South State Corporation (South State Bank) — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Amounts below are in U.S. dollars; financial statement amounts are shown in millions unless noted.
Business context
South State is a bank holding company headquartered in Columbia, South Carolina. It provides banking, mortgage, trust and investment services. At quarter-end, it reported $8.8 billion in assets and 2,038 full-time equivalent employees. Its stated strategy combines organic growth with selected acquisitions.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $81.2 | $83.0 | $244.2 | $246.3 |
| Noninterest income | $35.3 | $29.8 | $97.5 | $86.4 |
| Income before taxes | $42.5 | $38.5 | $116.5 | $112.5 |
| Net income | $28.1 | $25.1 | $77.1 | $73.9 |
| Diluted EPS | $1.16 | $1.04 | $3.18 | $3.05 |
- Revenue and earnings: Net interest income plus noninterest income was $116.6 million in Q3, up from $112.8 million. Net income increased 11.8% year over year. Nine-month net income rose 4.3%.
- Margins: Q3 taxable-equivalent net interest margin was 4.18%, down 34 basis points year over year and 9 basis points sequentially. Lower yields on acquired and non-acquired loans and securities weighed on margin.
- Expenses and returns: Q3 noninterest expense was essentially unchanged at $73.2 million. The efficiency ratio improved to 62.3% from 64.4% a year earlier. Annualized return on average assets was 1.28%; return on average equity was 10.00%.
- Loans and credit: Net loans were $6.49 billion, versus $5.84 billion a year earlier. Non-acquired loans grew 25.4% year over year to $5.01 billion, while acquired loans continued to run off. Q3 net charge-offs on non-acquired loans were $0.4 million, or 0.03% annualized. Non-acquired nonperforming assets fell to $21.6 million from $29.9 million a year earlier; the allowance was 0.75% of non-acquired loans and 2.49 times non-acquired nonperforming loans.
- Liquidity and funding: Cash and cash equivalents were $507.5 million, down from $695.8 million at year-end 2015. Deposits were $7.25 billion, up 2.4% year over year; noninterest-bearing deposits were $2.18 billion. Management described liquidity as adequate and reported substantial available federal funds, discount-window and FHLB capacity.
- Cash flow: Nine-month operating cash flow was $112.5 million, down from $149.9 million. Investing activities used $439.9 million, including a $533.4 million net increase in loans; financing activities provided $139.1 million. Cash decreased $188.3 million during the period.
- Capital and debt: Shareholders’ equity was $1.12 billion. At September 30, consolidated CET1, Tier 1, total risk-based capital and leverage ratios were 11.48%, 12.27%, 12.89% and 9.74%, respectively; the Bank exceeded regulatory well-capitalized thresholds. Federal funds purchased and repurchase agreements totaled $305.3 million, and other borrowings were $55.3 million.
Material changes, outlook and risks
- Net interest income declined as lower loan yields and the shrinking acquired-loan book outweighed growth in non-acquired lending. Fee income, acquired-loan recoveries and the absence of Q3 FDIC indemnification-asset amortization supported higher noninterest income. The filing’s discussion of mortgage banking income is inconsistent: the income statement shows Q3 income increased to $6.3 million from $4.8 million, while one MD&A passage describes a decline; verify the explanation.
- In June 2016, the Bank terminated all FDIC loss-share agreements, paying $2.3 million and writing off the remaining indemnification asset, for a reported $4.4 million pretax charge. Formerly covered assets became uncovered; the Bank now bears their future losses and recoveries without FDIC sharing.
- The proposed Southeastern Bank Financial Corporation merger was approved by both shareholder groups on October 18, 2016, and regulatory approvals had been received. Closing was expected around January 3, 2017. The deal was to issue approximately 4.97 million South State shares; Southeastern reported $1.9 billion of assets, $1.0 billion of loans and $1.6 billion of deposits.
- Management expected the merger and organic growth to take assets above $10 billion. Sustaining that level for four quarters would reduce interchange revenue and increase stress-testing and FDIC insurance costs. Planned branch consolidations were expected to cost $3.0 million and produce $3.0 million of 2017 savings, which management said would be redeployed to support growth.
- Key risks include loan credit quality and concentrations, interest-rate and liquidity exposure, merger integration and execution, cybersecurity, regulatory changes, and costs or revenue effects associated with crossing the $10 billion asset threshold. The filing provides no formal earnings guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- A shareholder lawsuit challenging merger disclosures was withdrawn in October 2016; the plaintiff reserved the possibility of seeking attorney fees. Management stated that ordinary-course legal matters were not expected to materially affect the financial statements.
Important facts for investors to verify
- Confirm the Southeastern merger’s closing, final consideration, integration costs, and expected effect on capital, earnings and the $10 billion threshold.
- Track loan growth, commercial real-estate concentrations, delinquency trends, nonperforming assets, charge-offs and allowance adequacy, especially after FDIC loss sharing ended.
- Assess whether growth in non-acquired loans can offset acquired-loan runoff and continued margin pressure.
- Reconcile the filing’s conflicting Q3 mortgage banking income commentary with the reported income statement figures.
- Monitor liquidity and funding mix, including deposit trends, wholesale funding usage and cash levels.
- Review branch consolidation costs and savings, and whether projected savings are realized or redeployed as management indicated.