South State Corporation — Q3 2014 Form 10-Q
Business context and reporting period. This is South State Corporation’s quarterly report for the three and nine months ended September 30, 2014. The company is a South Carolina bank holding company operating South State Bank and related investment and trust businesses. The company and bank adopted the South State name in June 2014. Results include the acquired First Financial Holdings (FFHI) business for all of Q3 2014, versus approximately two months of Q3 2013, limiting year-over-year comparability.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $80.4 million | $79.8 million | $244.8 million | $188.8 million |
| Noninterest income | $24.5 million | $15.2 million | $69.4 million | $33.2 million |
| Net income | $19.3 million | $12.1 million | $54.2 million | $35.2 million |
| Net income available to common shareholders | $19.3 million | $11.5 million | $53.1 million | $34.7 million |
| Diluted EPS | $0.80 | $0.52 | $2.20 | $1.85 |
| Net interest margin, taxable-equivalent | 4.65% | 5.11% | 4.83% | 5.03% |
- Q3 total revenue, defined as net interest income plus noninterest income, was $104.8 million versus $94.9 million. Management attributed the increase primarily to FFHI being included for a full quarter, along with growth in bankcard, trust, and mortgage banking income.
- Q3 provision for loan losses was $2.1 million versus $0.7 million. Noninterest expense was $75.1 million, down slightly from $75.4 million; merger and branding costs were $6.8 million. For the first nine months, noninterest expense rose to $228.4 million from $166.7 million, substantially reflecting the longer inclusion of FFHI and integration costs.
- Q3 efficiency ratio was 71.0%, compared with 78.7% a year earlier. Excluding OREO and merger and branding expenses, management reported 61.3% versus 64.3%.
- At September 30, total assets were $7.88 billion; net loans were $5.63 billion; deposits were $6.52 billion; and shareholders’ equity was $967.0 million. Total loans, excluding loans held for sale, were $5.67 billion. Non-acquired loans grew 20.6% year over year to $3.30 billion, while acquired loans continued to run off.
- Cash and cash equivalents were $503.0 million. For the first nine months, operating cash flow was $94.7 million, investing cash flow was $27.8 million, and financing cash flow was negative $98.9 million. The prior-year investing inflow of $522.0 million included $173.5 million of net acquisition cash and other portfolio cash flows; financing outflow in 2014 included the $65.0 million preferred-stock redemption.
- Period-end borrowings included $231.2 million of federal funds purchased and repurchase agreements and $101.1 million of other borrowings. Regulatory capital ratios remained well above stated minimums: company Tier 1 risk-based capital was 13.29%, total risk-based capital 14.12%, and Tier 1 leverage 9.16%. Management said the company remained “well-capitalized.”
Material changes versus comparable periods
- Q3 net income available to common shareholders increased to $19.3 million from $11.5 million; diluted EPS rose to $0.80 from $0.52. The comparison reflects FFHI’s partial-quarter contribution in 2013 and full-quarter contribution in 2014, as well as the higher 2014 weighted-average share count.
- Net interest income increased modestly year over year, but taxable-equivalent net interest margin fell 46 basis points. Management cited lower yields on acquired and non-acquired loans and excess liquidity, partly offset by growth in average earning assets and lower deposit costs.
- Non-acquired nonperforming assets declined to $39.8 million from $66.1 million a year earlier; total nonperforming assets including acquired assets were $88.2 million, down from $126.2 million. Non-acquired annualized net charge-offs were 0.26% in Q3 versus 0.45% a year earlier.
- The allowance for non-acquired loan losses was 1.05% of non-acquired loans, compared with 1.32% a year earlier; coverage of non-acquired nonperforming loans was 1.14 times versus 0.73 times.
- Noninterest income includes FDIC indemnification-asset amortization, a negative $4.8 million in Q3 and negative $17.7 million for the first nine months. The FDIC indemnification asset fell to $31.0 million from $86.4 million at year-end 2013.
Outlook, management commentary, risks, and unusual items
- The filing gives no formal earnings or revenue guidance. Management expected additional FFHI systems-conversion and integration costs during the remainder of 2014 and anticipated further cost savings and synergies; quantified savings guidance was not provided.
- Management described asset quality as manageable and improving, while cautioning that low charge-off levels may not be sustainable and that allowance estimates depend on economic conditions, portfolio mix, and management judgment.
- Non-acquired construction and land-development loans grew 33.7% year over year to $385.3 million; management reported four credit concentrations meeting its stated concentration threshold, including lending to lessors of residential and nonresidential buildings, religious organizations, and health practitioners.
- FFHI acquired credit-impaired loan cash-flow recasting produced $22.0 million of total credit releases in Q3, about two-thirds related to FFHI. Management said most of the effect would be recognized over the remaining life of the affected loan pools, not entirely in the quarter.
- Loss-share protection is diminishing: the Cape Fear commercial agreement expired June 30, 2014, and the CBT commercial agreement was scheduled to expire March 31, 2015. Management identified credit, interest-rate, liquidity, integration, operational, compliance, cyber-security, and broader economic risks.
- At September 30, the bank reported $376.0 million in federal funds credit lines and $164.9 million available at the Federal Reserve Discount Window, with no advances on either. It also had an FHLB facility of $981.6 million, subject to outstanding letters of credit and advances. A subsequent-event disclosure reports a $20 million unsecured U.S. Bank line entered into October 27, 2014; MD&A separately reports a $30 million unsecured line outstanding as an available facility at quarter-end.
- Commitments to extend credit and standby letters of credit totaled $1.3 billion. Management did not anticipate material losses from these commitments and did not expect ordinary-course litigation to materially affect the financial statements. Several merger-related shareholder lawsuits were settled and dismissed with prejudice.
Most important facts for investors to verify
- How much of earnings growth reflects recurring organic performance versus FFHI acquisition timing, integration effects, tax credits, and acquired-loan accounting.
- Whether margin compression continues and how loan growth, excess liquidity, deposit costs, and interest-rate movements affect net interest income.
- Credit quality and reserve adequacy, particularly the rapidly growing construction and land-development portfolio, acquired non-credit-impaired problem loans, and future charge-offs.
- The timing and amount of remaining FFHI integration costs and expected cost savings, neither of which is fully quantified in the filing.
- Future FDIC reimbursements and indemnification-asset amortization, including exposure as loss-share agreements expire.
- Liquidity and capital trends, including the availability and terms of borrowing facilities and the impact of the preferred-stock redemption and dividends.