South State Corporation (formerly First Financial Holdings, Inc.) — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The company and its bank subsidiary adopted the South State names on June 30. Unless noted otherwise, dollar amounts below are in millions.
Business context and results
South State is a South Carolina-based bank holding company. Results include First Financial Holdings (FFHI), acquired in July 2013, so year-over-year comparisons reflect a substantially larger company and are not fully comparable on an organic basis.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $81.0 | $55.3 | $164.3 | $109.1 |
| Provision for loan losses | $2.2 | $0.2 | $3.0 | $1.2 |
| Noninterest income | $24.4 | $8.5 | $45.1 | $18.0 |
| Noninterest expense | $75.9 | $44.9 | $153.3 | $91.3 |
| Net income | $17.9 | $12.5 | $34.9 | $23.2 |
| Net income available to common shareholders | $17.9 | $12.5 | $33.8 | $23.2 |
| Diluted EPS | $0.74 | $0.74 | $1.40 | $1.36 |
Financial position, cash flow and capital
- Assets: $7.994 billion at June 30, 2014, versus $7.931 billion at year-end 2013 and $5.043 billion a year earlier.
- Loans and deposits: Net loans were $5.634 billion, compared with $5.652 billion at year-end and $3.517 billion a year earlier. Deposits were $6.576 billion, versus $6.555 billion and $4.183 billion, respectively.
- Liquidity: Cash and cash equivalents totaled $589.5 million. The company reported $376 million in federal funds credit lines, $254.3 million available at the Federal Reserve Discount Window, and a $939.2 million FHLB facility, with $139,000 of advances outstanding. Management considered liquidity adequate.
- Borrowings: Federal funds purchased and repurchase agreements were $280.6 million; other borrowings were $101.0 million. Total shareholders’ equity was $953.0 million, down from $981.5 million at year-end, largely following redemption of $65 million of preferred stock.
- Six-month cash flow: Operating activities provided $63.9 million, investing activities provided $33.0 million, and financing activities provided $13.2 million. Cash increased $110.1 million to $589.5 million; operating cash flow was lower than the $92.0 million reported in the first half of 2013.
- Margins and returns: Q2 taxable-equivalent net interest margin was 4.75%, down 26 basis points year over year and 24 basis points sequentially. Q2 efficiency ratio was 71.5%; excluding OREO and merger/branding expenses, management reported 63.6%. Six-month return on average assets was 0.88%, versus 0.92% a year earlier.
- Capital: Company Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 12.94%, 13.80% and 8.93%, respectively. Ratios declined from year-end, but management said the company and bank remained well capitalized.
Material changes versus comparable periods
- Q2 net income rose $5.4 million year over year, but diluted EPS remained $0.74 as the FFHI transaction increased weighted-average shares by about 42%.
- Reported Q2 net interest income rose 46.5%, while net interest margin declined, reflecting lower loan yields and excess liquidity. Average earning assets grew 53.7% year over year, largely due to FFHI.
- Noninterest income increased substantially, driven by FFHI and growth in bankcard, trust, mortgage banking and deposit service revenues. Noninterest expense also rose materially, particularly salaries, occupancy, merger/branding costs and amortization.
- Non-acquired loans grew to $3.175 billion, up $509 million, or 19.1%, year over year. Acquired loans declined during Q2 due to repayments, charge-offs and transfers to OREO.
- Non-acquired asset quality improved: nonperforming assets were $44.3 million, down from $68.7 million a year earlier; annualized Q2 net charge-offs were 0.17%, versus 0.40%. The allowance was 1.12% of non-acquired loans and covered 100.3% of non-acquired nonperforming loans.
Outlook, commentary and risks
- Management expected additional FFHI systems-conversion and integration costs during the remainder of 2014, while anticipating further cost savings and business synergies; no quantified earnings guidance was provided.
- Q2 merger and branding expense was $6.5 million; first-half expense was $12.5 million. The filing attributes these costs to integration, branch closures, employment-related costs, professional services and the company and bank name changes.
- Negative accretion on the FDIC indemnification asset reduced noninterest income by $5.8 million in Q2 and $12.9 million in the first half. The indemnification asset was $43.8 million at June 30; management noted that projected cash flows were below its carrying value and that future impairment or revised estimates could affect earnings.
- The Cape Fear commercial loss-share agreement expired June 30, 2014; the CBT commercial agreement was scheduled to expire March 31, 2015. Expected FDIC reimbursements and final “true-up” amounts remain subject to agreement terms and estimates.
- Key risks include credit losses, interest-rate and liquidity changes, FFHI integration and customer-retention issues, regulatory changes including Basel III capital rules taking effect in 2015, cybersecurity, and economic conditions. Management cautioned that low recent charge-offs may not be sustainable.
- At June 30, commitments to extend credit and standby letters of credit totaled $1.4 billion; management did not anticipate material losses. The Rational Savannah shareholder settlement still required final court approval in the filing. Other described merger-related shareholder cases had been settled and dismissed.
Important facts for investors to verify
- How much of reported revenue and expense growth is attributable to FFHI, and whether expected integration savings materialize after conversion.
- Whether margin pressure continues as loan yields decline and acquired loan accretion runs off.
- Trends in non-acquired loan growth, construction and real-estate exposures, credit classifications, charge-offs and allowance adequacy.
- Assumptions underlying acquired-loan cash flows, FDIC indemnification asset accretion and reimbursement estimates, including the effect of expiring loss-share coverage.
- Capital ratios after the preferred stock redemption and the impact of Basel III implementation; also monitor liquidity funding costs and deposit retention.
- Potential valuation sensitivity in mortgage servicing rights, goodwill and other acquisition-related intangibles; management reported no goodwill impairment at its April 2014 annual test.