South State Corporation — FY 2014 Form 10-K
Business context and reporting period. South State Corporation is a regional bank holding company serving South Carolina, North Carolina and Georgia. This 10-K covers the year ended December 31, 2014; quarterly figures below compare Q4 2014 with Q4 2013. The comparison is affected by the July 2013 First Financial Holdings (FFHI) acquisition: 2014 includes twelve months of FFHI operations versus five months in 2013. The company changed its name from First Financial Holdings, Inc. to South State Corporation on June 30, 2014.
Financial performance and condition
- Annual earnings and revenue: Net interest income was $326.4 million, up 19.4%; noninterest income was $94.7 million, up 76.3%; together, reported revenue was $421.1 million. Net income was $75.4 million and net income available to common shareholders was $74.4 million, up 55.4% from 2013. Diluted EPS rose to $3.08 from $2.38.
- Margins and costs: Taxable-equivalent net interest margin declined to 4.80% from 4.99%, as asset yields fell; higher average earning assets, including acquired balances and organic loan growth, more than offset that pressure on annual net interest income. The efficiency ratio improved to 71.41% from 75.85% (63.0% versus 64.9% excluding merger/conversion and OREO/loan-related costs). Noninterest expense rose 20.9% to $303.0 million, including $23.9 million of merger expense; salaries and benefits increased 29.8% to $158.4 million.
- Q4 results: Net interest income was $81.6 million versus $84.4 million in Q4 2013. Net income available to common shareholders was $21.2 million versus $13.2 million; diluted EPS was $0.88 versus $0.55. Q4 noninterest income was $25.3 million and noninterest expense was $74.7 million.
- Credit costs and asset quality: Annual provision for loan losses was $6.6 million, versus $1.9 million in 2013, primarily reflecting growth in non-acquired loans. Non-acquired net charge-offs declined to 0.16% of average loans from 0.41%. Total nonperforming assets were $79.6 million, or 1.02% of assets, compared with $108.1 million, or 1.36%, a year earlier. The allowance was $41.9 million across non-acquired and acquired credit-impaired loans; the non-acquired allowance was 1.00% of non-acquired loans.
- Balance sheet and funding: Assets were $7.83 billion, down from $7.93 billion. Loans, net of unearned income, were $5.72 billion, nearly unchanged; non-acquired loans grew 21.0% to $3.47 billion while acquired loans declined. Deposits fell 1.4% to $6.46 billion as time deposits decreased, partly offset by core-deposit growth; noninterest-bearing deposits rose 10.3% to $1.64 billion. Shareholders’ equity was $984.9 million. Nondeposit borrowings totaled $322.8 million, including $221.5 million in federal funds and repurchase-agreement funding and $101.2 million in other borrowings.
- Cash flow and liquidity: Operating cash flow was $118.6 million, down from $242.4 million; investing cash flow was $(9.5) million and financing cash flow was $(170.7) million. Cash and cash equivalents declined $61.6 million to $417.9 million. Management described liquidity as adequate and reported $376.0 million in unused federal-funds lines, $164.9 million available at the Federal Reserve discount window, and approximately $940.7 million of unused FHLB capacity after letters of credit and advances.
- Capital and shareholder returns: The company reported a 14.43% total risk-based capital ratio, 13.62% Tier 1 risk-based ratio and 9.47% Tier 1 leverage ratio; the Bank was categorized as well capitalized. Common dividends were $0.82 per share for 2014, with a 26.61% payout ratio. The company redeemed $65 million of preferred stock in March 2014.
Material changes, outlook and risks
- Annual earnings growth benefited materially from the full-year contribution of the 2013 FFHI acquisition, as well as loan growth and higher fee income. It was partly offset by lower net interest margin, higher provision and operating costs. Thus reported growth is not a like-for-like measure of organic performance.
- Management said it expected improving economic and business activity in its markets to continue in 2015 and believed capital supported organic growth and selected strategic opportunities. It gave no formal quantified earnings or revenue guidance. Its rate simulation estimated that a 200-basis-point increase over 12 months would raise net interest income about 0.70% versus the forward-rate base case; falling-rate scenarios were considered not meaningful in the prevailing near-zero-rate environment.
- Key risks include real-estate exposure (81.5% of loans had real estate as a primary or secondary collateral component), commercial real-estate and construction credit risk, regional economic concentration, interest-rate and margin sensitivity, and the judgment involved in loan-loss and acquired-loan accounting. FDIC loss-share coverage is limited and some agreements have expired or were due to expire; true-up obligations and uncovered losses remain relevant.
- Other notable items: merger and branding costs were $23.9 million; the FDIC indemnification asset fell to $22.2 million from $86.4 million, with associated amortization reducing noninterest income. On January 7, 2015, the company redeemed $46.4 million of 7% junior subordinated debt, with management expecting interest savings. A February 2015 OREO auction involved properties with a carrying value of about $4.0 million and an estimated net loss of about $0.6 million. Management reported no pending or threatened litigation expected to materially affect financial position or results. Commitments to extend credit and standby letters of credit/financial guarantees totaled $1.28 billion.
- Basel III capital rules began taking effect in January 2015 and phase in through 2019. Management believed the company and Bank would have met the fully phased-in requirements using year-end 2014 figures. The company also identified cybersecurity, regulatory compliance, acquisition integration and deposit competition as risks.
Important facts for investors to verify
- How much of 2014’s earnings and fee growth reflects the FFHI full-year comparison versus sustainable organic growth, and how recurring are merger-related costs?
- Whether continued non-acquired loan growth, real-estate concentrations and acquired-loan performance warrant changes to provisions or reserves.
- The timing and terms of FDIC loss-share expirations, expected true-up payments, and losses no longer eligible for reimbursement.
- Post-redemption debt, liquidity and capital levels under Basel III, including the effects of deposit mix and interest-rate changes on margin.
- Q4’s lower net interest income versus Q4 2013 and whether subsequent quarterly trends support management’s 2015 commentary.