Southside Bancshares, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; financial statements are unaudited. Comparisons are with the corresponding 2012 periods unless otherwise noted. Amounts are in U.S. dollars.
Business context and reporting period
Southside is a Texas bank holding company. Its balance-sheet strategy combines lending with substantial holdings of agency mortgage-backed and municipal securities, funded by deposits and Federal Home Loan Bank (FHLB) advances. The company completed the closure of its broker-dealer subsidiary, Southside Securities, in Q2 2013.
Financial results and position
- Earnings: Q3 net income was $7.6 million, down from $8.6 million; diluted EPS was $0.42 versus $0.47. Nine-month net income was $26.2 million versus $26.5 million; diluted EPS was $1.46 versus $1.45.
- Net interest income and margin: Q3 net interest income rose 14.8% to $25.3 million; net interest margin increased to 3.51% from 3.22%. Nine-month net interest income rose 2.2% to $70.0 million, while reported net interest margin increased to 3.40% from 3.31%. Lower funding costs more than offset lower asset yields over the nine-month period.
- Other income and expenses: Q3 noninterest income fell to $6.6 million from $10.5 million, largely reflecting lower securities gains. Nine-month noninterest income was $28.0 million versus $29.4 million. Noninterest expense rose 6.2% in Q3 to $20.3 million and 8.9% over nine months to $61.7 million, including higher salaries and benefits and $1.0 million in FHLB prepayment fees.
- Credit costs and asset quality: The loan-loss provision was $3.6 million in Q3 and $6.2 million for nine months. At September 30, loans were $1.32 billion, up 4.3% from year-end 2012; the allowance was $19.4 million, or 1.47% of loans. Nine-month net charge-offs were $7.4 million, versus $6.2 million. Nonperforming assets declined to $13.7 million from $14.7 million at year-end; nonaccrual loans were $8.4 million. Restructured loans increased to $3.8 million from $3.0 million.
- Balance sheet, deposits and funding: Total assets were $3.47 billion, up from $3.24 billion at December 31, 2012. Deposits were $2.41 billion, up from $2.35 billion. FHLB advances totaled $697.2 million, up from $520.1 million; long-term debt, comprising trust-preferred-related obligations, was $60.3 million. Shareholders’ equity was $239.3 million, down from $257.8 million, primarily reflecting a $33.9 million nine-month decline in accumulated other comprehensive income, along with dividends and share repurchases.
- Securities: Investment and mortgage-backed securities totaled approximately $1.91 billion, or 55.1% of assets. During the first nine months, $452.9 million of securities were transferred from available-for-sale to held-to-maturity. At quarter-end, the available-for-sale portfolio had a $2.4 million net unrealized gain; the held-to-maturity portfolio’s fair value was $12.3 million below amortized cost.
- Cash flow and liquidity: Cash and cash equivalents were $59.7 million, down from $150.6 million at year-end. Nine-month operating cash flow was $49.3 million, investing cash flow was negative $362.4 million, and financing cash flow was positive $222.1 million. Management reported available additional FHLB funding capacity of approximately $342.2 million against unpledged securities. Cash, interest-earning deposits and short-term investments were 14.0% of assets, compared with 18.6% at year-end.
- Capital and dividends: The company reported consolidated total risk-based capital of 21.11%, Tier 1 risk-based capital of 19.85%, and Tier 1 leverage of 9.01% at September 30. Management said the company and bank met applicable capital requirements and expected to meet Basel III requirements on a fully phased-in basis. A 5% stock dividend was paid in May; cash dividends were $0.20 per share in Q3.
Material changes versus prior comparable periods
- Q3 and nine-month earnings declined modestly year over year, although nine-month net interest income increased as deposit and borrowing costs fell.
- Q3 net interest margin improved year over year, but management cited lower yields on loans and securities and competitive pressure to price new loans.
- Securities-sale gains were materially lower: $3,000 loss in Q3 2013 versus a $4.3 million gain in Q3 2012; nine-month gains were $9.4 million versus $13.6 million.
- Loan growth and increased securities holdings were accompanied by greater FHLB funding. Equity declined as market-related securities losses flowed through other comprehensive income.
- Nonaccrual loans and total nonperforming assets improved from year-end, while restructured loans and net charge-offs increased.
Outlook, management commentary, risks and unusual items
- Management described continued active balance-sheet and securities portfolio management, favoring shorter-duration securities and monitoring interest-rate exposure. It provided no numerical earnings or revenue guidance.
- Interest-rate simulations showed projected net interest income declines over the next 12 months of 6.75% and 8.26% under immediate rate increases of 100 and 200 basis points, respectively; modeled decreases of 100 and 200 basis points also produced declines of 3.16% and 3.09%. These are model estimates, not forecasts.
- Key stated risks include interest-rate and yield-curve changes, mortgage-backed security prepayments and valuation, reliance on wholesale funding, loan and collateral deterioration, liquidity, competition, regulation, and uncertainty in the allowance for loan losses. Management noted that higher rates could adversely affect the fair value of available-for-sale securities and equity.
- The company held pooled trust preferred securities with $2.7 million amortized cost and approximately $1.2 million fair value. Management’s modeled credit impairment was $3.3 million; valuation depends on significant unobservable assumptions and illiquid-market estimates.
- The Q3 FHLB advance prepayments totaled $90.2 million and incurred $1.0 million in fees. The filing also disclosed an approximately $2.0 million death-benefit gain expected to be recorded in Q4 2013.
- Management said normal-course litigation was not expected to materially affect financial position, results or liquidity. Disclosure controls were deemed effective, with no material change in internal control reported for the quarter.
Important facts for investors to verify
- Whether ongoing loan growth and margin performance can offset lower asset yields, higher operating expenses and reduced securities-sale gains.
- Developments in SFG consumer-auto loan charge-offs, restructured loans and the adequacy of the $19.4 million loan-loss allowance.
- Effects of securities valuation changes and interest-rate sensitivity on accumulated other comprehensive income, equity and regulatory capital.
- Whether higher FHLB borrowing and brokered deposits remain sustainable and cost-effective, and how liquidity evolves as cash balances decline.
- Actual timing and recognition of the expected $2.0 million death-benefit proceeds, and the subsequent performance of the impaired trust preferred securities.