Simmons First National Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited consolidated financial statements; the independent accountant performed an interim review, not an audit. Simmons First is an Arkansas-based bank holding company operating in Arkansas, Kansas, Missouri and Tennessee.
Business context and reporting period
- The May 15 acquisition of Hardeman County Investment Company and its First South Bank subsidiary added approximately $462.9 million of assets, $251.6 million of loans and $389.0 million of deposits. Consideration was approximately $42.6 million in stock and $30.0 million in cash; $29.4 million of goodwill was recorded.
- Two further acquisitions were pending: Southwest Bancorp, valued at approximately $564.4 million, and First Texas BHC, valued at approximately $462 million. The company anticipated closing as early as October 2017 or as late as January 2018, subject to approvals and other conditions.
- Total assets were $9.07 billion at June 30, up from $8.40 billion at year-end 2016. Management expected the pending transactions to take the company above $10 billion in assets.
Financial performance and condition
- Q2 results: Interest income was $83.9 million, net interest income $76.8 million, and non-interest income $35.7 million. Net income was $23.1 million and diluted EPS was $0.72, versus $22.9 million and $0.75 in Q2 2016. Non-interest expense rose 11.3% to $71.4 million; provision for loan losses increased to $7.0 million from $4.6 million.
- First six months: Net interest income was $149.2 million, non-interest income $65.8 million, net income available to common shareholders $45.2 million, and diluted EPS $1.42, compared with $46.4 million and $1.52 a year earlier. Provision expense was $11.3 million versus $7.4 million; non-interest expense was $137.7 million versus $125.9 million.
- Core, non-GAAP results: Q2 core earnings were $26.8 million and diluted core EPS $0.84, compared with $25.1 million and $0.82. Six-month core earnings were $49.3 million versus $48.3 million; diluted core EPS was $1.55 versus $1.59. These measures exclude specified non-core items and are not GAAP results.
- Net interest margin: Fully taxable-equivalent (FTE) margin was 4.04% for both Q2 and the first six months, down from 4.14% and 4.28%, respectively, in 2016. Management cited pressure from funding costs and lower acquired-loan accretion; core margin excluding acquired-loan accretion was 3.79% for the six months.
- Loans and credit: Total loans were $6.23 billion, up from $5.63 billion at year-end. Management reported $448 million of Q2 loan growth, including $270 million of legacy growth. Nonaccrual legacy loans increased to $57.1 million from $39.1 million; total non-performing loans were $57.4 million, and non-performing assets were $83.9 million. The allowance was $41.8 million, or 0.83% of total loans; allowance coverage of non-performing loans was 72%, down from 92% at year-end. Six-month annualized net charge-offs were 0.21% of loans.
- Cash flow and liquidity: Six-month operating cash flow was $75.9 million, investing cash flow was negative $186.6 million, and financing cash flow was positive $154.7 million. Cash and cash equivalents ended at $329.6 million, up $44.0 million from year-end. Management cited approximately $285 million of correspondent-bank federal funds lines and $1.3 billion of available FHLB capacity.
- Funding and debt: Deposits were $7.10 billion, up $368.3 million from year-end; 90.6% were classified as core deposits. Total other borrowings and subordinated debentures were $542.3 million, versus $333.6 million at year-end, primarily reflecting a $212.1 million increase in short-term FHLB advances. FHLB advances totaled $429.3 million.
- Capital: Stockholders’ equity was $1.23 billion; book value per share was $38.31 and tangible book value per share was $24.71. The CET1 ratio was 12.11%, Tier 1 leverage was 10.75%, and total risk-based capital was 13.73%; the company reported meeting applicable capital requirements.
Material changes, outlook, risks and unusual items
- Reported earnings include acquisition-related merger costs: $6.6 million in Q2 and $7.1 million for the six months. Branch-right-sizing costs were much lower than in 2016. Management attributed higher underlying expenses largely to acquired operations and preparation for growth beyond $10 billion in assets.
- The company sold 11 substandard loans in February with an approximately $11 million net principal balance, recognizing a $676,000 loss. In June it sold 35 classified loans with a $13.8 million discounted principal balance; the acquired-loan portion generated an approximately $700,000 net pretax benefit.
- The company exited indirect lending in March, describing it as a low-margin business; the portfolio balance at June 30 was $217 million. It also merged Simmons First Finance Company into Simmons Bank in January.
- Management described loan growth as strong but said rising deposit costs were preventing near-term net interest margin expansion. It expected competitive deposit pricing and recent Federal Reserve rate increases to continue pressuring funding costs.
- Expected consequences of crossing $10 billion in assets include debit-card interchange caps, additional stress-testing and compliance requirements, CFPB oversight, and potentially higher deposit insurance premiums. Management estimated after-tax debit-card fee reductions of approximately $3.8 million in 2018 and $7.5 million in 2019; it also anticipated additional stress-test compliance expenditures, without quantifying them.
- Credit risks include rising nonaccruals, particularly commercial real estate, and two Wichita-area relationships totaling $11 million cited as a driver of the increase in non-performing assets. Management noted that loan-loss estimates depend on subjective assumptions and could differ from realized losses.
- Management considered unrealized investment-security losses temporary, attributing them mainly to market-rate changes; it said it had the intent and ability to hold the securities until recovery. Various legal proceedings were disclosed, but management did not expect them, in aggregate, to have a material adverse effect.
- Common dividends were $0.50 per share for the first six months, versus $0.48 a year earlier. Future dividends remain subject to board discretion, earnings, liquidity, capital needs and regulatory limits. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Track nonaccrual loans, non-performing assets, specific reserves and charge-offs—especially commercial real estate exposures—and reconcile reported asset-quality ratios: the filing gives 0.93% for non-performing assets in its table, while another discussion cites 1.02% for a measure that includes TDRs and acquired foreclosed assets.
- Assess whether loan growth and acquisitions can offset margin pressure, higher funding costs, rising provisions and ongoing integration expenses; distinguish reported GAAP earnings from management’s non-GAAP core measures.
- Monitor completion, regulatory approvals, integration costs and expected synergies for the Southwest Bancorp and First Texas transactions, including the consequences of crossing the $10 billion asset threshold.
- Review the increase in FHLB borrowing, its short-term component, deposit mix and available liquidity, alongside capital ratios and the parent company’s reliance on bank dividends.
- Confirm the final Hardeman purchase-price allocation and acquired-loan marks, which remained preliminary, and follow the performance of acquired and purchased-credit-impaired loans.