Business Context and Reporting Period
Company: Southside Bancshares, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2007
Business Overview: A Texas-based bank holding company operating primarily through Southside Bank. The company utilizes a leverage strategy involving wholesale funding (FHLB advances and brokered CDs) invested primarily in mortgage-backed securities (MBS) and municipal securities to enhance profitability. The company recently completed the acquisition of Fort Worth Bancshares, Inc. on October 10, 2007.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 | As of Sep 30, 2007 |
|---|---|---|---|
| Net Income | $3.5 million | $11.9 million | N/A |
| Earnings Per Share (Diluted) | $0.26 | $0.88 | N/A |
| Total Assets | N/A | N/A | $1.904 billion |
| Total Loans | N/A | N/A | $795.6 million |
| Total Deposits | N/A | N/A | $1.354 billion |
| Shareholders' Equity | N/A | N/A | $123.1 million |
| Net Interest Margin | 2.52% | 2.52% | N/A |
| Net Interest Spread | 1.65% | 1.67% | N/A |
| Cash and Cash Equivalents | N/A | N/A | $54.1 million |
Material Changes vs. Prior Period
- Net Income: Decreased 13.6% to $3.5 million for the three months ended September 30, 2007, compared to $4.1 million in the prior year period. However, for the nine-month period, net income increased 9.5% to $11.9 million from $10.8 million.
- Net Interest Income: Decreased slightly for the quarter ($10.2 million vs. $10.4 million) and for the nine months ($30.3 million vs. $31.5 million) due to a compression in net interest spread (1.65% vs. 1.75% for the quarter) and lower average earning assets.
- Noninterest Income: Increased 3.5% for the quarter and 11.3% for the nine months, driven by higher deposit services fees, trust income, and gains on the sale of securities.
- Noninterest Expense: Increased 3.8% for the quarter and 0.3% for the nine months. Salaries and benefits increased due to the addition of Southside Financial Group, while retirement expenses decreased due to changes in actuarial assumptions.
- Loan Portfolio: Total loans increased 4.8% year-over-year to $795.6 million. Construction loans saw significant growth (43.3% increase from year-end 2006), while 1-4 family residential loans remained relatively flat.
- Allowance for Loan Losses: Increased to $7.7 million from $7.2 million at year-end 2006. Provision for loan losses was $0.6 million for the quarter and $0.95 million for the nine months.
Guidance, Outlook, Risks, and Unusual Items
- Restatement of Cash Flows: The company identified a material weakness in internal controls regarding the presentation of cash flows. Historical statements of cash flows for 2004, 2005, 2006, and the first two quarters of 2007 were restated to correctly classify unsettled securities trades as non-cash activities rather than operating/investing cash flows. This restatement did not affect net income, total assets, or regulatory capital.
- Acquisition: On October 10, 2007, the company completed the acquisition of Fort Worth Bancshares, Inc. for approximately $33.8 million in cash. This expands the company's footprint into Tarrant and Travis Counties.
- Interest Rate Risk: The company's leverage strategy exposes it to interest rate risk. Management notes that an inverted yield curve or significant changes in long-term rates could adversely impact net interest margin and the market value of the available-for-sale securities portfolio.
- Capital Adequacy: As of September 30, 2007, the company was "well capitalized" under regulatory guidelines, with a Total Capital ratio of 21.92% and a Tier 1 Capital ratio of 19.91% (consolidated).
- Unusual Items: The effective tax rate for the nine months ended September 30, 2007, was 17.3%, lower than the prior year's 20.7%, primarily due to a one-time state tax credit of $779,000 related to a change in Texas tax law.
Investor Verification Checklist
- Restatement Impact: Verify that the restatement of cash flows has been fully corrected in subsequent filings and that no other historical periods are affected.
- Acquisition Integration: Monitor the integration of Fort Worth Bancshares and the realization of expected synergies and market share gains in the new territories.
- Securities Portfolio Valuation: Review the unrealized losses on the available-for-sale securities portfolio ($6.2 million gross unrealized losses) and management's assessment of "other-than-temporary" impairment.
- Wholesale Funding Reliance: Assess the sustainability of the leverage strategy, noting that wholesale funding (FHLB advances and brokered CDs) represents a significant portion of liabilities.
- Loan Quality Trends: Monitor the increase in loans 90 days past due (up 264% from year-end 2006) and the adequacy of the allowance for loan losses given the growth in construction and commercial real estate loans.