South State Corporation — FY 2018 Form 10-K
Business context and reporting period. South State Corporation is a regional bank holding company headquartered in Columbia, South Carolina. Its principal subsidiary, South State Bank, provides retail and commercial banking, mortgage, trust and wealth-management services across the Southeast. This Form 10-K reports the fiscal year ended December 31, 2018, with comparisons to 2017 and 2016; it is not a standalone quarterly filing. The 2017 Park Sterling acquisition materially expanded the business and affected year-over-year comparisons.
Key financial metrics
| Metric | FY 2018 / Dec. 31, 2018 | Prior comparable period |
|---|---|---|
| Total assets | $14.68 billion | $14.47 billion at Dec. 31, 2017 |
| Loans, net | $10.96 billion | $10.58 billion at Dec. 31, 2017 |
| Deposits | $11.65 billion | $11.53 billion at Dec. 31, 2017 |
| Net interest income | $513.2 million | $409.0 million; up 25.5% |
| Net interest margin, taxable equivalent | 4.09% | 4.15%; down 6 basis points |
| Noninterest income | $145.7 million | $140.0 million; up 4.1% |
| Noninterest expense | $420.9 million | $368.3 million; up 14.3% |
| Provision for loan losses | $13.8 million | $11.9 million |
| Net income / diluted EPS | $178.9 million / $4.86 | $87.6 million / $2.93 |
| Operating cash flow | $283.7 million | $197.9 million |
| Cash and cash equivalents | $409.0 million | $377.6 million at Dec. 31, 2017 |
| Shareholders’ equity | $2.37 billion | $2.31 billion at Dec. 31, 2017 |
| Regulatory capital | CET1 12.05%; total risk-based 13.56%; Tier 1 leverage 10.65% | CET1 11.59%; total risk-based 13.04%; Tier 1 leverage 10.36% |
| Dividend per share | $1.38 | $1.32 |
At year-end, total borrowings were approximately $536.7 million: $270.6 million of federal funds purchased and repurchase agreements and $266.1 million of other borrowings. The latter included $150.0 million of FHLB advances maturing in 2019 and $115.2 million of junior subordinated debt, net of discount. The filing reports $1.7 billion of unused FHLB credit capacity and $556 million of federal funds credit lines, with no outstanding advances on those federal funds lines.
Material changes versus 2017
- Net income more than doubled, up 104.3%. Growth in net interest income reflected higher average earning assets, organic loan growth and a full year of Park Sterling balances, as well as higher asset yields.
- Reported earnings also benefited from a much lower effective tax rate: 20.24% in 2018 versus 48.13% in 2017. The 2017 rate included a $26.6 million charge to revalue deferred taxes after the federal corporate rate was reduced; 2018 included a $991,000 tax benefit from final adjustments.
- Interest expense rose $37.0 million as funding balances and costs increased. The average cost of interest-bearing liabilities increased 36 basis points; the taxable-equivalent net interest margin declined despite higher loan and securities yields.
- Operating costs rose with Park Sterling integration and the company’s expansion beyond $10 billion in assets. Salaries and benefits increased $38.7 million; merger and branch-consolidation expense declined $14.6 million but remained significant at $29.9 million.
- The Durbin Amendment became applicable July 1, 2018. Management estimated it reduced bankcard service income by about $9.6 million in the second half of the year.
- Non-acquired loans grew 22.2% to $7.93 billion, while acquired loans declined as they paid down, were charged off, foreclosed or renewed. Total loans increased 3.7% to $11.01 billion.
- Asset quality remained strong overall, though acquired non-credit-impaired nonperforming loans rose to $13.7 million from $9.4 million. Non-acquired nonperforming assets were $19.1 million, compared with $17.4 million.
- The company repurchased 1.0 million shares in 2018 for $68.4 million. A new authorization for up to 1.0 million shares was approved in January 2019; 500,000 shares had been repurchased by the filing date.
Outlook, risks and unusual items
- Outlook: Management described capital as supporting organic growth and potential strategic opportunities, but the filing provides no quantitative earnings, revenue or margin guidance.
- Interest rates and funding: The company was asset-sensitive in its models: a 100-basis-point rate increase was estimated to raise one-year net interest income 3.8%, while a 100-basis-point decrease was estimated to lower it 4.7%. Deposit competition and rising funding costs could pressure margins.
- Credit and concentrations: Real estate represented about 82.3% of loans as a primary or secondary collateral component. Non-owner-occupied commercial real estate loans were 216% of total risk-based capital; regulators scrutinize CRE concentration and underwriting. The allowance for non-acquired loans was $51.2 million, or 0.65% of that portfolio.
- Liquidity and market risk: Management considered liquidity adequate, but warned that deposit outflows, loan demand or adverse conditions could require greater use of wholesale funding, asset sales or slower growth. Available-for-sale securities had a $23.6 million unrealized loss versus amortized cost at year-end, primarily reflecting higher interest rates; management considered the losses temporary.
- Regulation and costs: The company is subject to additional oversight after exceeding $10 billion in assets, including CFPB examination, FDIC assessment changes and debit interchange fee limits. Basel III capital buffers became fully effective January 1, 2019.
- Accounting and unusual items: The company expects CECL adoption in 2020 to affect allowance measurement but could not reasonably estimate the impact. It expected to recognize about $82 million of lease right-of-use assets and lease liabilities upon adopting the new lease standard in 2019. Goodwill was tested after the share price fell below book value in Q4; no impairment was recorded.
- Other matters: The company reported no pending material legal proceeding and management stated that ordinary-course claims were not expected to materially affect results. The auditor issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls were effective.
Investor facts to verify
- How much of 2018 earnings growth persists after separating the lower tax rate, acquisition effects and merger-related costs; compare GAAP EPS of $4.86 with adjusted diluted EPS of $5.50.
- Whether deposit pricing and competition continue to outpace asset repricing, and the resulting effect on net interest margin.
- Trends in acquired and non-acquired delinquencies, nonperforming loans, charge-offs and allowance adequacy as the loan book grows.
- The realization of Park Sterling integration savings, the durability of higher operating expenses and the revenue impact of the Durbin Amendment.
- Liquidity and refinancing needs, including the $150 million FHLB advance maturing in 2019, and the effect of share repurchases and dividends on capital.
- The sensitivity of the securities portfolio and goodwill to interest rates, market values and future earnings; and the eventual impact of CECL adoption.