Business Context and Reporting Period
S.Y. Bancorp, Inc. and subsidiary Stock Yards Bank & Trust Company filed this unaudited Form 10-Q for the quarter ended September 30, 2013. The bank provides commercial banking, mortgage, brokerage, investment management, and trust services. Results include THE BANCorp, Inc. (Oldham), acquired April 30, 2013; prior-year comparisons do not include Oldham.
Financial Performance and Position
- Third-quarter earnings: Net income was $7.682 million, up 15.0% from $6.682 million; diluted EPS was $0.53 versus $0.48. Adjusted net income, a non-GAAP measure, was $7.351 million and adjusted diluted EPS was $0.51.
- Year-to-date earnings: Nine-month net income was $20.857 million, up 8.1% from $19.287 million; diluted EPS was $1.47 versus $1.38. Adjusted net income was $21.139 million and adjusted diluted EPS was $1.49.
- Interest income and margin: Nine-month net interest income was $57.455 million, up 3.3%. Net interest margin declined to 3.78% from 3.99%; management reported core margin of 3.63% for Q3, excluding specified items. Lower funding costs supported earnings, while low rates and competition pressured asset yields.
- Other income and expenses: Nine-month non-interest income rose 3.0% to $29.191 million, including a $449,000 acquisition gain. Non-interest expense increased 7.6% to $51.972 million, including $1.548 million of Oldham acquisition costs. The nine-month efficiency ratio increased to 59.46% from 56.77%.
- Credit costs: Nine-month provision for loan losses fell to $4.975 million from $9.025 million. Net charge-offs were $7.866 million versus $7.525 million; construction and development charge-offs were elevated, largely due to one borrower relationship. The allowance was $28.990 million, or 1.70% of loans, versus 2.01% at December 31, 2012.
- Balance sheet and funding: Total assets were $2.290 billion, up 6.6% from year-end 2012. Loans rose to $1.709 billion from $1.585 billion, and deposits to $1.882 billion from $1.782 billion. Stockholders’ equity was $226.535 million. Borrowings included $32.422 million of FHLB advances, $56.225 million in repurchase agreements, $31.861 million of federal funds purchased, and $30.900 million of subordinated debentures.
- Cash flow: For the first nine months, operating activities provided $48.473 million; investing activities used $28.698 million; and financing activities used $16.958 million. Cash and cash equivalents ended at $70.520 million.
- Capital and liquidity: At September 30, the Bank’s total risk-based capital, Tier 1 risk-based capital, and leverage ratios were 12.51%, 11.26%, and 9.23%, respectively; it met regulatory capital requirements. Core deposits were $1.53 billion, or 81% of deposits. Available FHLB borrowing capacity was $342.9 million and correspondent-bank federal-funds lines totaled $70 million.
Material Changes and Unusual Items
- Oldham added approximately $122.3 million of deposits and $38.8 million of loans, and issued 531,288 Bancorp shares as part of the consideration. The transaction generated a $449,000 non-taxable gain and $1.548 million of acquisition costs.
- Management refined its loan-loss allowance methodology in Q3 by allocating amounts previously classified as unallocated. Management said this did not change the overall 2013 provision, but the allowance allocation is not directly comparable with prior periods.
- Accumulated other comprehensive income shifted from $5.421 million at year-end 2012 to a $99,000 loss at September 30, 2013, primarily reflecting securities valuation changes as interest rates moved.
- The company announced it intended to redeem all $30 million of its 10% trust preferred securities. Management estimated about $3 million of annual interest savings beginning in 2014; the filing says capital ratios were expected to remain above well-capitalized thresholds after redemption.
Outlook, Risks, and Contingencies
- No quantified earnings or revenue guidance is provided. Management expected to remain cautious on credit and maintain the allowance at recently high levels, at least in the near term, pending further improvement in credit metrics.
- Management cited the low-rate environment and competitive loan pricing as likely to continue pressuring net interest margin. Its simulation estimated net interest income would decline 3.48% with a 100-basis-point rate increase and 2.68% with a 100-basis-point decrease; the model is indicative, not a forecast.
- Non-performing loans were $30.484 million, or 1.78% of loans, compared with $30.048 million, or 1.90%, at year-end. Non-performing assets were $37.049 million. Five borrowers accounted for $13.3 million, or 66%, of non-accrual loans; management estimated minimal loss exposure after collateral.
- Commitments to extend credit totaled $452.1 million, including $14.8 million of standby letters of credit. Management did not anticipate significant losses, but the contractual amounts represent potential exposure if counterparties draw or fail to perform.
- The IRS notified Bancorp that it would examine the 2011 federal tax return; the examination could result in additional taxes, interest, or penalties. Management believed its tax positions were appropriate. Pending legal matters were not expected by management to have a material adverse effect.
- Other risks identified include economic conditions, competition, regulation, interest-rate changes, and changes in customers’ liquidity or financial condition. Management reported effective disclosure controls and no significant quarterly change in internal control over financial reporting.
Important Facts for Investors to Verify
- Track whether loan growth, asset quality, charge-offs, and the revised allowance methodology support management’s reserve assessment.
- Assess whether margin pressure persists and compare reported net interest margin with core margin, including the effects of loan prepayment fees and other adjustments.
- Confirm the timing and completion of the planned trust-preferred redemption and resulting interest savings and capital ratios.
- Separate Oldham-related growth and one-time acquisition items from ongoing revenue, expenses, and earnings trends.
- Monitor the IRS examination, credit commitments, deposit behavior, and the company’s sensitivity to rate changes.