South State Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. South State Corporation is a bank holding company headquartered in Columbia, South Carolina; amounts below are in U.S. dollars unless noted.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $81.4 million | $82.3 million | $163.0 million | $163.3 million |
| Provision for loan losses | $2.7 million | $3.1 million | $5.3 million | $4.0 million |
| Noninterest income | $32.1 million | $30.1 million | $62.2 million | $56.6 million |
| Noninterest expense | $73.9 million | $71.5 million | $145.9 million | $142.0 million |
| Net income | $24.5 million | $24.9 million | $49.0 million | $48.8 million |
| Diluted EPS | $1.01 | $1.03 | $2.02 | $2.02 |
- Q2 net income declined 1.4% year over year; six-month net income was broadly unchanged. Q2 revenue growth from deposit fees and other income was offset by lower net interest income, increased expenses, and the FDIC termination charge.
- Q2 taxable-equivalent net interest margin was 4.27%, down 48 basis points year over year and 10 basis points from Q1 2016. Net interest income fell 1.1% year over year as loan yields declined; lower funding costs partly cushioned the decline.
- Q2 efficiency ratio was 64.5%, versus 63.2% a year earlier. Return on average assets was 1.13% and return on average equity was 9.02%, both below the comparable 2015 period.
Financial position, cash flow, and capital
- At June 30, 2016, total assets were $8.72 billion, net loans were $6.38 billion, deposits were $7.16 billion, and shareholders’ equity was $1.10 billion. Total assets were up 7.9% from June 30, 2015; deposits rose 7.4% and net loans rose 11.0% over that period.
- Loan growth was concentrated in the non-acquired portfolio, up about $1.0 billion, or 27.1%, year over year. Non-acquired loans made up 75% of the loan portfolio, compared with 65% a year earlier. Acquired loans continued to run off.
- Cash and cash equivalents were $481.9 million, down from $695.8 million at year-end 2015. For the six months, operating cash flow was $72.9 million; investing activities used $385.5 million, primarily reflecting $421.1 million of net loan growth; financing activities provided $98.7 million.
- Period-end funding included $341.1 million of federal funds purchased and repurchase agreements and $55.3 million of other borrowings. Management described liquidity as adequate and reported access to federal funds lines, Federal Reserve discount-window capacity, FHLB facilities, and a $20 million unsecured line.
- Consolidated regulatory capital ratios remained above “well capitalized” thresholds: CET1 11.23%, Tier 1 risk-based 12.02%, total risk-based 12.64%, and leverage 9.51%. The common equity-to-assets ratio was 12.66%.
Material changes and management commentary
- FDIC loss-share termination: On June 23, the Bank terminated all outstanding FDIC loss-share agreements. It recorded a $4.4 million pretax charge in Q2, including a $2.3 million payment and amortization of the remaining indemnification asset. Previously covered assets became uncovered; the Bank now bears the full future losses and gains on those assets. At termination, covered loans were $87.4 million and covered OREO was $3.0 million.
- Asset quality: Non-acquired nonperforming assets fell to $25.2 million from $30.5 million a year earlier. Q2 annualized net charge-offs on non-acquired loans were 0.06%, versus 0.12% a year earlier. The allowance was 0.77% of non-acquired loans and equaled 201% of non-acquired nonperforming loans. Management also noted that potential problem non-acquired loans increased to $15.3 million from $6.5 million a year earlier.
- Proposed acquisition: South State agreed to acquire Southeastern Bank Financial Corporation, which reported $1.9 billion in assets, $1.0 billion in loans, and $1.6 billion in deposits at June 30. Consideration is approximately 4.93 million South State shares at a fixed exchange ratio. Closing is expected in Q1 2017, subject to regulatory and shareholder approvals and other conditions.
- Branch actions: The company planned to consolidate nine branches and convert two to drive-through-only locations. It expected $3.0 million in 2017 cost savings, with resources intended to support growth, and $3.0 million of one-time costs. Eight locations were consolidated in Q2, with $1.6 million of costs incurred during the quarter.
- Management cited ongoing low interest rates and loan repricing as pressures on yields and margin. It also identified credit, interest-rate, liquidity, acquisition integration, operational, regulatory, cybersecurity, and broader economic risks. It provided no specific earnings or margin guidance; stated expectations are subject to forward-looking-statement risks.
- Commitments to extend credit and standby letters of credit totaled $1.6 billion; management did not anticipate material losses. Management said ordinary-course legal matters were not expected to materially affect the financial statements. The company was assessing the potential effects of newly issued CECL credit-loss guidance.
Important facts for investors to verify
- Track whether loan growth can continue without weakening underwriting or credit metrics, particularly given growth in commercial real estate and the increase in potential problem loans.
- Assess the effect of ending FDIC loss sharing on future credit costs and the treatment of the formerly covered loan and OREO portfolios.
- Monitor the Southeastern Bank Financial transaction’s approvals, final terms, integration costs, share dilution, and expected benefits.
- Check whether margin pressure, rising operating expenses, and branch-consolidation savings develop as management described.
- Review liquidity and capital trends alongside loan growth, deposit composition, and the company’s reliance on repurchase funding and other short-term sources.