First Financial Bankshares, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. First Financial is a Texas-based financial holding company operating primarily through its full-service bank; it reported 72 financial centers. Dollar amounts below are in millions unless otherwise noted.
Financial results and condition
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $67.6 | $59.1 | $133.1 | $116.1 |
| Provision for loan losses | $1.1 | $1.7 | $2.4 | $3.7 |
| Noninterest income | $25.5 | $23.2 | $49.9 | $44.5 |
| Noninterest expense | $47.1 | $43.8 | $94.9 | $85.9 |
| Net earnings | $37.6 | $28.3 | $72.2 | $54.9 |
| Basic EPS | $0.56 | $0.43 | $1.07 | $0.83 |
- Q2 net earnings rose about 33%; first-half earnings rose 31.5%. Management attributed the increase to the lower corporate tax rate and the January 2018 Commercial Bancshares acquisition. Excluding the tax-rate benefit, management reported adjusted net earnings of $33.0 million for Q2 and $63.3 million for the first half, with adjusted basic EPS of $0.49 and $0.94, respectively.
- Tax-equivalent net interest income increased to $69.9 million in Q2 and $137.8 million in the first half. Net interest margin was 3.92% in Q2 and 3.90% for the first half, down 13 and 14 basis points year over year.
- At June 30, assets were $7.69 billion, loans held for investment were $3.83 billion, deposits were $6.21 billion, borrowings were $456.9 million and shareholders’ equity was $985.6 million. Compared with June 2017, assets, loans and deposits were higher, with the acquisition contributing materially.
- Cash and cash equivalents were $286.2 million, down from $372.3 million at year-end 2017. First-half operating cash flow was $89.0 million; investing activities used $183.7 million and financing activities provided $8.6 million.
- The allowance for loan losses was $50.0 million, or 1.30% of period-end loans, versus 1.37% a year earlier. The first-half provision was lower than in 2017; net charge-offs were 0.03% of average loans, compared with 0.12%.
- Nonperforming assets were $28.1 million, or 0.73% of loans and foreclosed assets, versus $24.7 million and 0.71% a year earlier. Nonaccrual loans increased to $26.7 million from $21.5 million.
- Q2 and first-half efficiency ratios were 49.42% and 50.57%, compared with 49.32% and 49.49%. Return on average assets was 1.98% for Q2 and 1.91% for the first half; return on average equity was 15.53% and 15.14%.
- Consolidated regulatory capital ratios at June 30 included total risk-based capital of 19.81%, Tier 1 and common equity Tier 1 of 18.68%, and leverage of 11.14%. The bank’s ratios also exceeded its stated well-capitalized thresholds.
Material changes and notable items
- Acquisition: Commercial Bancshares and Commercial State Bank were acquired effective January 1, 2018, expanding the company’s Houston-area presence. The company issued 1,289,371 shares; recorded $31.6 million of goodwill; and included acquired loans of $266.3 million and deposits of $341.9 million at acquisition-date fair value. First-half results include the acquired business.
- Tax law: The federal corporate tax rate fell from 35% to 21%. Effective tax rates were 16.09% in Q2 and 15.72% for the first half, versus 23.13% and 22.70% in 2017. Management’s earnings comparisons therefore include a substantial tax benefit. The company also reclassified $5.8 million of tax effects from accumulated other comprehensive income to retained earnings.
- Securities and equity: Available-for-sale securities totaled $3.20 billion. Their net unrealized holding loss was $10.8 million before tax; accumulated other comprehensive earnings (loss) moved to a loss of $11.4 million at June 30, from positive $26.8 million at year-end. Management attributed unrealized securities losses primarily to interest rates and said it did not consider them other-than-temporary.
- Acquisition costs and expenses: First-half noninterest expense included $1.55 million of technology contract termination and conversion costs related to the acquisition. Salaries and benefits also rose, reflecting pay increases, profit sharing and acquired operations.
- Dividends: The company declared $0.21 per share for Q2, up from $0.19 a year earlier. Its stated long-term policy is to pay approximately 40% of annual net earnings as cash dividends, subject to capital and covenant restrictions.
Outlook, risks and contingencies
- The filing provides no specific earnings or financial guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- Management cited the potential effects of interest-rate changes, economic and employment conditions, Texas real estate and commodity markets, severe weather, credit quality, deposit competition, regulation, cybersecurity and acquisition integration. It said Hurricane Harvey-related facility damage was not significant after insurance, continued monitoring affected loans, and did not identify credit-related losses on evaluated municipal bonds.
- Interest-rate simulations estimated that a 100- or 200-basis-point rate increase would raise projected 12-month net interest income by 0.36% or 0.34%; a 100-basis-point decrease would reduce it by 3.41%. Management characterized the balance sheet as more liability-sensitive in short-term categories and cautioned that model assumptions limit the estimates.
- Liquidity sources include deposits, cash and marketable assets, a $1.14 billion FHLB line (with $60 million outstanding), other borrowing lines, and a $25 million Frost Bank revolving line that was undrawn and matures June 30, 2019. Management considered liquidity adequate and reported compliance with the Frost Bank covenants.
- Off-balance-sheet commercial commitments totaled $939.3 million: $610.7 million in unfunded lines, $298.3 million in commitments to extend credit and $30.3 million in standby letters of credit. Management noted that many commitments may expire unused.
- The company reported no material pending legal proceedings and no material change in previously disclosed risk factors. Management concluded disclosure controls were effective at the reasonable-assurance level.
Important facts for investors to verify
- How much of earnings growth reflects the lower tax rate and acquisition versus underlying organic growth; review management’s tax-adjusted figures and acquisition contribution.
- Whether rising nonaccrual loans and nonperforming assets remain manageable, and whether the allowance remains adequate as the loan portfolio grows.
- The effect of higher deposit and borrowing costs on net interest margin, especially given the year-over-year margin decline and disclosed rate sensitivity.
- Whether unrealized securities losses, including the material shift in accumulated other comprehensive income, change with market rates or create liquidity or capital pressures.
- Acquisition integration progress, including technology conversion costs, acquired credit performance, goodwill and expected contribution from the acquired bank.
- Hurricane Harvey-related loan and municipal-bond exposure, oil-and-gas lending growth, and the company’s assumptions for collateral and local economic conditions.