South State Corporation — Q2 2017 Form 10-Q
Business context and period. South State Corporation is a bank holding company headquartered in Columbia, South Carolina. This unaudited filing covers the three and six months ended June 30, 2017; balance-sheet comparisons are primarily with December 31, 2016 and June 30, 2016. Results include the January 3, 2017 acquisition of Southeastern Bank Financial Corporation (SBFC). Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Key financial results and condition
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $99.0 | $81.4 | $196.4 | $163.0 |
| Noninterest income | $37.6 | $32.1 | $74.0 | $62.2 |
| Provision for loan losses | $2.3 | $2.7 | $6.0 | $5.3 |
| Noninterest expense | $86.5 | $73.9 | $191.3 | $145.9 |
| Net income | $31.8 | $24.5 | $50.1 | $49.0 |
| Diluted earnings per share | $1.08 | $1.01 | $1.71 | $2.02 |
- Q2 net income rose 29.8% year over year; six-month net income rose 2.2%. Six-month diluted EPS declined, reflecting a larger average share count after the SBFC stock acquisition and elevated merger costs.
- Q2 net interest margin was 4.07% on a non-tax-equivalent basis and 4.13% tax-equivalent, compared with 4.22% and 4.27%, respectively, a year earlier. Management attributed margin pressure mainly to lower acquired-loan yields and higher funding costs.
- Q2 efficiency ratio was 62.8%, versus 64.5% a year earlier and 77.5% in Q1 2017. The sequential improvement primarily reflected lower merger-related costs.
- At June 30, total assets were $11.15 billion, loans net of allowance were $8.14 billion, deposits were $9.03 billion, and shareholders’ equity was $1.61 billion. Total assets and deposits increased substantially from year-end, in large part because of SBFC.
- Cash and cash equivalents were $431.9 million. For the six months, operating cash flow was $75.2 million, investing cash outflow was $124.8 million, financing cash inflow was $107.0 million, and cash increased $57.4 million.
- Federal funds purchased and repurchase-agreement liabilities totaled $334.0 million; other borrowings were $98.1 million. Regulatory capital ratios remained well above minimums: consolidated CET1 11.96%, total risk-based capital 13.35%, and leverage 10.12%.
- Non-acquired net charge-offs were 0.05% annualized in Q2. Non-acquired nonperforming assets were $18.1 million, down from $25.2 million a year earlier; the allowance was 0.67% of non-acquired loans and 2.97 times non-acquired nonperforming loans.
Material changes versus comparable periods
- Q2 net interest income increased 21.7% year over year, supported by SBFC and organic loan growth. Total loans, excluding loans held for sale, increased 27.5% from June 2016; non-acquired loans grew 24.4%.
- Q2 noninterest income increased 17.0%, including higher deposit fees and trust income. Comparison with 2016 is affected by the prior-year $4.4 million FDIC indemnification-asset amortization charge; the loss-share agreements had been terminated in June 2016.
- Q2 noninterest expense increased 17.2% year over year. Six-month expense rose 31.1%, including $25.3 million of merger and branch-consolidation costs, chiefly related to SBFC; those costs included severance/change-in-control and vendor-contract resolution payments.
- SBFC added 4,978,338 South State shares as consideration; shares outstanding increased from 24.23 million at December 31, 2016 to 29.26 million at June 30, 2017. Goodwill rose to $595.8 million, including $257.5 million from SBFC.
- Six-month pretax income was $73.1 million, compared with $74.0 million in 2016, despite higher net interest and noninterest income; increased operating and merger expenses offset much of the revenue growth.
Outlook, risks, contingencies and unusual items
- Park Sterling transaction: South State agreed in April 2017 to acquire Park Sterling Corporation in a stock transaction. The filing describes approximately 7.46 million South State shares and an expected fourth-quarter 2017 close, subject to regulatory approvals, shareholder votes, and customary conditions. Park Sterling reported $3.3 billion of assets, $2.5 billion of loans, and $2.5 billion of deposits at June 30, 2017.
- $10 billion threshold: South State exceeded $10 billion in assets upon the SBFC acquisition. Management said debit interchange-fee limits would apply from July 2018 and estimated that, had the limits applied in the first half of 2017, bankcard income would have been about $8 million lower.
- Credit and concentration risks: Management’s allowance estimates depend on credit grades, collateral values, historical losses, and economic conditions. The company disclosed commercial credit concentrations in loans to lessors of residential buildings ($349.4 million), lessors of nonresidential buildings ($859.6 million), religious organizations ($300.1 million), and construction ($299.0 million).
- Funding and rate risks: Management considered liquidity adequate and reported unused federal-funds lines of $516.0 million, $176.2 million available at the Federal Reserve discount window, and a $1.2 billion FHLB facility, subject to existing usage and terms. Rising rates may raise deposit and borrowing costs; the filing also identifies interest-rate, liquidity, merger-integration, regulatory, cybersecurity, and economic risks.
- Off-balance-sheet and legal matters: Commitments to extend credit and standby letters of credit totaled $2.0 billion; management did not anticipate material losses. The company reported ordinary-course legal actions and did not expect any liability to have a material financial-statement effect. No material subsequent event was disclosed.
- Management gave no specific full-year earnings guidance and cautioned that interim results are not necessarily indicative of full-year results. It expects the new revenue-recognition standard to be adopted in Q1 2018 and was still assessing the impact of the expected-credit-loss standard.
Most important facts for investors to verify
- Whether SBFC integration delivers expected cost savings and whether merger expenses, staffing, and customer or deposit retention evolve as management anticipates.
- Park Sterling deal terms, required approvals, closing timing, and resulting dilution; the filing contains an apparent reference to “SBFC” in one description of the Park Sterling exchange ratio, so the definitive agreement should be checked.
- How acquired-loan paydowns and declining accretion affect net interest income and margin, alongside loan growth and deposit-cost trends.
- Whether the allowance remains adequate as loan balances and identified credit concentrations grow, and whether acquired non-credit-impaired problem loans increase.
- The realized impact of debit interchange limits from July 2018 and other costs associated with exceeding the $10 billion asset threshold.
- Cash-flow generation, funding mix, capital ratios, and any changes in the stated liquidity resources or contingent commitments.