SOUTHSIDE BANCSHARES INC quarterly report, Q2 FY2017

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Southside Bancshares, Inc. — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017. The unaudited consolidated statements cover Southside Bancshares and subsidiaries, including Southside Bank. Unless stated otherwise, amounts below are in U.S. dollars.

Business context and reporting period

Southside is a Texas-based bank holding company. At June 30, 2017, it reported $5.58 billion in assets and $2.61 billion in loans. Its balance-sheet strategy combines lending with substantial investment in securities, particularly agency mortgage-backed securities and municipal securities, funded by deposits and FHLB advances.

Financial performance and condition

  • Q2 earnings: Net income was $14.5 million, up 27.1% from $11.4 million in Q2 2016. Diluted EPS was $0.49 versus $0.42.
  • First-half earnings: Net income was $29.5 million, up 18.3% from $24.9 million. Diluted EPS was $1.00 versus $0.92.
  • Net interest income: Q2 GAAP net interest income rose 3.0% to $35.4 million. First-half net interest income declined 0.4% to $70.7 million. The reported tax-equivalent net interest margin was 3.07% in both Q2 and the first half, versus 3.35% and 3.43%, respectively, in 2016.
  • Other income and expenses: Q2 noninterest income was $9.3 million, slightly below $9.4 million; first-half noninterest income fell 9.5% to $19.0 million, mainly reflecting lower securities-sale gains and loan-sale gains. Noninterest expense declined 1.1% in Q2 to $25.5 million and 6.9% in the first half to $51.4 million.
  • Credit costs: Provision for loan losses was $1.3 million in Q2 and $2.4 million in the first half, down from $3.8 million and $6.1 million in the comparable 2016 periods. Management attributed much of the year-over-year reduction to large commercial-loan charge-offs in 2016.
  • Cash flow: For the six months, operating activities provided $48.7 million and investing activities provided $70.2 million; financing activities used $52.8 million. Cash and cash equivalents increased $66.2 million to $235.8 million.
  • Balance sheet and funding: Since year-end 2016, assets increased 0.3% to $5.58 billion, loans increased 2.1% to $2.61 billion, and deposits increased 2.6% to $3.62 billion. Securities decreased 3.9% to $2.32 billion. Total FHLB advances were $1.18 billion, down $131.6 million; brokered CDs increased to $133.5 million from $35.5 million.
  • Debt and equity: Long-term obligations totaled $320.7 million, including $98.2 million of subordinated notes and $60.2 million of long-term debt; these amounts exclude FHLB advances classified as short-term obligations. Shareholders’ equity was $547.1 million, or 9.8% of assets. Regulatory capital ratios exceeded stated minimums; consolidated CET1 was 14.91%, Tier 1 risk-based capital 16.68%, and total risk-based capital 20.40%.
  • Asset quality: Nonperforming assets fell to $9.2 million, or 0.16% of assets, from $15.1 million at year-end 2016. Nonaccrual loans were $3.0 million; allowance for loan losses was $19.2 million, or 0.74% of loans.
  • Dividends: Cash dividends paid were $0.28 per share in Q2 and $0.53 per share for the first half. A 2.5% stock dividend was paid June 27, 2017.

Material changes versus comparable periods

  • Q2 earnings benefited from higher interest income, a lower loan-loss provision, and modestly lower noninterest expense, partly offset by a sharp rise in interest expense and higher tax expense.
  • For the first half, higher interest income and lower operating expense and provision were more than offset at the net-interest-income level by a 54.1% increase in interest expense. Management cited higher funding balances and rates, including the subordinated-note issuance in 2016 and rising deposit and borrowing costs.
  • Commercial real estate loans rose $87.7 million from year-end, while 1–4 family residential and individual loans declined. The individual-loan decline primarily reflected runoff of the acquired Omni indirect auto portfolio.
  • Nonperforming assets improved substantially from both year-end 2016 and June 2016. The allowance increased from $17.9 million at year-end, while first-half net charge-offs were lower than in 2016.

Outlook, risks, contingencies and unusual items

  • Acquisition: Southside agreed to acquire Diboll State Bancshares, parent of First Bank & Trust East Texas. Diboll had $993.8 million in assets at June 30. Consideration included 5,535,000 Southside shares and up to $25.0 million cash, subject to adjustment. Closing was expected in Q4 2017, subject to regulatory and shareholder approvals and other conditions. Q2 included $473,000 of related acquisition expense.
  • No earnings guidance: The filing provides no specific earnings or revenue guidance. Management described its balance-sheet and funding approach as subject to ongoing review as rates, securities economics, prepayments, and loan and deposit trends change.
  • Interest-rate and securities risks: Management reported modeled 12-month net-interest-income increases of 2.55% and 3.08% under immediate +100 and +200 basis-point rate shocks, and increases of 6.63% and 5.42% under -100 and -200 basis-point shocks. These are model estimates dependent on assumptions, not forecasts. Management also warned that rate and yield-curve changes, mortgage prepayments, and securities fair-value changes could affect earnings and equity.
  • Funding and liquidity: Cash and short-term investments were 7.5% of assets. The Bank reported approximately $683 million of additional FHLB borrowing capacity, net of required stock purchases. Brokered CDs carry potential higher-cost and customer-loyalty risks.
  • Credit and geographic risks: Lending is concentrated primarily in Texas. Management noted that prolonged low oil prices could pressure Texas borrowers; energy loans were approximately 1.14% of the portfolio. Commercial real estate exposure, collateral values, borrower creditworthiness, and allowance estimates remain relevant risks.
  • Commitments and litigation: Unused commitments to extend credit were $693.5 million and standby letters of credit were $9.8 million. The company is involved in ordinary-course litigation; management did not expect resulting liabilities to materially affect financial position, results, or liquidity.
  • Other notable items: Q2 securities sales produced a $75,000 net loss; first-half sales produced a $247,000 net gain. Two cash-flow hedge swaps with $40 million total notional were terminated in Q1; management said the hedged transactions remained probable and related accumulated gains or losses would be recognized as the forecast transactions affect earnings.

Important facts for investors to verify

  • Progress, regulatory approvals, final consideration, integration costs, and expected benefits of the pending Diboll acquisition.
  • Whether net interest margin stabilizes as funding costs rise and the company adjusts its securities, loan, and wholesale-funding mix.
  • Loan growth and credit quality, particularly commercial real estate, criticized/classified loans, charge-offs, and allowance adequacy.
  • Brokered-CD dependence, FHLB funding levels, liquidity availability, and the sensitivity of funding costs to market rates.
  • Realized and unrealized securities results, mortgage prepayment assumptions, and the effect of interest-rate changes on accumulated other comprehensive income and capital.
  • Delivery of cost savings and control of rising health-insurance and acquisition-related expenses.