SOUTHSIDE BANCSHARES INC quarterly report, Q3 FY2018

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Southside Bancshares, Inc. — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018. Southside Bancshares is a Texas-based bank holding company. Results include the Diboll acquisition, completed November 30, 2017; comparisons with 2017 are therefore affected by the acquired operations.

Financial performance

  • Third quarter: Net income was $20.3 million, up 39.9% year over year; diluted EPS was $0.58 versus $0.49. Net interest income rose 21.3% to $42.4 million. Total interest income increased 23.0% to $57.2 million, while interest expense rose 28.0% to $14.7 million. Provision for loan losses was $1.0 million.
  • Nine months: Net income was $56.8 million, up 29.0%; diluted EPS was $1.61 versus $1.49. Net interest income increased 22.7% to $129.7 million. Provision for loan losses rose to $6.0 million from $3.4 million.
  • Margins: Net interest margin on a fully taxable-equivalent (FTE, non-GAAP) basis was 3.14% for Q3 and 3.17% for the first nine months, compared with 3.02% and 3.06%, respectively, in 2017. Q3 FTE spread was 2.82%, unchanged year over year.
  • Noninterest items: Q3 noninterest income increased 6.5% to $10.0 million; nine-month income rose 8.0% to $30.6 million. Noninterest expense increased 15.8% to $29.0 million in Q3 and 17.7% to $89.9 million year to date, primarily reflecting Diboll-related staffing, integration and intangible amortization costs.
  • Taxes and dividends: Effective tax rates were 9.7% for Q3 and 11.9% for nine months, versus 21.1% and 18.9% in 2017. The lower rates reflect the Tax Cuts and Jobs Act and an approximately $0.8 million deferred-tax remeasurement benefit. Dividends paid were $0.30 per share in Q3 and $0.88 year to date.
  • Cash flow: For the first nine months, operating activities provided $103.1 million and investing activities provided $328.3 million; financing activities used $456.0 million. Cash and cash equivalents declined $24.6 million to $174.1 million.

Financial condition, liquidity and capital

  • Total assets were $6.11 billion, down 6.0% from December 31, 2017. Loans were $3.27 billion, down 0.6%; deposits were $4.55 billion, up 0.8%. Shareholders’ equity was $752.5 million, compared with $754.1 million at year-end.
  • Securities declined $345.6 million to $2.10 billion, principally from sales of lower-yielding securities. Accumulated other comprehensive loss increased $32.7 million during the nine-month period, substantially reflecting securities valuation changes.
  • FHLB borrowings fell 44.8% to $561.3 million. Brokered deposits increased to approximately $210.7 million from $62.7 million at year-end. The company reported approximately $1.25 billion in additional FHLB funding capacity, subject to collateral and requirements.
  • At September 30, the consolidated CET1, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 15.90%, 17.43%, 20.75% and 11.06%, respectively. Management said the company and bank met applicable capital requirements.

Material changes, risks and management commentary

  • Asset quality worsened: Nonperforming assets rose to $39.6 million, or 0.65% of assets, from $10.5 million, or 0.16%, at year-end. Nonaccrual loans increased to $32.5 million from $2.9 million, primarily because two large commercial real estate relationships, comprising three loans, were placed on nonaccrual in Q1. The allowance was $26.1 million, 0.80% of loans, versus $20.8 million, 0.63%, at year-end.
  • Portfolio and funding strategy: Management attributed higher interest income and improved margins partly to rising rates and the larger earning-asset base following Diboll. It reduced securities and FHLB funding while increasing brokered CDs as it adjusted interest-rate-risk and funding objectives. Management noted brokered CDs can carry higher interest expense and less customer loyalty.
  • Unusual securities and accounting items: Southside recognized a $1.9 million net loss on available-for-sale securities sales for the first nine months. It also reclassified approximately $743.4 million of securities from held-to-maturity to available-for-sale under a transition election accompanying early adoption of updated hedge-accounting guidance. The reclassification contributed to reported AOCI changes; it was not a sale of those securities.
  • Interest-rate exposure: Model estimates indicated that an immediate +100 or +200 basis-point rate shock would change next-12-month net interest income by +1.45% or +0.13%, respectively; −100 or −200 basis points would change it by −1.06% or −6.04%. These are model-based estimates dependent on assumptions, not forecasts.
  • Outlook and contingencies: No specific earnings or growth guidance was provided. Management said balance-sheet strategy would be reassessed as rates, funding costs, loan and deposit trends, security spreads and mortgage prepayments change. Risks include credit deterioration, interest-rate and securities valuation risk, liquidity and funding costs, cybersecurity, regulatory and tax changes, and acquisition integration. Commitments to extend credit and standby letters of credit totaled $847.5 million. Management said ordinary-course litigation was not expected to materially affect financial position, results or liquidity.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to the previously disclosed risk factors.

Important facts for investors to verify

  • Performance excluding Diboll’s acquired operations and the associated integration, personnel and intangible-amortization costs.
  • Updates on the two large commercial real estate relationships, nonaccrual balances, collateral values, and the adequacy of the allowance for loan losses.
  • Whether deposit pricing and brokered-CD usage pressure funding costs and net interest margins as rates and market conditions change.
  • The composition, valuation sensitivity and potential realized-loss exposure of the securities portfolio, including the impact of AOCI on equity.
  • Assumptions behind interest-rate sensitivity estimates, liquidity capacity, and the future effects of new accounting standards, including expected-credit-loss adoption and callable-security premium amortization.