flow was $155.1 million, investing cash flow was negative $157.7 million, and financing cash flow was positive $90.5 million. Cash and cash equivalents ended at $344.4 million; the cash-flow statement reports an $87.9 million increase from the beginning of the period. The bank reported no balance drawn on its $1.18 billion FHLB line, $130 million of correspondent-bank lines, or the parent’s $25 million revolving credit line.
- Debt and capital: Borrowings were $351.4 million, down from $513.8 million a year earlier and $445.8 million at year-end 2016. Shareholders’ equity was $906.6 million, 12.93% of assets. Consolidated regulatory ratios included 19.54% total capital to risk-weighted assets, 18.35% Tier 1 and common equity Tier 1, and a 10.84% leverage ratio; the bank exceeded the disclosed well-capitalized thresholds.
Material changes and management commentary
- Higher average earning assets supported net interest income growth, while interest costs rose: Q3 interest expense was $2.9 million versus $1.4 million. Deposit costs and borrowing rates increased, while the yield on earning assets edged down.
- Trust fees, deposit service charges, and card-related fees increased. Trust fees benefited from managed trust assets rising to $4.92 billion from $4.22 billion a year earlier. Real-estate mortgage income and interest on loan recoveries declined.
- Q3 noninterest income included $1.1 million of securities gains and a $505,000 litigation settlement. Noninterest expense rose, including increased fraud- and weather-related losses and software cost write-offs. Management attributed higher compensation expense to merit increases, profit sharing, and stock-based compensation.
- Hurricane Harvey affected areas where the company had branches and loans. Management reported damage primarily at its Mauriceville branch, with uninsured building and equipment damage not expected to be significant. Loans in the Conroe and Southeast Texas/Orange regions totaled approximately $448.8 million and $397.6 million, respectively; the company was continuing to assess borrowers, collateral, and operations and had recorded additional loan-loss allowance as deemed appropriate. Management did not identify credit-related other-than-temporary impairment in municipal bonds in affected counties.
- Oil-and-gas loans were $69.4 million, or 1.99% of gross loans, down from $78.5 million at year-end 2016. Management said price volatility continued to stress some credits despite overall improvement and noted enhanced monitoring.
Outlook, transactions, risks, and contingencies
- The filing provides no earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results and cited seasonality, economic and credit conditions, interest rates, and regulatory changes.
- On October 12, 2017, the company announced a definitive agreement to acquire Commercial Bancshares, Inc. for First Financial common stock valued at approximately $59.4 million, plus a planned $15.6 million special dividend by the seller before closing, subject to specified adjustments. The transaction was subject to regulatory and shareholder approval and expected to close in Q1 2018. At September 30, the target reported $366.8 million of assets, $322.1 million of deposits, and $263.8 million of gross loans.
- The board authorized repurchases of up to 2.0 million shares through September 30, 2020; no shares had been repurchased under the new or prior authorization through October 27, 2017. The company’s stated long-term dividend policy is approximately 40% of annual net earnings; its nine-month payout ratio was 44.0%.
- Key disclosed risks include local economic and real-estate conditions, severe weather, commodity prices, loan demand and credit losses, interest-rate and liquidity changes, competition, regulatory changes, cyber and information-system risks, and acquisition integration. A modeled 100- or 200-basis-point rate increase was estimated to reduce next-12-month net interest income by 0.80% or 2.33%; a 100-basis-point decrease by 3.89%. Management cautioned that these estimates depend on assumptions and actual results may differ materially.
- Unfunded lines of credit and commitments totaled $787.6 million, with $32.6 million of standby letters of credit. The company said these commitments generally may expire without being drawn. It reported no material pending legal proceedings, no material change in previously disclosed risk factors, and effective disclosure controls as of quarter-end.
Important facts for investors to verify
- Whether the Harvey-related credit review led to further provisions, borrower losses, or collateral impairments after quarter-end.
- Whether margin pressure and rising deposit funding costs continue, and how balance-sheet repricing affects earnings under changing rates.
- Whether asset-quality improvement is sustained, particularly in real estate and oil-and-gas exposures, and how the allowance compares with subsequent losses.
- Regulatory and shareholder approval, final terms, and integration progress for the Commercial Bancshares acquisition.
- The persistence of securities-sale gains and the unusual litigation settlement, fraud/weather losses, and software write-offs when assessing recurring earnings.