Cass Information Systems, Inc. — Q3 2018 Form 10-Q
Business context and period: Cass provides payment and information-processing services to large businesses and banking services through Cass Commercial Bank. This unaudited filing covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Payment and processing revenue | $26.0 | $23.8 | $76.1 | $69.3 |
| Total net revenue | $37.6 | $34.3 | $110.0 | $100.3 |
| Net interest income | $11.2 | $10.1 | $32.5 | $29.5 |
| Operating expenses | $28.5 | $25.0 | $82.2 | $74.3 |
| Net income | $7.6 | $6.9 | $23.2 | $19.7 |
| Diluted EPS | $0.61 | $0.55 | $1.87 | $1.58 |
| Net interest margin, tax-equivalent | 3.34% | 3.27% | 3.32% | 3.35% |
- Management reported net income growth of 10.9% for Q3 and 17.9% for the nine-month period; diluted EPS rose 10.9% and 18.4%, respectively.
- Q3 payment and processing revenue increased 9.5%. Transportation invoice dollar volume rose 17.9%, and expense-management dollar volume rose 8.1%. For the nine months, those volumes increased 16.2% and 7.2%, respectively.
- Tax-equivalent net interest income increased 2.0% in Q3 and 1.8% year to date. Management cited higher earning assets and improving interest rates; the lower federal tax rate reduced the tax-equivalent adjustment and affected reported margin and yield comparisons.
- Operating expenses rose 13.9% in Q3 and 10.7% year to date. Personnel costs were the largest increase, reflecting technology and staffing investments, cybersecurity needs, merit increases, and higher retirement-plan costs.
Financial position, cash flow, and liquidity
- At September 30, total assets were $1,678.2, loans $726.2, deposits $634.7, accounts and drafts payable $769.6, and shareholders’ equity $229.3. Compared with year-end 2017, assets increased 1.3%, loans increased $40.0, deposits decreased $43.4, and accounts and drafts payable increased $53.8.
- Cash and cash equivalents were $180.0, down $48.1 from December 31, 2017. Available-for-sale securities were $446.4, down $24.1. The securities portfolio had $7.0 of gross unrealized losses; management considered the losses temporary and said it was not more likely than not the company would need to sell before recovery.
- For the first nine months, operating cash flow was $38.8, versus $27.9 in 2017. Investing activities used $60.1 and financing activities used $26.7; cash and cash equivalents declined $48.1. Dividends paid were $9.3 and treasury-stock purchases were $1.4.
- No amounts were outstanding on credit lines at September 30. Available facilities included $83.0 of unsecured correspondent-bank lines, a $189.9 secured Federal Home Loan Bank line, and two $50.0 secured bank lines. Management expected cash, maturing investments, and operating cash flow to fund operations and estimated 2018 capital spending of $6–$9.
- The company and bank exceeded regulatory capital requirements. The company’s total capital ratio was 21.42% and common equity Tier 1 ratio was 20.54%; the bank’s corresponding ratios were 18.23% and 17.16%.
Changes, outlook, and risks
- Loan balances grew, with commercial and industrial loans increasing to $270.9 from $236.4 at year-end. There were no nonperforming, impaired, or delinquent loans reported at September 30, and no loan-loss provision was recorded in either the 2018 or comparable 2017 period. The allowance was $10.2, or 1.41% of loans, versus 1.49% at year-end.
- Deposits declined amid increased competition for funding as customers moved some balances to higher-yielding investments. Management described accounts and drafts payable as historically stable, while noting that balances fluctuate with payment-processing activity.
- The company sold $58.5 of securities during the nine months as part of efforts to adjust the portfolio to higher interest rates and lower tax rates, recognizing $42,000 in losses. Net unrealized securities losses contributed to a $10.0 increase in accumulated other comprehensive loss from year-end.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21%. The company had not completed its accounting for the law and expected to finalize provisional amounts in Q4 2018.
- The Board declared a 20% stock dividend and a Q4 cash dividend of $0.26 per share, payable December 14, 2018, and restored stock-repurchase capacity to 500,000 shares. The filing gives no earnings guidance.
- Key risks include interest-rate changes, economic and invoice-volume trends, energy costs, competition for deposits, credit quality, and execution of new-business and technology investments. Management’s interest-rate policy seeks to limit the change in annualized net interest income to 15% under an immediate, sustained 200-basis-point parallel rate move; management said its risk position had not materially changed.
- Pending legal proceedings were not expected by management to have a material effect. The filing reported no material changes to the risk factors in the 2017 Form 10-K. Adoption of the expected-credit-loss standard was still under evaluation; the filing said it would require an allowance based on expected lifetime loan losses.
Important facts for investors to verify
- Whether processing-volume growth and new customer wins continue to support fee revenue, and whether expense growth moderates.
- How deposit competition, customer balance shifts, and rising deposit rates affect funding costs and net interest income.
- Whether securities unrealized losses remain temporary and whether portfolio repositioning affects future income.
- Loan growth, credit quality, and the adequacy of the allowance, particularly as the expected-credit-loss standard approaches.
- The final accounting impact of the Tax Cuts and Jobs Act and the effect of the announced stock and cash dividends on per-share measures and capital.