Great Southern Bancorp, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. Great Southern is a one-bank holding company operating primarily through Great Southern Bank, serving customers mainly across Missouri and nearby Midwestern states. This unaudited filing covers the three and nine months ended September 30, 2018; balance-sheet comparisons are against December 31, 2017. Amounts below are in millions of dollars unless stated otherwise.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $43.0 | $39.3 | $123.6 | $115.9 |
| Provision for loan losses | $1.3 | $3.0 | $5.2 | $7.2 |
| Non-interest income | $14.6 | $7.7 | $29.0 | $31.2 |
| Non-interest expense | $28.3 | $28.0 | $86.5 | $85.0 |
| Net income | $22.5 | $11.7 | $49.8 | $39.4 |
| Diluted earnings per share | $1.57 | $0.82 | $3.49 | $2.77 |
| Net interest margin | 4.02% | 3.77% | 3.96% | 3.75% |
Balance sheet and credit. At September 30, total assets were $4.58 billion, net loans $3.94 billion, deposits $3.60 billion, and stockholders’ equity $508.1 million. Net loans grew 5.8% from year-end; excluding acquired FDIC-assisted loans and loans held for sale, gross loans increased $356.2 million. The portfolio includes substantial commercial construction ($1.28 billion) and commercial real estate ($1.38 billion) balances. The allowance for loan losses was $37.5 million. Non-performing assets excluding FDIC-assisted acquired assets were $15.9 million, or 0.35% of assets; non-performing loans were $6.5 million and troubled debt restructurings $7.0 million.
Funding, debt, and liquidity. Deposits were nearly unchanged from year-end. FHLB advances increased to $240.0 million from $127.5 million; customer repurchase agreements were $112.2 million. Brokered deposits, including CDARS purchased funds, were $260.4 million. Cash and cash equivalents were $208.8 million, down $33.4 million since year-end. The company reported $448.1 million of available FHLB secured capacity, $460.5 million of Federal Reserve capacity, and $44.4 million of unpledged securities. Commitments included $222.3 million to fund loan originations, $1.12 billion of unused lines and unadvanced loans, and $25.1 million of letters of credit.
For the nine months, operating cash flow was $73.4 million, investing cash flow was negative $289.3 million, and financing cash flow was positive $182.5 million. Cash and cash equivalents declined by $33.4 million to $208.8 million. The company had $73.8 million of subordinated notes outstanding, net of issuance costs, and $25.8 million of subordinated debentures.
Capital and shareholder returns. The Bank was well capitalized: its September 30 CET1, Tier 1, total capital, and Tier 1 leverage ratios were 12.6%, 12.6%, 13.5%, and 12.4%, respectively. Company tangible common equity to tangible assets was 10.9%. Nine-month dividends declared were $0.88 per share. No shares were repurchased during the quarter; a new authorization permits repurchase of up to 500,000 shares.
Material changes and unusual items
- Q3 net income rose 93.1%, primarily reflecting the $7.4 million pre-tax gain on the July sale of four Omaha-area banking centers and related deposits, higher net interest income, and lower loan-loss provision. The gain included $165,000 of transaction expenses in the stated sale accounting.
- Nine-month net income rose 26.6%. Net interest income increased 6.7% and provision expense declined, while non-interest income fell 6.9%, primarily because 2017 included a $7.7 million gain on termination of InterBank FDIC loss-sharing agreements.
- Loan growth and higher yields supported net interest income, but funding costs increased: nine-month interest expense rose 26.8%, including higher deposit and FHLB advance costs. The nine-month net interest margin increased 21 basis points.
- Cash-flow accretion on FDIC-acquired loan pools contributed $3.7 million to nine-month interest income; management expected to recognize a further $1.0 million during the remainder of 2018 from the then-remaining accretable-yield adjustment.
- Other real estate owned and repossessions declined to $12.8 million from $22.0 million at year-end, but nine-month foreclosed-asset expense increased to $4.4 million, including valuation write-downs.
Outlook, management commentary, and risks
- Management expected the 2018 combined effective tax rate to be approximately 16.5%–18.5%, compared with approximately 26.7% in 2017, principally reflecting the lower federal corporate tax rate. This is tax-rate commentary, not earnings guidance.
- Following the Omaha branch sale, management expected annual non-interest income to decline $300,000–$350,000, non-interest expense to decline $1.1–$1.2 million, and interest expense to increase $400,000–$500,000, based on then-current funding rates.
- The company expected to open a commercial loan production office in Atlanta in November 2018 and was seeking final approval for a Denver office. Management cautioned that future loan growth cannot be assured and emphasized pricing discipline and credit quality.
- Management described interest-rate risk as its most significant market risk. Models indicated rising rates would generally benefit net interest income, while falling rates would generally hurt it; modeled effects were not expected to be material in the first 12 months, with potentially greater effects over 12–36 months. Deposit repricing and competition may pressure margins.
- Management considered the allowance adequate, but noted estimates are judgmental and additional provision could be required if economic conditions or loan assessments deteriorate. Consumer auto charge-offs remained a focus; the company had tightened underwriting and expected auto balances to decline further through the remainder of 2018.
- In October 2018, after quarter-end, the company entered a $400 million interest-rate swap through 2025, receiving fixed interest of 3.018% and paying one-month LIBOR. Future net settlements depend on LIBOR relative to the fixed rate.
- The company was preparing for the expected 2020 adoption of the current-expected-credit-loss standard and could not yet estimate its impact. It estimated adoption of the 2019 lease standard would add approximately $6–$8 million to assets and liabilities, with no expected material income-statement impact.
- Other stated risks include economic and real-estate conditions, loan and investment credit losses, funding access, regulatory changes, litigation, competition, cybersecurity, and execution and retention risks associated with business changes. Management reported no material change to the prior annual report’s risk factors and no material adverse expected outcome from ordinary-course litigation.
Important facts for investors to verify
- How much of reported earnings growth is recurring after excluding the Omaha sale gain, FDIC-acquired loan accretion, and prior-year FDIC termination gain.
- Whether commercial construction and commercial real estate growth is accompanied by stable credit quality, allowance coverage, delinquencies, and charge-offs, particularly in consumer auto lending.
- Whether deposit pricing, brokered funding, FHLB advances, and repurchase funding continue to pressure funding costs and net interest margin.
- The realized operating effects of the Omaha sale, planned Atlanta and Denver lending offices, and the $400 million post-quarter swap.
- The eventual allowance impact of the expected-credit-loss standard and the sustainability of management’s projected 2018 effective tax-rate range.