South State Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are primarily to December 31, 2016 and March 31, 2016. Amounts below are in millions of dollars unless otherwise noted.
Business context and reporting period
South State is a bank holding company headquartered in Columbia, South Carolina. It provides banking, mortgage, trust and investment services. On January 3, 2017, it completed its acquisition of Southeastern Bank Financial Corporation (SBFC), issuing about 4.98 million shares for total consideration of approximately $435.1 million. The acquisition materially increased reported assets, loans, deposits and expenses.
Financial results and condition
| Metric | Q1 2017 / March 31, 2017 | Comparable period / date |
|---|---|---|
| Net interest income | $97.4 | $81.6 in Q1 2016 |
| Total noninterest income | $36.4 | $30.0 in Q1 2016 |
| Net interest plus noninterest income | $133.8 | $111.6 in Q1 2016 |
| Provision for loan losses | $3.7 | $2.6 in Q1 2016 |
| Noninterest expense | $104.7 | $72.0 in Q1 2016 |
| Net income | $18.3 | $24.5 in Q1 2016 |
| Diluted earnings per share | $0.63 | $1.01 in Q1 2016 |
| Net interest margin, non-taxable-equivalent | 4.14% | 4.32% in Q1 2016 |
| Efficiency ratio | 77.5% | 64.1% in Q1 2016; 65.8% in Q4 2016 |
| Operating cash flow | $41.3 | $46.9 in Q1 2016 |
- Balance sheet: Total assets were $11.15 billion, up 25.3% from $8.90 billion at year-end 2016 and 28.6% from $8.67 billion a year earlier. Net loans were $7.87 billion; deposits were $9.03 billion; shareholders’ equity was $1.58 billion.
- Growth and funding: Loans increased to $7.91 billion before the allowance, including $2.35 billion of acquired loans. Deposits rose to $9.03 billion. Cash and cash equivalents were $663.1 million, compared with $374.4 million at year-end 2016.
- Borrowings: Federal funds purchased and repurchase agreements totaled $352.4 million; other borrowings totaled $108.0 million. Total liabilities were $9.57 billion.
- Cash flows: Investing activities provided $101.3 million, including $71.6 million of net cash received from acquisitions; financing activities provided $146.1 million. Cash increased $288.7 million during the quarter.
- Capital: Consolidated CET1, Tier 1, total risk-based capital and leverage ratios were 11.90%, 12.77%, 13.31% and 10.05%, respectively. The filing states the Company and Bank exceeded well-capitalized thresholds.
Material changes versus comparable periods
- Net interest income increased 19.3% year over year, primarily from SBFC and organic loan growth. Higher interest income was partly offset by increased funding costs; non-taxable-equivalent net interest margin declined from 4.32% to 4.14%.
- Net income fell 25.4%, while diluted EPS fell from $1.01 to $0.63. The share count increased following the stock-funded SBFC acquisition.
- Noninterest expense rose 45.4%, chiefly due to $21.0 million of merger and branch-consolidation expense, compared with $1.0 million in Q1 2016. Management identifies change-in-control, severance and other merger payments, and vendor contract resolution costs among the 2017 charges.
- Noninterest income increased 21.3%, supported by deposit fees, mortgage banking and trust income, as well as the absence of the prior-year FDIC indemnification asset amortization charge.
- Non-acquired asset quality improved year over year: nonperforming assets were $18.7 million versus $27.0 million, and annualized net charge-offs were 0.05% versus 0.09%. Total nonperforming assets including acquired assets were $38.7 million.
Outlook, risks and unusual items
- No quantified earnings or margin guidance is provided. Management cautions that first-quarter results are not necessarily indicative of full-year results.
- On April 26, 2017, the Company agreed to acquire Park Sterling Corporation in an all-stock transaction valued at approximately $690.8 million based on the stated reference share price. The deal requires regulatory and shareholder approvals and was expected to close in Q4 2017.
- Crossing $10 billion in assets exposes the Company to additional regulatory costs and a potential reduction in debit-card interchange revenue. Management said the interchange limit was expected to take effect in July 2018 and estimated Q1 2017 bankcard income would have been about $4 million lower if the limit had then applied.
- The SBFC acquisition-related tax benefit included $735,000 of excess stock-award tax benefits, which reduced the effective tax rate by 2.90 percentage points; management says this discrete benefit is not expected to recur at that level in subsequent 2017 quarters.
- All FDIC loss-share agreements had been terminated in June 2016. The Company now bears the full future credit costs and recoveries on formerly covered assets.
- Risks highlighted include credit quality, interest rates, liquidity, merger integration and costs, regulatory changes, cybersecurity, economic conditions, and the consequences of exceeding the $10 billion asset threshold. The Company reported $2.0 billion of commitments to extend credit and standby letters of credit, but did not anticipate material losses from them. Management stated pending legal matters were not expected to have a material effect.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of post-acquisition revenue and loan growth is sustainable organic growth, and how quickly merger-related costs and integration activities normalize.
- Whether net interest margin stabilizes as loan yields, deposit costs and acquired-loan accretion evolve.
- Credit performance in acquired loan pools, including the reported impairment provisions, delinquency trends and acquired nonperforming assets.
- The timing, approvals, consideration and integration assumptions for the proposed Park Sterling acquisition.
- The financial impact of the $10 billion asset threshold, particularly the anticipated debit interchange revenue reduction and regulatory expenses.
- Liquidity and funding composition, capital ratios, and the Company’s capacity to support loan growth and acquisition plans.