South State Corporation (SouthState Bank) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
South State is a regional banking company operating across six states. On June 7, 2020, it completed its stock merger with CenterState Bank Corporation (CSFL), issuing 37.27 million shares. The acquisition added approximately $13.0 billion of loans and $15.6 billion of deposits; reported year-over-year growth and results therefore reflect a substantially larger company and are not directly comparable with the legacy business.
Financial performance and condition
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $270.3 | $127.4 | $560.9 | $377.8 |
| Provision for credit losses | $29.8 | $4.0 | $217.8 | $9.2 |
| Noninterest income | $114.8 | $37.6 | $213.3 | $107.3 |
| Noninterest expense | $236.9 | $96.4 | $519.2 | $304.0 |
| Net income | $95.2 | $51.6 | $34.4 | $137.4 |
| Diluted EPS | $1.34 | $1.50 | $0.69 | $3.92 |
| Non-TE net interest margin | 3.21% | 3.72% | 3.31% | 3.81% |
- Q3 net income rose 84.7% year over year, but diluted EPS fell 10.7%, primarily reflecting the shares issued in the CSFL merger. The nine-month net income decline chiefly reflects the much higher credit-loss provision and merger-related costs.
- Q3 noninterest income growth was led by mortgage banking ($48.0 million) and correspondent banking and capital markets ($26.4 million). Management attributed mortgage banking strength to higher production and sales activity in the low-rate environment, as well as the acquired business.
- Q3 noninterest expense included $21.7 million of merger and branch-consolidation costs. For the first nine months, merger-related expense was $66.1 million. Management said systems conversion and integration expenses were expected to continue into 2021.
- At September 30, assets were $37.82 billion, loans $25.24 billion, deposits $29.97 billion, and shareholders’ equity $4.56 billion. Cash and cash equivalents were $4.47 billion. Loans and deposits increased sharply largely because of the acquisition.
- Other borrowings were $1.09 billion, including $700.1 million of FHLB advances and $389.5 million of corporate and subordinated debentures. Federal funds purchased and repurchase agreements totaled $706.7 million.
- For the first nine months, operating cash flow was $356.1 million and cash increased $3.78 billion to $4.47 billion. Investing cash flow included $2.57 billion of net cash received from acquisitions; financing cash flow included $2.17 billion of net deposit growth.
- Consolidated regulatory capital ratios were 11.48% CET1, 11.48% Tier 1, 13.86% total capital, and 8.12% Tier 1 leverage. The company and bank exceeded applicable minimums and the bank’s well-capitalized thresholds.
Material changes and notable items
- CECL was adopted January 1, 2020. Adoption increased the loan allowance by $54.4 million, the reserve for unfunded commitments by $6.4 million, and deferred tax assets by $12.6 million, and reduced retained earnings by $44.8 million. The company elected a five-year regulatory-capital transition for CECL effects.
- The September 30 allowance for credit losses was $440.2 million, or 1.74% of loans, with 3.91 times coverage of nonperforming loans. The separate reserve for unfunded commitments was $43.2 million. Q3 provision included $7.7 million for loans and $22.1 million for unfunded commitments; management cited the consolidated post-merger model and a revised funding-rate approach for commitments.
- Nonperforming assets were $126.2 million, or 0.50% of loans and repossessed assets, down from $142.0 million at June 30. The increase versus 2019 largely reflects the acquired portfolio and CECL-related treatment of certain purchased credit-deteriorated loans. Q3 annualized net charge-offs were 0.01% of average loans.
- Q3 efficiency ratio was 61.4%, versus 58.4% a year earlier; management attributed the year-over-year change to the larger acquired expense base, partly offset by higher revenue.
- Goodwill rose to $1.57 billion, including $563.6 million from CSFL. The company reported no impairment in its April 2020 annual assessment, while noting its share price remained below book value and that it would continue to monitor COVID-19 effects.
Outlook, risks and contingencies
- The filing provides no formal earnings or financial guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- Management described COVID-19 impacts as uncertain and dependent on the pandemic’s duration, economic conditions, and government responses. As of October 23, loan payment deferrals were $452 million, or 1.98% of loans excluding loans held for sale and PPP loans. The company reported approximately 20,000 PPP loans totaling $2.4 billion at September 30.
- Management identified lodging loans of $973 million, restaurant loans of $497 million, and retail commercial real estate loans of $2.2 billion as areas of greater pandemic risk. Deferral shares were 12%, 2%, and 4%, respectively; reported weighted-average LTVs were 55%, 55% for secured restaurant real estate, and 57% for retail CRE.
- Commitments to extend credit and standby letters of credit totaled $5.9 billion. PPP-related risks include potential borrower or third-party litigation and the possibility that the SBA could deny or reduce loan guarantees if it identifies deficiencies.
- Liquidity resources included $776 million of federal funds lines and $1.2 billion of Federal Reserve discount-window availability, both undrawn, plus $1.9 billion of available FHLB facility capacity. Management stated liquidity was adequate. Deposit outflows or higher wholesale funding costs could affect liquidity and margins.
- In November, the company announced plans to close 20 branches. It estimated $5.0 million in costs, approximately $7.0 million of annual savings in 2021, and about $825,000 of 2020 impact. Separately, a proposed Duncan-Williams acquisition, announced October 15, was expected to close in Q1 2021 subject to approvals and customary conditions.
- Management stated ordinary-course legal matters were not expected to have a material effect. It also disclosed that CSFL operations were excluded from the quarter-end internal-control evaluation as permitted following the acquisition; integration of controls was ongoing.
Most important facts for investors to verify
- How much reported earnings growth is sustainable after separating CSFL’s contribution, merger costs, purchase-accounting accretion, and mortgage-banking gains.
- Whether COVID-19 deferrals, exposures in lodging, restaurant and retail CRE, and the large unfunded-commitment reserve translate into future delinquencies, charge-offs, or additional provisions.
- Whether the $440.2 million loan allowance and CECL assumptions adequately reflect economic conditions, acquired-loan performance, and the company’s revised methodology.
- How integration costs, branch closures, projected savings, and anticipated merger synergies develop, and whether goodwill remains unimpaired.
- Whether deposit growth, liquidity availability, capital ratios, and net interest margins hold up as rates and funding conditions change.
- The status and financial terms of the proposed Duncan-Williams transaction, and any subsequent developments affecting PPP guarantees or litigation exposure.