South State Corporation — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; balance-sheet comparisons are to December 31, 2020 unless otherwise noted. South State is a regional banking company operating across six states. Results include the June 2020 CenterState (CSFL) merger and, from February 1, 2021, Duncan-Williams, making year-over-year comparisons materially affected by acquisitions.
Financial performance and condition
- Revenue and earnings: Net interest income was $262.0 million, up from $128.0 million; noninterest income was $96.3 million, up from $44.1 million. Together, these were $358.3 million versus $172.1 million. Net income rose to $146.9 million from $24.1 million; diluted EPS was $2.06 versus $0.71. Average diluted shares more than doubled following the CSFL merger, so per-share comparisons also reflect dilution.
- Key margins and returns: Net interest margin was 3.10% on a non-tax-equivalent basis and 3.12% tax-equivalent, down from 3.67% and 3.68%. Return on average assets was 1.56% versus 0.60%; return on average equity was 12.71% versus 4.15%. The efficiency ratio increased to 61.1% from 60.4%.
- Credit costs and asset quality: The company recorded a $58.4 million recovery of credit losses, compared with a $36.5 million provision a year earlier. The loan allowance was $406.5 million, or 1.66% of loans, down from $457.3 million at year-end; coverage was about 4.02 times nonperforming loans. Nonperforming assets were $113.0 million, or 0.28% of assets, and nonperforming loans were 0.41% of loans. Net recoveries were approximately zero.
- Balance sheet and liquidity: Assets were $39.73 billion, up 5.1% from year-end. Deposits increased 5.7% to $32.44 billion; noninterest-bearing deposits were $10.80 billion. Loans, net of allowance, were $24.09 billion; the loan-to-deposit ratio was 75%, down from 80%. Cash and cash equivalents were $5.97 billion, including $366.8 million of restricted cash pledged as swap collateral.
- Debt and capital: Corporate and subordinated debentures were $390.3 million; federal funds purchased and repurchase agreements totaled $878.6 million. Consolidated CET1 and total risk-based capital ratios were 12.13% and 14.49%; the Bank’s were 12.87% and 13.70%. Both were above regulatory minimums and well-capitalized thresholds.
- Cash flows: Operating activities provided $299.0 million; investing activities used $750.4 million; financing activities provided $1.82 billion. Cash and cash equivalents increased $1.36 billion during the quarter.
- Equity and securities: Shareholders’ equity was $4.72 billion. A $48.6 million after-tax decline in available-for-sale securities’ value reduced accumulated other comprehensive income, which moved from $47.6 million to a $1.0 million loss.
Material changes versus comparable periods
- Reported net income increased 509.5% year over year, reflecting the CSFL merger, a $95.0 million favorable year-over-year swing in credit-loss expense, and higher interest and fee income. Acquired scale also substantially increased expenses; noninterest expense rose 113.3% to $228.7 million.
- Net interest income benefited from higher average loan and securities balances, while asset yields fell 93 basis points to 3.30%. Lower funding costs partly offset this pressure: average interest-bearing liability cost fell 48 basis points to 0.30%.
- Noninterest income increased 118.2%, notably from correspondent banking and capital markets, mortgage banking, and deposit fees. Approximately $7.5 million of correspondent and capital markets income was attributable to Duncan-Williams.
- Total loans declined slightly from year-end as acquired loans paid down, partly offset by growth in non-acquired loans. Non-acquired commercial and industrial loans and commercial non-owner-occupied loans grew during the quarter.
- Available-for-sale and held-to-maturity securities in an unrealized loss position increased to 217 securities with $79.2 million of losses, from 86 securities and $5.3 million at year-end. Management attributed the change primarily to rising interest rates and reported no credit-loss provision on the portfolio.
Outlook, commentary, risks, and unusual items
- The filing provides no specific earnings or financial guidance. Management said Q1 results are not necessarily indicative of full-year results and expects continued CSFL systems-conversion and integration costs in 2021, while anticipating further cost savings and synergies that are not reflected in the cited pro forma results.
- COVID-19 remains a material uncertainty. At March 31, $186 million, or 0.83% of the loan portfolio excluding loans held for sale and PPP loans, was under deferral. Management identified lodging, restaurant, and retail real estate exposures as areas to monitor. It reported approximately 26,000 PPP loans totaling $3.1 billion.
- The $58.4 million credit-loss recovery reflected improved economic forecasts and vaccine availability. Management used equal weighting of baseline and more adverse forecast scenarios; it estimated that a less conservative weighting would have generated about $35 million of additional release, which it did not consider appropriate given remaining uncertainty. ACL estimates depend on judgment, models, and forecasts.
- Management said unrealized securities losses were temporary and it did not intend, nor consider it more likely than not that it would be required, to sell the securities before recovery. Future market or credit changes could nevertheless lead to earnings charges or further AOCI declines.
- The company closed four branches in Q1, estimating approximately $400,000 in related costs and $750,000 of annual 2021 savings. It authorized a new 3.5 million-share repurchase program; no shares were repurchased under that program by quarter-end. Q1 repurchases were associated with employee stock plans.
- On April 28, 2021, the company announced redemptions of $25.0 million of subordinated notes and $38.5 million of trust preferred securities, scheduled for Q2 2021. The redemptions were expected to reduce Tier 2 capital by $63.5 million and accelerate approximately $11.0 million of unamortized fair-value discount.
- Other risks include merger integration and realization of synergies, deposit attrition, interest-rate and liquidity risk, commercial real estate concentrations, cybersecurity, regulatory and model risk. Management reported no pending material legal proceeding and no material change in market-risk disclosures.
Important facts for investors to verify
- How much of the earnings increase is sustainable after separating merger-related scale, acquisition accounting, mortgage and capital-markets activity, and the credit-loss recovery?
- Whether loan deferrals, COVID-sensitive commercial real estate exposures, and the equal-weighted CECL forecast assumptions change materially in subsequent quarters.
- Whether integration costs decline and anticipated CSFL synergies and branch savings are achieved, and how Duncan-Williams contributes to recurring results.
- How deposit growth, excess liquidity, loan growth, securities duration, and rising-rate exposure affect future net interest margin and unrealized securities losses.
- The effect of the announced debt redemptions on capital, interest expense, and the accelerated fair-value discount, alongside the company’s capital and repurchase priorities.
- Reconcile cash-flow movements and restricted swap collateral to liquidity needs; assess contingent commitments to extend credit and standby letters of credit, which totaled $6.0 billion.