Southside Bancshares, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Unaudited consolidated results; monetary amounts are in millions unless stated otherwise. Southside is a Texas-based bank holding company. Interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net interest income | $22.5 | $24.6 | $46.5 | $46.8 |
| Provision for loan losses | $2.2 | $1.9 | $5.2 | $4.0 |
| Noninterest income | $8.1 | $12.6 | $18.9 | $22.3 |
| Noninterest expense | $19.1 | $18.1 | $37.6 | $36.8 |
| Net income attributable to Southside | $7.7 | $12.6 | $17.9 | $21.0 |
| Diluted earnings per share | $0.45 | $0.73 | $1.03 | $1.22 |
- Q2 net interest margin was 3.21%, down from 3.80%; net interest spread was 2.98%, versus 3.52%. For the first half, net interest margin was 3.36%, versus 3.68%.
- Six-month operating cash flow was $36.7 million, investing cash outflow $26.4 million, and financing cash inflow $52.6 million. Cash and cash equivalents rose to $106.2 million from $43.2 million at year-end 2011.
- At June 30, assets totaled $3.40 billion, loans $1.18 billion, deposits $2.40 billion, and shareholders’ equity $263.4 million. Total assets increased 2.9% and loans 8.8% from December 31, 2011.
- FHLB advances totaled $608.2 million ($241.2 million short-term and $367.0 million long-term); long-term debt was $60.3 million. Total liabilities were $3.14 billion.
- Bank capital ratios were strong: total risk-based capital 22.27%, Tier 1 risk-based capital 21.02%, and Tier 1 leverage 8.75%. The Bank exceeded the reported “well-capitalized” thresholds.
Material changes and operating trends
- Profitability declined year over year: attributable net income fell 38.8% in Q2 and 14.9% for the first half. Lower interest income and reduced securities-related income were the principal factors.
- Lower funding costs partly offset lower asset yields. For the first half, interest income decreased $4.5 million, while interest expense decreased $4.2 million. Average interest-earning assets grew 7.7%, but their average yield fell to 4.32% from 5.01%.
- Q2 noninterest income declined 36.2%, in part because 2011 included fair-value gains on securities; Southside sold all securities carried at fair value through income during Q1 2012, recording a $498,000 sale loss. First-half AFS securities gains were $9.3 million, compared with $5.5 million in 2011; management cautioned that securities gains may not recur.
- Loans grew 8.8% from year-end, led by 1–4 family residential loans, which rose 31.6% to $325.7 million. Deposits increased $74.2 million; noninterest-bearing deposits rose while interest-bearing deposits declined.
- Nonperforming assets were $13.8 million, up 4.5% from year-end but down 12.3% year over year. Nonaccrual loans were $10.1 million; restructured loans increased to $2.4 million and foreclosed real estate to $1.0 million. The allowance was $20.2 million, or 1.71% of loans.
Outlook, risks, and unusual items
- No specific earnings or financial guidance was provided. Management said competitive loan pricing could continue to pressure loan yields and profitability. It expects to reassess the balance sheet and funding mix as rates, prepayments, spreads, and loan and deposit conditions change; balance-sheet growth in securities remains uncertain.
- Management describes a strategy of funding securities primarily with FHLB advances and deposits. Securities were 57.5% of assets at quarter-end. The strategy supports liquidity and asset quality but may constrain spreads and exposes results and equity to interest-rate, yield-curve, prepayment, and municipal-credit risks.
- The pooled trust preferred securities (TRUPs) had $2.7 million amortized cost and estimated fair value of $623,000. Management estimated cumulative credit impairment of $3.3 million and recognized an additional $181,000 impairment charge in first-half 2012. Valuation relies on Level 3 assumptions and illiquid-market estimates.
- FHLB advance-option fees incurred $1.8 million of impairment charges in the first half; only $195,000 remained on the balance sheet. Further impairment or non-exercise of commitments could lead to additional expense.
- Unused lending commitments were $138.9 million and standby letters of credit $6.1 million. Management said normal-course litigation was not expected to materially affect financial position, results, or liquidity.
- Disclosure controls and procedures were reported ineffective at June 30, 2012 due to a material weakness in security-price verification controls. Management said the weakness concerning FHLB-option impairment had been remediated; sustained effectiveness of security-price controls had not yet been established, and monitoring and testing were continuing.
- Management cited economic and real-estate conditions, credit quality, liquidity, interest-rate movements, mortgage prepayments, regulatory changes (including Dodd-Frank), competition, and the accuracy of estimates as risks. No material risk-factor changes from the 2011 Form 10-K were reported.
Important facts for investors to verify
- Whether earnings and net interest margin stabilize as lower asset yields and securities prepayments persist.
- Loan growth and credit performance, particularly residential real estate, construction, municipal, and SFG automobile loans; track charge-offs, restructurings, and OREO.
- The assumptions, fair value, and further impairment risk of the TRUP portfolio and remaining FHLB advance-option fees.
- Funding dependence on FHLB advances, deposit composition, available liquidity, and the interest-rate sensitivity of the securities portfolio.
- Progress in testing and sustaining the remediated security-price verification controls.
- Dividend sustainability: the company paid $0.20 per share in Q2 and declared a 5% stock dividend; future cash dividends remain subject to earnings, financial condition, and board discretion.