First Financial Bankshares, Inc. — Q3 2016 Form 10-Q
Business context and reporting period. The company is a Texas-based financial holding company operating a full-service commercial bank, trust and other financial businesses. It reported the quarter and nine months ended September 30, 2016. Unless otherwise stated, dollar amounts below are in millions. The prior-year comparison includes First Bank only from August 1, 2015, following its acquisition.
Financial results and position
- Q3 earnings: Net interest income was $56.7, up 1.1% year over year; provision for loan losses was $3.8 versus $2.7; noninterest income was $22.2, up 8.3%; and noninterest expense was $42.0, up 5.1%. Net earnings were $25.6, down 1.1%, and diluted EPS was $0.39 versus $0.40.
- Nine-month earnings: Net interest income was $170.3, up 6.7%; provision was $8.2 versus $5.5; noninterest income was $63.4, up 17.1%; and noninterest expense was $123.8, up 13.5%. Net earnings were $78.1, up 3.9%, and diluted EPS was $1.18 versus $1.16.
- Margins and returns: Net interest margin was 4.04% for Q3, down from 4.13%; it was 4.10% for the first nine months, unchanged. Efficiency ratio increased to 49.33% from 48.44% for Q3 and to 49.09% from 47.34% year to date. Return on average assets was 1.54% for Q3 (versus 1.61%) and 1.59% year to date (versus 1.64%). Return on average equity was 11.72% for Q3 (versus 13.63%) and 12.33% year to date (versus 13.99%). The MD&A labels the Q3 ROAA comparison as “third quarter of 2016” on both sides; the comparator appears unclear in the filing text.
- Balance sheet at September 30: Total assets were $6,686.7; loans held for investment were $3,337.8, net loans $3,324.1, and available-for-sale securities $2,729.0. Total deposits were $5,235.5, up from $5,097.3 a year earlier. Shareholders’ equity was $867.9, or 12.98% of assets.
- Liquidity and funding: Cash and cash equivalents were $287.7. Short-term borrowings totaled $513.8, including $345.6 in repurchase agreements, $160.0 in FHLB advances and $8.2 in federal funds purchased. Nine-month operating cash flow was $127.8; investing cash flow was negative $24.4 and financing cash flow negative $88.6, producing a $14.8 increase in cash. Management considered liquidity adequate and reported no known event likely to materially impair it.
- Credit quality: Nonperforming assets were $34.9, or 1.04% of loans and foreclosed assets, up from $22.7 and 0.69% a year earlier. Nonaccrual loans were $33.7. The allowance for loan losses was $45.3, equal to 1.34% of held-for-investment loans, versus 1.23% a year earlier. Annualized net charge-offs were 0.43% of average loans in Q3 versus 0.16%; management attributed the increase primarily to one commercial loan.
- Capital: Consolidated total risk-based capital ratio was 18.28%, Tier 1 and common equity Tier 1 ratios were each 17.12%, and leverage ratio was 10.60%. The bank subsidiary also exceeded the disclosed well-capitalized thresholds.
Material changes versus the prior comparable period
- Growth in average earning assets, loans and tax-exempt securities—largely attributed to the First Bank acquisition—supported higher net interest income. However, Q3 asset yield declined seven basis points while funding costs rose, compressing the margin.
- Nine-month noninterest income growth reflected higher mortgage origination fees, card and deposit service fees, security-sale gains and loan-recovery interest. Mortgage fees also benefited from the 4Trust Mortgage asset purchase.
- Expense growth, including salaries, employee healthcare, equipment and professional fees, outpaced income growth and weakened the efficiency ratio. Acquisition-related staffing and operating costs were cited as contributors.
- Nonperforming assets and provisions increased. Management cited one commercial credit and continued oil-and-gas-related economic pressure.
- Available-for-sale securities were slightly lower than at September 30, 2015, while cash and cash equivalents were substantially higher. Accumulated other comprehensive earnings rose to $64.3 from $50.6 a year earlier; Q3 comprehensive earnings were affected by a $19.2 pretax decline in unrealized securities gains.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management expected interest rates to remain low, continuing pressure on net interest margin. Its interest-rate model estimated net interest income increases of 0.84% and 1.05% under +100 and +200 basis-point scenarios, respectively, and a 2.23% decrease under a -50 basis-point scenario; management cautioned these are estimates based on assumptions.
- Oil-and-gas-related loans were $86.8, or 2.58% of gross loans. Management said these loans remained stressed by depressed commodity prices and described additional monitoring and credit actions. Classified oil-and-gas loans were $31.5 and nonaccrual oil-and-gas loans $5.1.
- Other key risks include general economic and employment conditions, Texas real estate markets, interest-rate and securities valuation changes, loan demand and credit losses, regulatory changes, competition, deposit gathering, cybersecurity and acquisition integration. Management identified loan-loss estimates and securities valuation as critical accounting policies.
- At September 30, commercial commitments totaled $790.4, including $540.0 of unfunded lines, $227.2 of commitments to extend credit and $23.3 of standby letters of credit. The filing states that commitments often expire undrawn and are not necessarily future cash requirements.
- Management reported no material pending legal proceedings and no material change to previously disclosed risk factors. Disclosure controls were assessed as effective at a reasonable-assurance level.
- Management did not expect a significant impact from the new revenue-recognition standard; it was still evaluating the lease and credit-loss standards. It generally expected the credit-loss standard to increase the allowance, with implementation scheduled for 2020.
Important facts for investors to verify
- Whether elevated nonaccrual loans, charge-offs and provisions persist, particularly in commercial and oil-and-gas exposures.
- How much of year-to-date earnings growth reflects acquisition-related scale, mortgage activity, security gains and loan-recovery interest, versus recurring operating performance.
- Whether margin pressure and expense growth continue, and the assumptions behind management’s interest-rate sensitivity estimates.
- The quality and valuation sensitivity of the large securities portfolio, including its unrealized gains and the $1,805.8 pledged as collateral.
- Liquidity and funding dependence on deposits, repurchase agreements and FHLB advances, together with compliance with capital and dividend restrictions.