Great Southern Bancorp, Inc. — Q2 2018 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2018. The company is a one-bank holding company serving primarily Missouri, Iowa, Kansas, Minnesota, Nebraska and Arkansas, with commercial loan production offices in other markets. Amounts below are in millions unless otherwise stated.
Financial performance and position
- Q2 earnings: Net income was $13.8 million, down 14.4% from $16.2 million a year earlier. Diluted EPS was $0.97 versus $1.14; declared dividends were $0.28 per share versus $0.24.
- First-half earnings: Net income was $27.3 million, down 1.4% from $27.7 million. Diluted EPS was $1.91 versus $1.95; declared dividends were $0.56 per share versus $0.46.
- Interest income and margin: Q2 net interest income rose 8.7% to $41.2 million; net interest margin was 3.94%, up 26 basis points. First-half net interest income increased 5.3% to $80.7 million; margin was 3.93%, up 20 basis points. Higher loan yields and loan growth supported results, partly offset by higher deposit costs.
- Non-interest items and expenses: Non-interest income declined to $7.5 million in Q2 and $14.4 million in the first half, largely because the 2017 comparable periods included a $7.7 million gain from terminating an FDIC loss-sharing agreement. Non-interest expense increased 5.4% to $29.9 million in Q2 and 2.3% to $58.2 million for the first half. Foreclosed-asset expenses included significant property write-downs. The efficiency ratio was 61.46% for Q2 and 61.26% for the first half.
- Assets and loans: Total assets were $4.57 billion at June 30, up 3.5% from year-end. Net loans were $3.86 billion, up $133.5 million, or 3.6%; growth was concentrated in commercial construction, commercial real estate, multifamily and residential mortgage lending. Consumer auto loans declined about $58 million.
- Credit quality: The allowance for loan losses was $37.6 million, compared with $36.5 million at year-end. First-half provision was $3.9 million, down from $4.2 million. Excluding FDIC-acquired assets, nonperforming assets fell to $21.5 million, or 0.47% of assets, from $27.8 million, or 0.63%. Nonperforming loans were $8.1 million; potential problem loans rose to $8.7 million. The allowance was 1.02% of loans excluding FDIC-acquired loans.
- Deposits, borrowings and equity: Deposits were essentially unchanged at $3.60 billion. FHLB advances increased to $259.0 million from $127.5 million; reverse repurchase agreements were $95.5 million, and short-term borrowings were $1.4 million. Stockholders’ equity was $490.3 million, or 10.7% of assets; tangible common equity to tangible assets was 10.53%.
- Cash flow and liquidity: First-half operating cash flow was $50.4 million, investing cash outflow was $139.9 million, and financing cash inflow was $127.7 million. Cash and cash equivalents ended at $280.5 million. Available sources included $463.5 million in FHLB secured lines, $486.3 million in Federal Reserve lines, and $45.9 million of unpledged securities. The company reported $175.2 million of loan-origination commitments, $1.13 billion of unused lines and unadvanced loans, and $26.0 million of letters of credit.
- Capital: The Bank was reported well capitalized: CET1 12.3%, Tier 1 12.3%, total capital 13.2%, and Tier 1 leverage 12.1%. The holding company’s corresponding ratios were 10.9%, 11.5%, 14.1% and 11.3%.
Material changes and unusual items
- The 2017 comparison benefited from the one-time $7.7 million pretax FDIC loss-sharing termination gain; its absence materially reduced reported non-interest income in 2018.
- Q2 2018 foreclosed-asset expense rose to $2.7 million, including $2.8 million of valuation write-downs, partly offset by gains on asset sales. First-half write-downs were $3.4 million. Other real estate owned and repossessions declined to $18.3 million from $22.0 million at year-end.
- Federal tax reform reduced the federal corporate rate to 21%. The company reported effective tax rates of 17.6% for Q2 and 17.0% for the first half, versus 30.8% and 28.9% in 2017. Management expected a full-year 2018 effective rate of approximately 16.5%–18.5%.
- Unrealized losses on available-for-sale securities contributed to a $2.0 million decline in accumulated other comprehensive income during the first half. Management considered the securities’ fair-value declines temporary and reported no other-than-temporary impairments.
- On July 20, 2018, the company completed the sale of four Omaha-area banking centers and approximately $56 million of deposits. It expected a pretax gain of about $7.4 million, or approximately $0.38 per diluted share after tax, in Q3 2018. It also forecast annual reductions of $300,000–$350,000 in non-interest income and $1.1–$1.2 million in non-interest expense, and an annual increase of $400,000–$500,000 in interest expense, based on then-current rates.
Outlook, risks and contingencies
- Management said loan growth depends on economic conditions, competition, pricing discipline and credit quality, and provided no assurance of future growth. It expected consumer auto loan balances to continue declining during the remainder of 2018.
- Management described the expected near-term net-interest-income effect of rate changes as broadly neutral over the first 12 months, with potentially greater effects over 12–36 months. Its models indicated rising rates generally could benefit net interest income, while falling rates could hurt it; deposit repricing, loan floors and competition may affect outcomes.
- The company expected to open commercial loan production offices in Atlanta and Denver during Q3, subject to regulatory approvals, and added a role focused on SBA lending.
- Key risks include credit and collateral losses, real estate conditions, funding costs and access to brokered deposits or FHLB advances, interest-rate changes, competition, regulatory changes, technology and cybersecurity threats, litigation and the performance of acquired loan pools. Management noted that all FDIC loss-sharing agreements had ended, leaving the company responsible for subsequent gains, losses and expenses on those assets.
- The company was evaluating the future expected-credit-loss standard (CECL); it expected a one-time allowance adjustment at adoption but could not yet estimate its magnitude. It expected the 2019 lease standard to increase reported assets and liabilities, without a material income-statement effect anticipated based on leases then outstanding.
- Management reported disclosure controls and procedures were effective as of June 30, 2018, and no material change in internal control over financial reporting occurred during the quarter. It reported no material changes to the risk factors in its 2017 Form 10-K.
Important facts for investors to verify
- Whether loan growth, credit performance and the allowance remain consistent with management’s assumptions, particularly in commercial construction, commercial real estate and consumer auto lending.
- How much deposit and borrowing costs rise as certificates of deposit reprice, and whether funding needs continue to increase.
- The realized Q3 gain and ongoing earnings, deposit and expense effects of the Omaha branch sale.
- The extent to which acquired-loan accretion supports future net interest income; management cited $2.9 million of remaining accretable yield adjustments, with $1.4 million expected to be recognized during the rest of 2018.
- Whether property write-downs, potential problem loans, securities valuation changes or regulatory and economic developments create additional losses or capital needs.