Stock Yards Bancorp, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; the filing also reports unaudited fourth-quarter results. Stock Yards Bancorp is a Kentucky bank holding company operating Stock Yards Bank & Trust, with 37 offices in Louisville, Indianapolis and Cincinnati. Its businesses include commercial and personal banking, wealth management and trust, and residential mortgage origination.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net interest income | $97.3 million | $88.3 million |
| Non-interest income | $43.5 million | $40.0 million |
| Net income | $41.0 million | $37.2 million |
| Diluted EPS | $1.80 | $1.65 |
| Total assets at year-end | $3.04 billion | $2.82 billion |
| Loans at year-end | $2.31 billion | $2.03 billion |
| Deposits at year-end | $2.52 billion | $2.37 billion |
| Stockholders’ equity at year-end | $313.9 million | $286.5 million |
- Profitability and margins: Net income increased 10% and diluted EPS increased 9%, marking a sixth consecutive year of record diluted EPS. Net interest margin declined to 3.59% from 3.67%; return on average assets was 1.42% versus 1.44%, and return on average equity was 13.49% versus 13.55%. The efficiency ratio rose to 57.6% from 56.8%; excluding tax-credit partnership amortization, the company’s non-GAAP adjusted ratio improved to 54.4% from 56.3%.
- Drivers and expenses: Tax-equivalent net interest income grew 9.9%, mainly from loan and securities volume, while lower asset yields offset some of the gain. Non-interest income increased 9.0%; wealth management and trust revenue rose 6.3% and represented about 44% of non-interest income. Non-interest expense rose 11.1%, including a $3.8 million increase in tax-credit partnership amortization and higher personnel and technology costs. The effective tax rate fell to 27.1% from 31.3%, primarily due to greater use of federal tax credits.
- Credit: Loans grew 13% year over year. The provision for loan losses was $3.0 million, up from $0.75 million. Non-performing loans declined to $6.7 million from $8.9 million; non-performing loans were 0.29% of total loans versus 0.44%, and net charge-offs were 0.07% of average loans versus 0.17%. The allowance was $24.0 million, or 1.04% of loans, compared with $22.4 million, or 1.10%.
- Cash flow and liquidity: Operating activities provided $63.3 million; investing activities used $289.6 million and financing activities provided $170.5 million. Cash and cash equivalents declined $55.9 million to $48.0 million, largely in the context of loan growth and securities activity. Management reported $2.5 billion of core deposits, 98% of total deposits, and $443.5 million of available FHLB credit. About 67% of the available-for-sale securities portfolio was pledged, leaving $190 million unpledged.
- Debt and capital: Year-end FHLB advances were $51.1 million, up from $43.5 million; federal funds purchased were $47.4 million, up from $22.5 million. The company reported no subordinated debentures in 2016 or 2015. Consolidated Tier 1 risk-based capital was 12.10%, total risk-based capital 13.04%, and leverage 10.54%; management said the company and Bank met well-capitalized requirements. The tangible common equity ratio, a non-GAAP measure, was 10.26% versus 10.10%.
Material changes and unusual items
- Loan growth was funded by deposit growth and borrowings; total deposits increased 6.3%, while average loans grew 12.3%. Commercial and industrial and commercial real estate lending were notable growth areas.
- Accumulated other comprehensive income shifted from positive $0.6 million to a loss of $1.5 million, primarily reflecting the effect of interest-rate changes on securities valuations.
- A $588,000 pre-tax recovery of a prior impairment on an investment was recorded in fourth-quarter 2016. Net gains on sales of other real estate owned were $409,000, compared with a $147,000 loss in 2015.
- A 3-for-2 stock split was effected as a 50% stock dividend in May 2016; share and per-share figures in the filing reflect the split. Annual dividends declared per share increased to $0.72 from $0.64.
Outlook, risks and contingencies
- Management expected net interest margins to increase in 2017 following short-term rate increases, but warned that competition for loans and deposits, longer-term rates, and repricing dynamics could undermine that expectation. Its 2017 goals included loan growth at a pace comparable to 2014–2015 and continued deposit growth.
- Management identified managing margins, sustaining loan growth, preserving credit quality and adapting to regulation as key challenges. A seasonal deposit surge left about $100 million in excess cash at year-end; management expected balances to normalize during the first half of 2017 and said the short-term investment of those funds could weigh on margins.
- Interest-rate simulation estimated net interest income would fall 0.87% if rates immediately rose 100 basis points, 1.18% with a 200-basis-point rise, and 3.69% with a 100-basis-point decline. Management cautioned that model scenarios are estimates, not forecasts.
- Control weakness: Management identified a material weakness in the operating effectiveness of controls over assessing loan grades used in the allowance estimate, including the completeness and accuracy of supporting information. Management reported no restatement, change to previously released results, or adjustment to the fourth-quarter allowance as a result. Management was evaluating remediation; disclosure controls were also deemed ineffective. The auditor issued an adverse opinion on internal control over financial reporting, while issuing an unqualified opinion on the financial statements.
- Other risks include local economic and real-estate conditions, credit-loss estimation, competition, cybersecurity and third-party systems, regulation, and dependence of trust-fee revenue on financial-market values. The filing says adoption of the expected-credit-loss standard (ASU 2016-13) could significantly affect the allowance and earnings; the stated effective date was for periods beginning after December 15, 2019.
- Off-balance-sheet commitments included $628.3 million of unused loan commitments and $15.6 million of standby letters of credit; actual funding needs may be lower because some commitments expire unused. Management believed pending legal actions would not materially adversely affect financial position or results.
Most important facts for investors to verify
- Whether remediation of the loan-grade review control weakness is completed and whether subsequent filings report effective controls or any resulting allowance adjustments.
- Whether rapid loan growth can continue without weakening underwriting, credit metrics or allowance coverage.
- Whether margin and earnings expectations withstand competitive deposit pricing, loan pricing pressure and changing interest rates.
- How sustainable tax-credit benefits are, including the relationship between credits and the substantially higher partnership amortization expense in 2016.
- Whether deposits normalize as management expected and how loan funding, short-term liquidity and borrowing levels develop.
- How forthcoming credit-loss accounting requirements affect the allowance, capital and reported earnings; the filing does not provide a clear quantified estimate of that impact.