Stock Yards Bancorp, Inc. quarterly report, Q2 FY2018

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Stock Yards Bancorp, Inc. — Q2 2018 Form 10-Q

Business context and reporting period. The filing reports unaudited consolidated results for the three and six months ended June 30, 2018, with comparisons to 2017. The company operates through commercial banking and wealth management and trust services.

Financial performance and position

  • Q2 earnings: Net income was $13.6 million, up 28.1% from $10.6 million; diluted EPS was $0.59, versus $0.46.
  • First-half earnings: Net income was $27.0 million, up 26.1% from $21.4 million; diluted EPS was $1.17, versus $0.93.
  • Net interest income and margin: GAAP net interest income was $28.7 million for Q2 and $56.0 million for the first half. On a fully tax-equivalent basis, first-half net interest income rose 10.5% to $56.2 million. Tax-equivalent net interest margin was 3.88% in Q2 and 3.84% for the first half, compared with 3.60% and 3.62%, respectively, in 2017.
  • Revenue, fees and expenses: First-half non-interest income increased 0.9% to $22.3 million, led by wealth management and trust fees, which rose 5.8% to $10.8 million. Non-interest expense increased 2.3% to $43.2 million. The first-half efficiency ratio improved to 55.0% from 57.8%; the adjusted ratio, excluding tax-credit partnership amortization, was 54.9% versus 56.1%.
  • Taxes: The first-half effective tax rate declined to 18.7% from 26.0%, primarily reflecting the federal rate reduction from 35% to 21% under tax reform. Q2 effective tax rate was 18.9%, versus 29.1%.
  • Loans and credit: Loans reached $2.58 billion, up $168.4 million, or 7.0%, from year-end 2017 and 12% year over year. The first-half provision for loan losses was $2.0 million, compared with $1.5 million. The allowance was $24.9 million, or 0.96% of period-end loans, versus 1.09% a year earlier. Non-performing loans were $7.4 million, or 0.29% of loans; non-performing assets were $7.7 million, or 0.23% of assets.
  • Balance sheet and capital: Total assets were $3.32 billion, up from $3.24 billion at December 31, 2017. Stockholders’ equity was $345.5 million; the tangible common equity ratio was 10.35%. The Bank’s total risk-based capital ratio was 12.70% and leverage ratio was 10.85%; the company reported that it met applicable capital requirements and was well capitalized.
  • Liquidity, deposits and borrowings: Cash and cash equivalents were $55.0 million, down from $139.2 million at year-end. Deposits declined $37.8 million to $2.54 billion. Federal funds purchased and other short-term borrowings rose to $286.5 million from $161.4 million; repurchase agreements were $58.8 million and FHLB advances were $48.8 million. The company also reported $275 million of short-term FHLB cash-management advances, including $75 million used to supplement liquidity. Available FHLB credit was $205.8 million.
  • Cash flow: For the six months, operating activities provided $33.5 million, investing activities used $180.2 million, and financing activities provided $62.4 million. The resulting decrease in cash and cash equivalents was $84.2 million.

Material changes versus comparable periods

  • First-half net income and diluted EPS increased 26.1% and 25.8%, respectively, as loan growth, higher asset yields and a lower tax rate outweighed increased funding costs.
  • First-half interest income rose 15.0%, while interest expense increased 78.5%, reflecting higher deposit and borrowing costs.
  • Loan growth was broad, with commercial and industrial balances increasing to $855.0 million from $779.0 million at year-end.
  • Unrealized losses on available-for-sale securities increased to $9.6 million from $4.1 million at year-end; accumulated other comprehensive loss widened to $7.0 million from $1.9 million.
  • Non-performing assets declined from $10.0 million at year-end, mainly as foreclosed real estate fell to $0.4 million from $2.6 million. Non-accrual loans were broadly stable at $6.4 million.

Outlook, risks and unusual items

  • Management expects deposit-rate pressure to continue through the remainder of 2018. Competition and efforts to grow deposits to fund loans may require higher deposit rates, potentially offsetting some benefit from higher loan rates.
  • Management expected wealth management and trust revenue to grow 4%–6% in 2018; it also cited potential near-term effects from increased market volatility. Treasury management revenue and commercial card activity were expected to continue growing. No company-wide earnings or revenue guidance is provided in the filing.
  • Interest-rate simulations estimated net interest income changes of +2.11% for a 200-basis-point increase, +1.06% for a 100-basis-point increase, −0.94% for a 100-basis-point decrease, and −7.07% for a 200-basis-point decrease. Management cautioned that simulations are estimates, not forecasts of actual results.
  • The allowance methodology’s historical loss look-back period was extended from 28 to 32 quarters to capture a full economic cycle; management estimated this increased the allowance by approximately $1.3 million versus the prior period at March 31, 2018. Management also cited a commercial relationship charge-off as a driver of higher net charge-offs.
  • Available-for-sale securities’ unrealized losses were attributed by management to interest-rate changes; it stated it did not intend to sell the securities and did not expect to be required to sell before recovery of amortized cost.
  • Off-balance-sheet commitments to extend credit were $687.7 million, including $18.9 million of standby letters of credit. Management said pending legal proceedings were not expected to have a material adverse effect. The company had recorded provisional tax-reform amounts and expected to complete the related accounting by December 22, 2018.
  • Adoption of the expected-credit-loss standard (CECL) was expected in 2020; the filing says its impact could not yet be quantified and anticipates a one-time cumulative adjustment to the allowance. Lease accounting adoption was expected to add approximately $11 million of right-of-use assets and lease liabilities.

Important facts for investors to verify

  • Whether loan growth can be funded without sustained increases in deposit costs or reliance on short-term borrowings and FHLB advances.
  • Trends in net interest margin, deposit pricing, and realized results compared with the filing’s interest-rate sensitivity estimates.
  • Credit quality, including commercial charge-offs, the allowance relative to loan growth, and the concentration of non-accrual loans: two relationships represented 67% of non-accrual loans.
  • Whether increased securities-market losses remain temporary and how interest-rate movements affect accumulated other comprehensive loss and capital.
  • Performance of wealth management and trust, commercial card, and other fee businesses against management’s commentary, alongside pressure in mortgage banking and deposit service charges.
  • The final tax-reform accounting, CECL implementation impact, and potential drawdowns under the $687.7 million of credit commitments.