South State Corporation — Q3 2019 Form 10-Q
Business context and period. Regional bank holding company headquartered in Columbia, South Carolina. This unaudited report covers the quarter and nine months ended September 30, 2019; comparisons are primarily with 2018. Management cautions that interim results are not necessarily indicative of full-year results.
Financial performance and condition
- Q3 earnings: Net income was $51.6 million, up 9.5% year over year; diluted EPS was $1.50 versus $1.28. For the first nine months, net income was $137.4 million versus $129.9 million and diluted EPS was $3.92 versus $3.52.
- Revenue and margin: Q3 net interest income was $127.4 million, down 0.7% from $128.3 million, as higher interest expense more than offset higher interest income. Noninterest income rose 17.3% to $37.6 million, led by mortgage banking and deposit-account fees. Non-tax-equivalent net interest margin fell to 3.72% from 4.02%; the efficiency ratio improved to 58.4% from 62.3%.
- Profitability: Q3 return on average assets was 1.31% versus 1.28%; return on average equity was 8.70% versus 7.89%. The company’s non-GAAP return on average tangible equity was 16.62% versus 15.29%.
- Balance sheet and liquidity: Total assets were $15.75 billion at September 30, up from $14.52 billion a year earlier. Loans, net, were $11.23 billion; deposits were $12.02 billion, up 3.5% year over year. Cash and equivalents were $719.2 million. Equity totaled $2.35 billion, or 14.92% of assets.
- Funding and debt: Other borrowings were $815.8 million, versus $115.9 million a year earlier, including $700.1 million of FHLB advances. The company said the advances, hedged to fixed rates, were used to fund balance-sheet growth. It reported $1.3 billion of remaining FHLB facility availability, $606 million in federal funds lines with no balance outstanding, and $394 million available at the Federal Reserve Discount Window.
- Cash flows: For the first nine months, operating cash flow was $129.0 million versus $223.8 million in 2018; investing used $557.0 million versus $222.5 million; financing provided $738.1 million versus using $71.6 million. Cash increased $310.2 million to $719.2 million.
- Credit and capital: Q3 provision for loan losses was $4.0 million versus $3.1 million. The allowance was $60.3 million, including $54.9 million on non-acquired loans; non-acquired allowance coverage was 0.62% of those loans. Non-acquired nonperforming loans were $19.2 million, up from $15.3 million a year earlier. Regulatory capital ratios remained above minimums; consolidated CET1 was 11.22% and the Bank’s was 12.00%.
Material changes versus comparable periods
- Organic non-acquired loan growth was strong: balances rose 17.4% year over year to $8.9 billion. Acquired loans declined, and their share of total loans fell to 20.9% from 30.4%.
- Funding costs rose: Q3 interest expense increased $7.4 million year over year, with the average rate on interest-bearing liabilities up 24 basis points. The company cited deposit competition and higher average borrowings. Falling rates during Q3 also caused earning assets to reprice faster than liabilities, pressuring margin.
- Q3 noninterest expense fell 3.9% year over year to $96.4 million, chiefly because there were no merger/branch-consolidation costs and FDIC charges were lower. Nine-month expense included a $9.5 million pension-plan termination charge; the prior-year period had higher merger-related costs.
- Q3 mortgage banking income increased to $6.1 million from $2.8 million, benefiting from higher secondary-market activity as rates declined. Nine-month noninterest income nevertheless decreased 2.6%, largely reflecting lower deposit-fee income following the Durbin Amendment cap on debit interchange fees.
- Cash dividends declared were $0.43 per share in Q3 2019 versus $0.35 in Q3 2018. The company repurchased 858,800 shares for $64.5 million during Q3.
Outlook, commentary, risks, and unusual items
- Management expected $13.0 million of annual savings from 2019 branch closures and cost initiatives, with an approximately $10.0 million net impact anticipated in 2019; it reported about $3.2 million of Q3 savings and said it remained on track.
- The company estimated a preliminary CECL allowance of $105 million to $120 million at adoption, an increase of roughly $35 million to $50 million from the then-current allowance. The estimate depends on portfolio composition and economic forecasts and may change; CECL was scheduled for adoption in 2020.
- The pension plan was terminated in Q2 2019; distributions were expected to be completed by Q4 2019. Its $9.5 million termination charge included recognition of prior accumulated pension losses and write-off of a plan asset.
- Management said asset quality remained generally strong but noted higher non-acquired nonperforming loans, including three commercial relationships totaling $2.9 million. It cited credit, real-estate, interest-rate, liquidity, deposit-competition, regulatory, cybersecurity, litigation, and acquisition-integration risks.
- Commercial real-estate concentrations included $1.4 billion in loans to lessors of nonresidential buildings and $598.7 million in loans to lessors of residential buildings. Management reported the Bank remained below the cited regulatory concentration guidelines.
- Commitments to extend credit and standby letters of credit totaled $2.9 billion; management did not anticipate material losses. The filing reports ordinary-course litigation but no pending or threatened matter expected to materially affect financial position or results.
- Q3 results included $0.4 million of securities gains. Nine-month securities gains of $2.7 million included $5.4 million from VISA Class B share sales, partly offset by losses on securities sales. No specific earnings or revenue guidance was provided.
Important facts for investors to verify
- Whether deposit pricing and higher funding costs continue to pressure net interest margin, particularly after rate changes.
- Whether organic loan growth is maintained without deterioration in nonperforming loans, charge-offs, or allowance coverage.
- The assumptions and eventual transition impact of CECL relative to the disclosed preliminary $105 million to $120 million allowance estimate.
- Delivery of the projected branch and cost savings, and the effect of ongoing operating costs and pension-plan distributions.
- How repurchases, dividends, FHLB borrowing, and balance-sheet growth affect capital ratios and liquidity; confirm remaining authorization and required regulatory approvals.
- Mortgage banking and servicing results’ sensitivity to rates, prepayments, and MSR valuation assumptions; also distinguish recurring earnings from securities-sale gains.