SOUTHSIDE BANCSHARES INC quarterly report, Q1 FY2017

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Southside Bancshares, Inc. — Q1 2017 Form 10-Q

Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016 unless noted. Southside is a Texas bank holding company operating Southside Bank, with lending primarily in Texas. Dollar amounts below are U.S. dollars.

Financial performance

  • Net income: $15.0 million, up 10.9% from $13.5 million in Q1 2016. Diluted EPS was $0.52, versus $0.51; dividends were $0.25 per share, versus $0.23.
  • Interest income and margin: Interest income rose 4.4% to $44.9 million, but interest expense increased 50.2% to $9.6 million. Net interest income consequently fell 3.6% to $35.3 million. Tax-equivalent net interest margin was 3.08%, down from 3.51%; net interest spread was 2.93%, down from 3.40%.
  • Credit provision: Provision for loan losses was $1.1 million, down from $2.3 million. Net interest income after provision was $34.2 million, compared with $34.3 million.
  • Noninterest results: Noninterest income declined 16.6% to $9.7 million, mainly because securities-sale gains fell to $0.3 million from $2.4 million. Noninterest expense decreased 12.1% to $25.9 million, including lower retirement, occupancy, professional-fee and other costs.
  • Profitability: Return on average assets was 1.08% (1.07% in Q1 2016); return on average equity was 11.57% (11.96%). The effective tax rate was 16.7%, versus 18.0%; adoption of a stock-compensation accounting standard reduced Q1 tax expense by $126,000.

Financial position, cash flow and capital

  • Assets and lending: Total assets were $5.66 billion, up 1.7%. Loans were $2.54 billion, down 0.7% from year-end but up 3.9% from March 2016. Commercial real estate loans rose 3.0% from year-end to $974.3 million; construction loans fell 4.7% to $362.4 million. Average loans were up 4.7% year over year.
  • Securities: The investment and mortgage-backed securities portfolio totaled approximately $2.37 billion, down $43.3 million from year-end. Securities were 42.0% of assets, versus 43.4% at year-end.
  • Deposits and funding: Deposits increased 4.9% to $3.71 billion. FHLB advances totaled $1.21 billion, down $103.8 million; short-term advances rose $86.4 million while long-term advances fell $190.2 million. Brokered CDs increased to $120.5 million from $35.5 million at year-end.
  • Liquidity and cash flow: Cash and cash equivalents were $247.0 million, up $77.3 million during the quarter. Operating cash flow was $32.7 million, investing cash flow $12.9 million and financing cash flow $31.7 million. Management reported approximately $753.7 million of additional FHLB borrowing capacity, net of required FHLB stock purchases.
  • Equity and regulatory capital: Shareholders’ equity was $531.5 million, or 9.4% of assets. Consolidated CET1, Tier 1 and total risk-based capital ratios were 14.58%, 16.34% and 20.01%, respectively; the Tier 1 leverage ratio was 9.51%. Management said the company and bank met applicable capital requirements.

Asset quality and material changes

  • Nonperforming assets were $14.1 million, or 0.25% of assets, down from $15.1 million and 0.27% at year-end, and down from $34.0 million in March 2016. Nonaccrual loans declined to $7.3 million from $8.3 million at year-end.
  • The allowance for loan losses was $18.5 million, equal to 0.73% of loans, versus $17.9 million and 0.70% at year-end. Q1 charge-offs were $1.1 million and recoveries $0.5 million. Substandard loans were $56.5 million, compared with $51.3 million at year-end.
  • Management attributed the year-over-year earnings increase mainly to lower loan-loss provision and noninterest expense, partly offset by higher funding costs and lower securities gains. Lower 2016 retirement expense reflected early-retirement packages accepted by 16 employees in Q1 2016.

Outlook, risks and contingencies

  • The filing provides no specific earnings or growth guidance. Management said it would continue adjusting securities and wholesale funding to market conditions and ALCO objectives, with a stated goal of enhancing profitability while managing risk.
  • Management highlighted pressure on margins from funding costs, yield-curve changes, interest-rate movements and mortgage-security prepayments. Its rate simulations estimated that an immediate +100/+200 basis-point shock would change 12-month net interest income by +1.03%/+0.27%; a −100/−200 basis-point shock by +3.28%/+1.53%. These are model estimates, not forecasts.
  • Other stated risks include credit deterioration, real-estate collateral values, Texas economic conditions and oil prices, reliance on FHLB and brokered-CD funding, securities valuation and prepayment risk, competition, regulation, cyber incidents and litigation. Energy loans were 1.14% of the portfolio.
  • Off-balance-sheet commitments to extend credit were $666.2 million and standby letters of credit $8.6 million. Management said ordinary-course litigation was not expected to materially affect financial position, results or liquidity. No material change to previously disclosed risk factors was reported.
  • Two cash-flow hedge swaps with $40 million total notional were terminated in Q1; management said the hedged transactions remained probable and related gains would be recognized over time. No securities were transferred from available-for-sale to held-to-maturity in the quarter.

Investor verification priorities

  1. Track net interest margin and funding costs, particularly the impact of FHLB advances and the sharp increase in brokered CDs.
  2. Assess commercial real-estate exposure, classified loans and the allowance relative to subsequent credit performance.
  3. Monitor whether commercial real-estate growth offsets declines in construction, residential and consumer lending without weakening underwriting.
  4. Review securities valuation, unrealized losses, prepayment assumptions and the sensitivity of equity and earnings to interest-rate changes.
  5. Confirm that reported capital and liquidity remain adequate as funding mix, deposits and lending needs evolve.