Southside Bancshares, Inc. — FY 2017 Form 10-K
Reporting period: Year ended December 31, 2017. Southside is a Texas community bank holding company operating primarily in East and Southeast Texas and the Fort Worth and Austin markets. Unless noted otherwise, amounts below are in U.S. dollars.
Business context and reporting period
Southside completed its acquisition of Diboll State Bancshares on November 30, 2017, expanding its East Texas presence. The transaction was funded with approximately 5.5 million Southside shares and $23.9 million cash. Diboll contributed only one month of operating results to 2017; year-end balance-sheet comparisons include the acquired company. Southside ended the year with 60 branches and approximately $1.96 billion of trust assets under management.
Financial results and position
| Metric | FY 2017 / Dec. 31, 2017 | Prior comparable period |
|---|---|---|
| Net income | $54.3 million | $49.3 million in 2016 |
| Diluted EPS | $1.81 | $1.81 in 2016 |
| Net interest income | $144.0 million | $139.6 million in 2016 |
| Net interest margin, FTE | 3.07% | 3.26% in 2016 |
| Total assets | $6.50 billion | $5.56 billion in 2016 |
| Total loans | $3.29 billion | $2.56 billion in 2016 |
| Total deposits | $4.52 billion | $3.53 billion in 2016 |
| Shareholders’ equity | $754.1 million | $518.3 million in 2016 |
Net income rose 10.1%, supported by higher interest income, a lower loan-loss provision, and lower noninterest expense; increased interest expense and income taxes, and lower noninterest income, partly offset the gains. The effective tax rate rose to 22.9% from 17.3%, including a $2.4 million charge to remeasure deferred taxes following the Tax Cuts and Jobs Act. Return on average assets was 0.96% (0.94% in 2016); return on average equity was 9.65% (10.54%). Cash dividends were $1.11 per share, up from $1.01.
Net interest income increased 3.2%, but the fully taxable-equivalent margin declined 19 basis points as deposit and borrowing costs rose. Interest expense increased 48.2%, including higher deposit costs and subordinated-note expense. The provision for loan losses fell to $4.7 million from $9.8 million; net charge-offs were $1.8 million versus $11.6 million in 2016, when two commercial relationships drove substantial charge-offs. The year-end allowance was $20.8 million, or 0.63% of loans, compared with $17.9 million, or 0.70%.
Operating cash flow was $91.7 million, compared with $86.7 million in 2016. Investing activities provided $172.7 million, including acquired cash, while financing activities used $235.4 million. Cash and cash equivalents ended at $198.7 million, up from $169.7 million.
FHLB borrowings were $1.02 billion, down from $1.31 billion. Long-term debt included $98.2 million of subordinated notes and $60.2 million of trust-preferred subordinated debentures. The Bank reported regulatory capital ratios of 18.27% CET1, 18.27% Tier 1 risk-based capital, 18.86% total risk-based capital, and 12.66% leverage; it was categorized as well capitalized. Additional FHLB borrowing capacity was approximately $729.7 million.
Material changes versus 2016
- Assets grew 16.8%; loans rose 28.9% and deposits rose 27.8%, primarily because of Diboll. Approximately $621.3 million of year-end loans and $899.3 million of deposits came from the acquisition.
- Equity increased 45.5%, largely reflecting approximately $200.1 million of shares issued for Diboll, alongside retained earnings and other equity changes.
- Nonperforming assets decreased to $10.5 million, or 0.16% of assets, from $15.1 million, or 0.27%. Nonaccrual loans declined to $2.9 million from $8.3 million; acquired OREO contributed to an increase in OREO to $1.6 million.
- Noninterest income fell 4.9%, mainly because securities-sale gains declined to $0.6 million from $2.8 million. Noninterest expense declined 2.9%, despite $4.4 million of Diboll-related acquisition expense.
- Diluted EPS was unchanged despite higher net income, reflecting a larger weighted-average share count. The filing reports a 2.5% stock dividend in 2017.
Outlook, risks, contingencies, and unusual items
- Management cited expectations for slow-to-modest growth in its Texas markets in 2018, supported by rising rates, lower unemployment, and residential construction. The filing provides no numerical earnings or margin guidance.
- Interest-rate and funding risk are significant: management’s 12-month model projected net interest income changes of +0.88% for an immediate 100-basis-point rate increase and −1.13% for a 200-basis-point increase. Outcomes depend on assumptions about deposits, repricing, yield curves, and mortgage prepayments.
- Real estate is a major credit exposure: approximately 77.3% of loans had real estate as a primary or secondary collateral component. Energy loans were approximately 1.50% of loans; management warned that prolonged low oil prices could weaken borrowers and Texas market conditions.
- After year-end, a $12.5 million commercial real estate loan was placed on nonaccrual following notice that its primary tenant would not renew its lease. It was substandard and accruing at December 31, 2017.
- Management reported no material borrower disruptions or losses to date from Hurricane Harvey. Litigation arising in the ordinary course was considered immaterial by management.
- The Diboll purchase-price allocation remained preliminary. Southside recorded $109.7 million of acquisition goodwill, which is not expected to be tax deductible, and $4.4 million of merger-related expense.
- Southside recorded a $234,000 impairment charge on $109 million of agency debentures it intended to sell in January 2018. It also early-adopted a hedge-accounting standard in January 2018 and reclassified approximately $743.4 million of securities from held-to-maturity to available-for-sale.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The control assessment excluded Diboll, acquired shortly before year-end; the auditor likewise did not evaluate Diboll’s controls.
Important facts for investors to verify
- Integration progress and realized benefits from the Diboll acquisition, including final purchase accounting and goodwill impairment risk.
- Credit quality and reserves, especially the $12.5 million tenant-dependent loan, $86.9 million of accruing substandard loans, and the effect of acquired credits on future provisions.
- Margin sensitivity as deposit costs reprice, FHLB funding matures, and the balance sheet responds to rate changes and mortgage-security prepayments.
- The impact of the tax-law changes on future effective tax rates, deferred taxes, and the potential tax-event redemption provision for subordinated notes.
- Liquidity and securities valuation, including the post-year-end held-to-maturity reclassification and unrealized losses in the securities portfolio.