South State Corporation — Q2 2018 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2018; balance-sheet comparisons are primarily with December 31, 2017 and June 30, 2017. South State is a regional bank holding company headquartered in Columbia, South Carolina. Results include Park Sterling Corporation (PSC), acquired November 30, 2017, so year-over-year comparisons reflect both acquisition and organic growth.
Financial performance and condition
| Metric | Q2 2018 | Comparable period / change |
|---|---|---|
| Net interest income | $129.6 million | $99.0 million in Q2 2017; up 30.8% |
| Noninterest income | $37.5 million | $35.3 million in Q2 2017; up 6.3% |
| Provision for loan losses | $4.5 million | $2.3 million in Q2 2017 |
| Noninterest expense | $110.5 million | $84.3 million in Q2 2017; up 31.2% |
| Net income | $40.5 million | $31.8 million in Q2 2017; up 27.1% |
| Diluted EPS | $1.09 | $1.08 in Q2 2017 |
| Net interest margin | 4.12% non-taxable-equivalent | 4.07% in Q2 2017; down 7 basis points from Q1 2018 |
| Efficiency ratio | 65.6% | 62.2% in Q2 2017; improved from 66.7% in Q1 2018 |
For the six months, net income was $82.8 million versus $50.1 million, diluted EPS was $2.24 versus $1.71, and net interest income was $258.5 million versus $196.4 million. The effective tax rate fell to 21.69% from 31.50%, primarily reflecting federal tax reform.
Balance sheet and liquidity at June 30, 2018: Total assets were $14.57 billion, loans net of allowance were $10.78 billion, deposits were $11.64 billion, and shareholders’ equity was $2.35 billion. Cash and cash equivalents totaled $396.8 million. Federal funds purchased and repurchase agreements were $332.0 million; other borrowings were $115.8 million. The company reported $160.2 million of operating cash flow for the first half, versus $75.2 million in 2017; cash increased $19.2 million.
Regulatory capital remained well above minimums: consolidated CET1 was 12.00%, total risk-based capital 13.48%, and Tier 1 leverage 10.62%. The Bank was also classified as well capitalized. Management reported available liquidity facilities, including $556 million in federal funds lines and a $1.9 billion FHLB facility, and considered liquidity adequate.
Credit quality: Non-acquired nonperforming loans were $14.9 million, or 0.21% of non-acquired loans. Non-acquired OREO rose to $8.0 million, largely from PSC-related branch closures. The allowance was 0.67% of non-acquired loans and covered non-acquired nonperforming loans 3.22 times. Q2 annualized net charge-offs on non-acquired loans were 0.01%; acquired non-credit-impaired loan charge-offs were $1.1 million, attributed primarily to one relationship.
Material changes versus prior periods
- Total assets rose from $11.15 billion at June 30, 2017, principally reflecting PSC. Loans increased 32.3% year over year; non-acquired loans grew 20.1% organically, while acquired loans represented 33.5% of the portfolio at quarter-end.
- Q2 interest income increased substantially with PSC-acquired loans and organic lending, but interest expense also rose as acquired deposits carried higher costs and market rates increased. The average cost of interest-bearing liabilities rose 33 basis points year over year.
- Operating costs increased with PSC integration: Q2 merger and branch-consolidation expense was $14.1 million, and total noninterest expense rose 31.2%. The company completed a systems conversion and closed 10 branches during the quarter.
- Available-for-sale securities had $38.6 million of gross unrealized losses at quarter-end, versus $12.8 million at year-end 2017; management attributed the increase to higher interest rates and did not consider the losses other-than-temporary. Accumulated other comprehensive loss widened to $36.1 million.
Outlook, risks, and unusual items
- No specific earnings or revenue guidance is provided. Management expected PSC-related systems, contract-cancellation, and personnel expenses to continue into Q3 2018, while anticipating operating cost savings and synergies from acquisitions.
- Because assets exceeded $10 billion for four consecutive quarters, the Durbin Amendment interchange fee cap took effect for the Bank on July 1, 2018. Management estimated a second-half 2018 reduction in bankcard services income of approximately $8.5 million pretax and $6.6 million after tax. The company also expected approximately $4 million of additional FDIC insurance costs in 2018 versus the prior year.
- Management cited risks including credit and interest-rate exposure, liquidity, merger integration, regulatory and compliance changes, cybersecurity, economic conditions, and the revenue and expense effects of exceeding the $10 billion asset threshold. It noted that rising funding costs were outpacing asset-yield increases in Q2.
- Commitments to extend credit and standby letters of credit totaled $2.9 billion; management did not anticipate material losses. Ordinary-course legal matters were not expected to have a material financial effect. No material subsequent event was disclosed.
- The company early adopted the accounting change allowing stranded tax effects to be reclassified from AOCI to retained earnings, moving $2.9 million. Revenue-standard adoption primarily changed the presentation of debit-card network costs, netted against related fees, and did not materially change revenue recognition.
Important facts for investors to verify
- PSC integration progress, remaining Q3 merger costs, realized cost savings, and customer or deposit retention.
- Actual impact of the Durbin interchange cap and higher FDIC assessments on second-half earnings.
- Deposit pricing and funding-cost trends relative to loan and securities yields, including the margin decline from Q1.
- Credit performance in acquired portfolios, the specific relationship behind acquired loan charge-offs, and the increase in OREO.
- Whether unrealized securities losses remain temporary and how further rate changes affect AOCI, capital, and liquidity.
- Growth in commercial real estate exposures; the filing identifies concentrations in nonresidential-building lessors, hotel and motel loans, and nonresidential construction.