Great Southern Bancorp, Inc. — 2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018. Great Southern is a bank holding company operating Great Southern Bank, a regional lender and deposit-taking institution with 99 banking centers in six states and commercial loan offices in several additional markets. Its lending is concentrated in real estate, including commercial construction, commercial real estate and multifamily loans.
Financial performance and condition
- Profitability: Net income was $67.1 million, up 30.1% from $51.6 million in 2017. Diluted EPS rose to $4.71 from $3.64. Return on average assets was 1.49%; return on average equity was 13.46%.
- Interest income and margins: Net interest income increased 8.4% to $168.2 million; net interest margin rose to 3.99% from 3.74%. Total interest income was $205.9 million and interest expense was $37.8 million. Higher loan yields and balances supported growth, while deposit and borrowing costs also increased.
- Other income and expenses: Noninterest income declined 6.0% to $36.2 million, partly because 2017 included a $7.7 million gain from terminating an FDIC loss-sharing agreement. Noninterest expense increased 0.9% to $115.3 million. The reported efficiency ratio improved to 56.41% from 58.99%, but included a $7.4 million gain on the Omaha branch sale.
- Credit costs and quality: Provision for loan losses was $7.2 million, down from $9.1 million; net charge-offs were $5.2 million, or 0.13% of average loans. The allowance was $38.4 million, approximately 0.98% of loans excluding FDIC-acquired loans. Nonperforming assets were $11.8 million, or 0.25% of assets, versus $27.8 million and 0.63% a year earlier.
- Balance sheet and growth: Assets increased 5.9% to $4.68 billion. Net loans rose 7.0% to $3.99 billion; gross loans excluding acquired loans and loans held for sale grew 10.8%. Deposits increased 3.6% to $3.73 billion. Stockholders’ equity increased to $532.0 million, and book value per share was $37.59.
- Cash flow: Operating activities provided $94.2 million; investing activities used $381.3 million, largely reflecting loan and securities growth and the Omaha sale; financing activities provided $247.6 million. Cash and cash equivalents ended the year at $202.7 million, down from $242.3 million.
- Debt and liquidity: Borrowings and other interest-bearing liabilities, excluding deposits, totaled $397.6 million, including $298.0 million of short-term borrowings, $73.8 million of subordinated notes and $25.8 million of subordinated debentures. There were $178.0 million of overnight FHLBank borrowings at year-end. The Bank reported $666.8 million available under its FHLBank line and $460.7 million under its Federal Reserve line; neither line had outstanding draws at year-end. Loans were 106.76% of deposits.
- Capital and shareholder returns: The Bank’s CET1 ratio was 12.4%, total capital ratio 13.3% and leverage ratio 12.2%; both the Bank and Company were classified as well-capitalized. The Company declared $1.20 per share in dividends and repurchased 17,542 shares during 2018.
Material changes versus 2017
- Net income increased $15.5 million. Higher net interest income, lower loan-loss provision and lower income-tax expense more than offset lower noninterest income and modestly higher operating expense.
- Net interest margin increased 25 basis points. The benefit included $5.1 million of accretion income from improved expected cash flows on acquired loan pools, compared with $5.0 million in 2017.
- Loan growth was led by commercial construction, commercial real estate, and one- to four-family and multifamily residential lending. Consumer auto loans fell $103.6 million as underwriting had been tightened.
- Nonperforming assets and foreclosed assets declined substantially. The allowance for loan losses increased to $38.4 million from $36.5 million.
- Brokered deposits increased $101.4 million to $326.9 million. Year-end overnight FHLBank borrowings increased to $178.0 million from $15.0 million, while reported term FHLBank advances fell to zero from $127.5 million.
Outlook, risks and unusual items
- Management expected a combined effective tax rate of approximately 17.0%–18.5% in future periods, subject to the level of tax-credit investments, tax-exempt income and pretax earnings.
- Management expected to limit land-development lending in 2019, with commercial real estate and construction lending potentially increasing if economic conditions remained strong. The Company decided to stop originating indirect auto loans after March 31, 2019, while continuing to service existing loans; direct consumer lending was expected to continue.
- Management described interest-rate models as modestly favorable to rising rates overall, while noting that effects may be more pronounced 12–36 months after a rate change. A $400 million interest-rate swap entered in October 2018 receives a fixed 3.018% and pays one-month LIBOR; future settlements could reduce loan income if LIBOR exceeds the fixed rate.
- Key risks include the high concentration in commercial and residential construction, commercial real estate, multifamily and other commercial lending; real estate and regional economic downturns; loan losses and allowance estimation; interest-rate and funding-cost changes; reliance on brokered deposits and short-term borrowings; competition; cybersecurity and operational disruptions; regulation; and the planned transition from LIBOR.
- CECL was scheduled to take effect January 1, 2020. The Company was evaluating its impact and had not determined the size of the expected initial allowance adjustment. The 2018 adoption of revenue-recognition guidance did not materially affect results.
- Unusual items included the $7.4 million pretax gain on the sale of four Omaha branches and related deposits, $2.1 million of foreclosed-asset valuation write-downs during the second quarter, and acquired-loan accretion that contributed $5.1 million to pretax income. No securities were found to have other-than-temporary impairment.
- The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective. Management said pending and threatened litigation was not expected to have a material adverse effect, and did not expect significant adjustments from the disclosed tax examinations.
Important facts for investors to verify
- Whether loan growth and higher net interest margin can continue as deposit costs rise and competition for funding intensifies.
- Commercial construction and real estate exposures, geographic concentrations, loan maturities, delinquencies and the adequacy of the allowance—especially as the loan portfolio expands.
- The extent to which reported earnings and efficiency improvement depended on the Omaha sale gain and acquired-loan accretion, and how earnings perform without those items.
- The cost, stability and maturity profile of brokered deposits and other short-term funding, and the effect of a loans-to-deposits ratio above 100% on liquidity.
- The eventual CECL allowance and capital impact, as well as the operational and contractual implications of replacing LIBOR in loans and debt.
- Execution and financial effects of exiting indirect auto lending, consolidating the Fayetteville office, and expanding commercial lending offices.