FIRST FINANCIAL BANKSHARES INC quarterly report, Q2 FY2018

First Financial Bankshares, Inc. — Q2 2018 Form 10-Q

Reporting period: Three and six months ended June 30, 2018. First Financial is a Texas-based financial holding company operating primarily through its full-service bank; it reported 72 financial centers. Dollar amounts below are in millions unless otherwise noted.

Financial results and condition

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net interest income	$67.6	$59.1	$133.1	$116.1
Provision for loan losses	$1.1	$1.7	$2.4	$3.7
Noninterest income	$25.5	$23.2	$49.9	$44.5
Noninterest expense	$47.1	$43.8	$94.9	$85.9
Net earnings	$37.6	$28.3	$72.2	$54.9
Basic EPS	$0.56	$0.43	$1.07	$0.83

Q2 net earnings rose about 33%; first-half earnings rose 31.5%. Management attributed the increase to the lower corporate tax rate and the January 2018 Commercial Bancshares acquisition. Excluding the tax-rate benefit, management reported adjusted net earnings of $33.0 million for Q2 and $63.3 million for the first half, with adjusted basic EPS of $0.49 and $0.94, respectively.
Tax-equivalent net interest income increased to $69.9 million in Q2 and $137.8 million in the first half. Net interest margin was 3.92% in Q2 and 3.90% for the first half, down 13 and 14 basis points year over year.
At June 30, assets were $7.69 billion, loans held for investment were $3.83 billion, deposits were $6.21 billion, borrowings were $456.9 million and shareholders’ equity was $985.6 million. Compared with June 2017, assets, loans and deposits were higher, with the acquisition contributing materially.
Cash and cash equivalents were $286.2 million, down from $372.3 million at year-end 2017. First-half operating cash flow was $89.0 million; investing activities used $183.7 million and financing activities provided $8.6 million.
The allowance for loan losses was $50.0 million, or 1.30% of period-end loans, versus 1.37% a year earlier. The first-half provision was lower than in 2017; net charge-offs were 0.03% of average loans, compared with 0.12%.
Nonperforming assets were $28.1 million, or 0.73% of loans and foreclosed assets, versus $24.7 million and 0.71% a year earlier. Nonaccrual loans increased to $26.7 million from $21.5 million.
Q2 and first-half efficiency ratios were 49.42% and 50.57%, compared with 49.32% and 49.49%. Return on average assets was 1.98% for Q2 and 1.91% for the first half; return on average equity was 15.53% and 15.14%.
Consolidated regulatory capital ratios at June 30 included total risk-based capital of 19.81%, Tier 1 and common equity Tier 1 of 18.68%, and leverage of 11.14%. The bank’s ratios also exceeded its stated well-capitalized thresholds.

Material changes and notable items

Acquisition: Commercial Bancshares and Commercial State Bank were acquired effective January 1, 2018, expanding the company’s Houston-area presence. The company issued 1,289,371 shares; recorded $31.6 million of goodwill; and included acquired loans of $266.3 million and deposits of $341.9 million at acquisition-date fair value. First-half results include the acquired business.
Tax law: The federal corporate tax rate fell from 35% to 21%. Effective tax rates were 16.09% in Q2 and 15.72% for the first half, versus 23.13% and 22.70% in 2017. Management’s earnings comparisons therefore include a substantial tax benefit. The company also reclassified $5.8 million of tax effects from accumulated other comprehensive income to retained earnings.
Securities and equity: Available-for-sale securities totaled $3.20 billion. Their net unrealized holding loss was $10.8 million before tax; accumulated other comprehensive earnings (loss) moved to a loss of $11.4 million at June 30, from positive $26.8 million at year-end. Management attributed unrealized securities losses primarily to interest rates and said it did not consider them other-than-temporary.
Acquisition costs and expenses: First-half noninterest expense included $1.55 million of technology contract termination and conversion costs related to the acquisition. Salaries and benefits also rose, reflecting pay increases, profit sharing and acquired operations.
Dividends: The company declared $0.21 per share for Q2, up from $0.19 a year earlier. Its stated long-term policy is to pay approximately 40% of annual net earnings as cash dividends, subject to capital and covenant restrictions.

Outlook, risks and contingencies

The filing provides no specific earnings or financial guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
Management cited the potential effects of interest-rate changes, economic and employment conditions, Texas real estate and commodity markets, severe weather, credit quality, deposit competition, regulation, cybersecurity and acquisition integration. It said Hurricane Harvey-related facility damage was not significant after insurance, continued monitoring affected loans, and did not identify credit-related losses on evaluated municipal bonds.
Interest-rate simulations estimated that a 100- or 200-basis-point rate increase would raise projected 12-month net interest income by 0.36% or 0.34%; a 100-basis-point decrease would reduce it by 3.41%. Management characterized the balance sheet as more liability-sensitive in short-term categories and cautioned that model assumptions limit the estimates.
Liquidity sources include deposits, cash and marketable assets, a $1.14 billion FHLB line (with $60 million outstanding), other borrowing lines, and a $25 million Frost Bank revolving line that was undrawn and matures June 30, 2019. Management considered liquidity adequate and reported compliance with the Frost Bank covenants.
Off-balance-sheet commercial commitments totaled $939.3 million: $610.7 million in unfunded lines, $298.3 million in commitments to extend credit and $30.3 million in standby letters of credit. Management noted that many commitments may expire unused.
The company reported no material pending legal proceedings and no material change in previously disclosed risk factors. Management concluded disclosure controls were effective at the reasonable-assurance level.

Important facts for investors to verify

How much of earnings growth reflects the lower tax rate and acquisition versus underlying organic growth; review management’s tax-adjusted figures and acquisition contribution.
Whether rising nonaccrual loans and nonperforming assets remain manageable, and whether the allowance remains adequate as the loan portfolio grows.
The effect of higher deposit and borrowing costs on net interest margin, especially given the year-over-year margin decline and disclosed rate sensitivity.
Whether unrealized securities losses, including the material shift in accumulated other comprehensive income, change with market rates or create liquidity or capital pressures.
Acquisition integration progress, including technology conversion costs, acquired credit performance, goodwill and expected contribution from the acquired bank.
Hurricane Harvey-related loan and municipal-bond exposure, oil-and-gas lending growth, and the company’s assumptions for collateral and local economic conditions.