South State Corporation (Nasdaq: SSB) — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet comparisons are primarily against December 31, 2019 and March 31, 2019. South State is a South Carolina bank holding company. Results reflect the onset of COVID-19 and adoption of the CECL credit-loss standard on January 1, 2020.
Financial results and position
| Metric | Q1 2020 / March 31, 2020 | Comparable period / change |
|---|---|---|
| Total interest income | $147.8 million | $143.4 million in Q1 2019 |
| Net interest income | $128.0 million | $123.3 million in Q1 2019 |
| Provision for loan losses | $36.5 million | $1.5 million in Q1 2019 |
| Noninterest income | $44.1 million | $32.1 million in Q1 2019 |
| Noninterest expense | $107.2 million | $98.2 million in Q1 2019 |
| Net income / diluted EPS | $24.1 million / $0.71 | $44.4 million / $1.25 in Q1 2019 |
| Net interest margin | 3.67% non-taxable-equivalent; 3.68% taxable-equivalent | 3.90% and 3.92%, respectively, in Q1 2019 |
| Assets / shareholders’ equity | $16.64 billion / $2.32 billion | Assets $15.92 billion and equity $2.37 billion at December 31, 2019 |
| Loans / allowance for credit losses | $11.51 billion / $144.8 million | Allowance was $57.0 million at December 31, 2019; accounting basis changed with CECL adoption |
| Deposits / other borrowings | $12.34 billion / $1.32 billion | Deposits $12.18 billion / borrowings $815.9 million at December 31, 2019 |
Net income fell 45.7% year over year; diluted EPS declined 43.2%. The $35.0 million increase in provision expense was the principal earnings headwind. Mortgage banking income rose to $14.6 million from $2.4 million, supporting higher noninterest income. The quarterly efficiency ratio was 62.1%, versus 63.2% in Q1 2019. Return on average assets was 0.60%, compared with 1.21%.
Operating cash flow was $41.1 million, investing cash flow was negative $119.4 million, and financing cash flow was positive $652.4 million. Cash and cash equivalents increased $574.1 million to $1.26 billion, aided by $500 million of new borrowings and deposit growth. Regulatory capital remained above well-capitalized thresholds: consolidated CET1 was 11.09%, total risk-based capital 12.72%, and Tier 1 leverage 9.56%.
Material changes and developments
- CECL adoption increased the loan allowance by $54.4 million and the unfunded-commitment reserve by $6.4 million, with a $44.8 million after-tax reduction to opening retained earnings. The quarter-end loan allowance was 1.26% of loans; the company also reported an $8.6 million reserve for unfunded commitments.
- Total loans grew 1.2% from year-end to $11.51 billion. Non-acquired loans increased by $310.1 million, while acquired loans declined. Deposits rose $167.5 million from year-end; other borrowings increased approximately $500 million.
- Net interest income increased year over year, but margin narrowed by 23 basis points on a non-taxable-equivalent basis, reflecting lower asset yields and a shift toward lower-yielding liquid assets, partly offset by lower funding costs.
- Nonperforming assets reached $69.9 million, up from $46.2 million at year-end. Management attributed $21.0 million of the increase to CECL’s changed classification of certain acquired credit-impaired loans as nonaccrual; excluding that accounting effect, the increase from year-end was $2.6 million.
- Available-for-sale securities were $1.97 billion, with a $55.7 million net unrealized gain. The company reported no credit-loss provision on securities and said it did not intend, and was not more likely than not required, to sell securities in unrealized-loss positions.
Outlook, risks and unusual items
- COVID-19: Management said the pandemic had adversely affected the business and that the ultimate impact was uncertain. Loan payment deferrals covered $1.7 billion at March 31 and $2.4 billion at April 30. As of April 30, South State reported approximately 9,300 funded PPP loans totaling $1.1 billion. Management identified lodging, restaurants, and retail commercial real estate as areas of elevated exposure; lodging loans totaled $590 million, restaurants $225 million, and retail CRE $558 million.
- Management warned that pandemic-related deterioration could increase credit losses, reduce collateral values, pressure loan demand and earnings, and lead to further allowance increases. The $36.5 million Q1 credit provision incorporated pandemic-related forecasts. Goodwill of $1.0 billion was tested and no impairment was recorded; management said it would continue monitoring conditions.
- Proposed merger: South State agreed to an all-stock merger of equals with CenterState Bank Corporation. CenterState shareholders would receive 0.3001 South State shares per share; anticipated ownership of the combined company was approximately 53% CenterState shareholders and 47% South State shareholders. The transaction, valued at approximately $2.2 billion using the stated April 30 share price, was expected to close by Q3 2020, subject to shareholder, regulatory and other approvals.
- Other unusual items included $4.1 million of merger and branch-consolidation expense and a $1.2 million life-insurance-policy payout included in other noninterest income. No full-year earnings guidance is provided in the supplied filing text.
- Management reported adequate liquidity, including $1.26 billion in cash and cash equivalents, $606 million of federal-funds credit lines with no balance outstanding, and approximately $1.2 billion of remaining FHLB facility availability. It also noted potential funding-cost, credit, market, operational, merger-integration and PPP-related litigation or guarantee risks.
Most important facts for investors to verify
- How pandemic-related deferrals, borrower performance and sector concentrations evolve, and whether allowance estimates adequately reflect expected lifetime losses.
- Whether the CECL-driven increase in nonperforming assets is distinguished consistently from underlying credit deterioration, and how credit trends develop beyond Q1.
- The merger’s approval and closing status, expected integration costs and execution risks, and the resulting ownership dilution and capital effects.
- Whether liquidity, borrowings and deposit trends remain sustainable, particularly as pandemic conditions and funding needs change.
- The durability of mortgage banking income, which rose sharply year over year, and the sensitivity of mortgage servicing rights and securities to interest rates and market conditions.