Southside Bancshares, Inc. — Q3 2019 Form 10-Q
Business context and reporting period: Southside Bancshares is a Texas-based bank holding company operating through Southside Bank. This unaudited quarterly report covers the three and nine months ended September 30, 2019; balance-sheet comparisons are with December 31, 2018.
Financial performance and condition
- Earnings: Q3 net income was $19.8 million, down 2.5% from $20.3 million a year earlier; diluted EPS was $0.58 in both periods. Nine-month net income increased 0.8% to $57.2 million, and diluted EPS rose to $1.69 from $1.61.
- Interest income and margins: Q3 interest income increased 6.0% to $60.6 million, but interest expense rose 23.3% to $18.2 million; net interest income was nearly unchanged at $42.4 million. For the first nine months, net interest income declined 2.3% to $126.6 million. Fully taxable-equivalent net interest margin fell to 3.03% from 3.14% in Q3 and to 3.09% from 3.17% year to date.
- Other income and expenses: Nine-month noninterest income increased 4.1% to $31.9 million, while noninterest expense decreased 1.7% to $88.4 million. Nine-month provision for loan losses declined to $2.6 million from $6.0 million. The effective tax rate rose to 15.3% from 11.9% year to date, partly because 2018 included a discrete tax benefit.
- Assets and lending: Total assets grew 6.8% to $6.54 billion. Loans rose 5.6% to $3.50 billion, led by construction lending, which increased 22.3% to $621.0 million. Securities increased 10.6% to $2.38 billion.
- Credit quality: Nonperforming assets declined to $29.7 million, or 0.45% of assets, from $42.9 million, or 0.70%, at year-end. Nonaccrual loans fell to $17.1 million from $35.8 million, mainly after the sale of three commercial real estate loans. Restructured loans increased to $11.7 million from $5.9 million. The allowance was $25.1 million, or 0.72% of loans, versus $27.0 million, or 0.82%, at year-end.
- Funding, debt and liquidity: Deposits increased 1.5% to $4.49 billion. FHLB borrowings rose 36.1% to $979.0 million and long-term debt was $158.8 million. Brokered CDs increased to $387.1 million, near the company’s stated $400 million policy limit, with weighted average cost of 2.24% and maturities under nine months. Cash and cash equivalents were $114.8 million. The Bank reported approximately $1.27 billion of additional FHLB funding capacity.
- Cash flow and capital: For the first nine months, operating cash flow was $60.0 million, compared with $103.1 million in 2018; investing activities used $349.0 million, versus providing $328.3 million; financing activities provided $283.1 million, versus using $456.0 million. Shareholders’ equity was $810.5 million, or 12.4% of assets. At September 30, consolidated CET1, Tier 1, total capital and leverage ratios were 14.19%, 15.61%, 18.65% and 10.46%, respectively; management said capital requirements were met.
Material changes and unusual items
- Higher funding costs—especially for deposits and FHLB borrowings—outpaced interest-income growth and compressed margins. The Federal Reserve cut its target rate by 50 basis points during Q3; management cited the prior rate increases and a flattening yield curve as pressures on margins.
- The company bought approximately $1.02 billion of agency mortgage-backed and Texas municipal securities and sold approximately $727 million of lower-yielding available-for-sale securities during the first nine months, recording a $714,000 net gain.
- Adoption of the callable-debt premium amortization standard reduced beginning retained earnings by $16.5 million before tax. Adoption of lease accounting added $10.1 million of lease liabilities and $9.8 million of right-of-use assets; management said it did not materially affect earnings or cash flows.
- Other comprehensive income was $66.9 million for the first nine months, substantially improving reported equity; accumulated other comprehensive income moved from a $50.2 million loss at year-end to $16.7 million of income, largely reflecting securities valuation changes.
- The Board authorized repurchases of up to 1 million shares in September. No plan purchases occurred during Q3; 25,615 shares were purchased after quarter-end through October 28 at an average $33.47. Cash dividends were $0.31 per share for Q3.
Outlook, commentary and risks
The filing provides no specific earnings or growth guidance. Management said balance-sheet strategy will continue to be reassessed in response to interest rates, yield-curve shape, prepayments, funding costs and loan and deposit trends. It expects to adopt CECL on January 1, 2020 and anticipates a material effect on the measurement of its loan-loss allowance; the amount was not yet clear and will depend on economic conditions, forecasts and portfolios at adoption.
Key exposures include interest-rate and margin risk, mortgage-backed security prepayments and fair-value volatility, reliance on FHLB and brokered-CD funding, Texas real estate and economic conditions, borrower credit quality, and cyber and operational risks. Management’s interest-rate simulations projected net interest income changes over the next 12 months of +1.59% for an immediate 100-basis-point rise, -1.37% for a 200-basis-point rise, +0.86% for a 100-basis-point decline and -0.19% for a 200-basis-point decline, relative to its base case; these are model estimates subject to assumptions. Management expected ordinary-course litigation not to materially affect financial position, results or liquidity. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether margin pressure and higher deposit and wholesale funding costs persist, particularly as brokered CDs approach the stated policy limit.
- Whether loan growth, construction and commercial real estate exposures, restructured loans and charge-offs affect future credit costs and allowance adequacy.
- The eventual CECL transition adjustment and its effect on reserves, capital and earnings.
- How securities portfolio growth, interest-rate movements and mortgage prepayments affect fair value, equity and net interest income.
- Whether liquidity, capital ratios and funding capacity remain adequate as the balance sheet grows and funding sources shift.
- Whether the post-quarter share repurchases and dividend level remain consistent with capital needs and future earnings.