Southside Bancshares, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise.
Business context
Southside is a Texas-based bank holding company. Its balance sheet strategy combines customer lending with investment securities, funded by deposits and FHLB advances. The company completed the closure of Southside Securities, Inc. during Q2.
Financial performance and condition
- Q2 earnings: Net income was $10.1 million, up from $7.7 million in Q2 2012; diluted EPS was $0.56 versus $0.42. For the first half, net income was $18.6 million versus $17.9 million, and diluted EPS was $1.04 versus $0.98.
- Net interest: Q2 GAAP net interest income was $23.8 million, compared with $22.5 million a year earlier. First-half net interest income was $44.8 million, down 3.8% from $46.5 million. Q2 net interest margin was 3.47%, up from 3.21%; first-half margin was 3.34%, versus 3.36%.
- Other income and expenses: Q2 noninterest income rose to $11.1 million from $8.1 million, including $5.1 million of securities-sale gains. First-half noninterest income was $21.4 million versus $18.9 million. Noninterest expense increased 10.8% in Q2 to $21.2 million and 10.3% for the first half to $41.5 million; Q2 included $1.0 million of FHLB prepayment fees.
- Loans and credit: Loans totaled $1.293 billion, up 2.4% from year-end 2012. The allowance for loan losses was $18.4 million, or 1.42% of loans, down from $20.6 million, or 1.63%, at year-end. Nonperforming assets declined to $12.3 million from $14.7 million; nonaccrual loans were $8.2 million. First-half net charge-offs increased to $4.7 million from $3.6 million.
- Deposits, debt and liquidity: Deposits were $2.499 billion, up from $2.352 billion at year-end. FHLB advances totaled $526.7 million and long-term debt was $60.3 million. Cash and cash equivalents fell to $49.8 million from $150.6 million. The company reported $23.0 million of operating cash flow for the first half, versus $36.7 million in 2012; investing activities used $258.5 million, partly offset by $134.6 million from financing activities. Management reported approximately $196.2 million of additional FHLB borrowing capacity against unpledged securities.
- Capital and equity: Shareholders’ equity was $235.4 million, down $22.3 million from year-end, and was 7.0% of assets versus 8.0%. The decline mainly reflected a $33.1 million after-tax other comprehensive loss, largely from unrealized securities losses. Consolidated total risk-based and Tier 1 risk-based capital ratios were 21.04% and 19.83%; the Tier 1 leverage ratio was 9.20%. The company paid $0.40 per share in first-half dividends and declared a 5% stock dividend.
Changes versus prior periods and unusual items
- Q2 earnings growth reflected higher net interest income and noninterest income, while first-half GAAP net interest income declined as lower yields on securities outweighed reduced funding costs.
- Management sold securities and repositioned the portfolio; first-half gains on available-for-sale securities were $9.4 million. The filing cautions that this level of gains may not continue.
- During Q2, $290.1 million of securities were transferred from available-for-sale to held-to-maturity. The company also prepaid $90.2 million of higher-cost FHLB advances, incurring a $1.0 million fee.
- First-half provision for loan losses fell to $2.5 million from $5.2 million, although net charge-offs rose. Management attributed lower provision expense mainly to improved credit quality and fewer nonperforming assets.
Outlook, risks and contingencies
No specific earnings or revenue guidance is provided. Management said loan growth may continue, but competitive pricing could pressure loan yields and profitability. It expects to continually reassess its securities and funding strategy as rates, prepayments, spreads, and loan and deposit trends change; it may allow securities to run off if their economics deteriorate.
- Interest-rate exposure is material: modeled immediate rate increases of 100 and 200 basis points implied 12-month net interest income declines of 5.90% and 7.52% relative to the base case. Management cautions that model assumptions may not match actual outcomes.
- Available-for-sale securities had a $10.6 million net unrealized loss at June 30; held-to-maturity securities had a $13.2 million net unrealized loss. The pooled trust preferred securities were valued at approximately $1.1 million against $2.7 million amortized cost, with fair value dependent on Level 3 assumptions.
- Other stated risks include credit and collateral deterioration, mortgage-backed security prepayments, liquidity and wholesale-funding costs, regulatory changes, and economic conditions in Texas and other markets. Unused credit commitments were $147.2 million and standby letters of credit were $5.7 million.
- Management said ordinary-course litigation was not expected to materially affect financial position, results, or liquidity. It also reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether securities-sale gains, lower provision expense, and reduced funding costs are sustainable contributors to earnings.
- How the securities portfolio’s unrealized losses, interest-rate sensitivity, and transferred held-to-maturity assets affect future equity and flexibility.
- Whether loan growth and asset quality remain healthy, particularly given higher net charge-offs and the consumer auto-loan exposure.
- How FHLB advances and brokered CDs affect liquidity, funding costs, and interest-rate risk.
- The assumptions behind the trust preferred securities valuation and allowance for loan losses, and the impact of forthcoming Basel III capital requirements.