Stock Yards Bancorp, Inc. quarterly report, Q2 FY2017

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Stock Yards Bancorp, Inc. — Q2 2017 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2017. Unaudited consolidated results include Stock Yards Bank & Trust Company. Unless noted otherwise, financial amounts below are in U.S. dollars.

Business context and financial performance

  • Quarter: Net income was $10.6 million, up 4.9% from $10.1 million a year earlier. Diluted EPS was $0.46 versus $0.45. Net interest income was $25.2 million, up 5.4%; non-interest income was $11.7 million, up 8.3%; and non-interest expense was $21.3 million, up 5.7%.
  • First six months: Net income was $21.4 million, up 7.3% from $19.9 million. Diluted EPS was $0.92 versus $0.88. Net interest income was $50.4 million, up 6.3%; non-interest income was $22.5 million, up 7.7%; and non-interest expense was $42.5 million, up 6.9%.
  • Margins and returns: First-half net interest margin was 3.62%, versus 3.58% in 2016; second-quarter margin was 3.60%, versus 3.59%. First-half return on average assets was 1.44% (1.41% prior year) and return on average equity was 13.45% (13.52%). The first-half efficiency ratio was 58.0%, compared with 57.8%; adjusted for tax-credit partnership amortization, it was 56.3% versus 54.9%.
  • Balance sheet at June 30: Total assets were $3.13 billion, up 2.9% from year-end 2016. Loans were $2.31 billion, nearly unchanged from year-end; management reported loan growth of more than 6% year over year. Deposits were $2.48 billion, down 1.7% from year-end. Stockholders’ equity was $326.5 million, up $12.6 million.
  • Cash flow, six months: Operating activities provided $29.3 million, versus $34.1 million in 2016. Investing activities used $10.1 million, compared with $142.8 million used in 2016, largely reflecting much lower net loan growth. Financing activities provided $57.9 million. Cash and cash equivalents increased $77.2 million to $125.1 million.

Material changes and key financial metrics

  • Loan interest income and average loan balances rose, supporting net interest income. Deposit interest expense also increased as deposit rates rose; management said competition, liquidity effects, and a flatter yield curve pressured margins.
  • Wealth management and trust revenue rose 8.8% in the first half to $10.2 million. Assets under management were $2.64 billion, up 12.8% year over year; management attributed growth mainly to new clients, with some benefit from market appreciation.
  • First-half salaries and benefits increased 8.7%, data processing costs 16.5%, and other non-interest expenses 18.4%. Lower tax-credit partnership amortization and FDIC insurance expense partially offset these increases.
  • The effective tax rate declined to 26.0% from 26.9%. Adoption of ASU 2016-09 caused $1.1 million of excess share-based compensation tax benefits to be recognized in first-half earnings; these benefits were previously recorded in equity.
  • Allowance for loan losses was $25.1 million, or 1.09% of period-end loans, versus $24.0 million and 1.04% at year-end. First-half provision was $1.5 million versus $1.3 million. Net charge-offs were $392,000, compared with $550,000 of net charge-offs in 2016.
  • Non-performing loans were $6.1 million, or 0.26% of loans, and non-performing assets were $9.3 million, or 0.30% of assets, down from $6.7 million and $11.7 million at year-end, respectively. Non-accrual loans were $4.9 million; foreclosed real estate was $3.2 million.
  • Regulatory capital remained strong: the Bank’s common equity Tier 1 ratio was 12.08%, total risk-based capital ratio 13.06%, and leverage ratio 10.48%. Bancorp reported that it met well-capitalized requirements. Tangible common equity to tangible assets was 10.38%, versus 10.26% at year-end.

Liquidity, debt, risks, and outlook

  • Cash and cash equivalents were $125.1 million; federal funds sold and interest-bearing deposits were $80.2 million. Available-for-sale securities had a fair value of $576.3 million, of which $262.1 million was unpledged. The company reported $316.8 million of available FHLB credit and $105 million of correspondent-bank federal funds lines.
  • Short-term borrowings rose to $161.5 million from $47.4 million at year-end. The increase principally reflected a $150 million FHLB cash-management advance used to manage cash around short-term investments; it matured in the first week of July 2017. Separately, FHLB advances were $50.4 million and repurchase agreements were $65.0 million.
  • Management anticipated stronger net loan growth in the second half and an overall mid-single-digit percentage increase in loans for 2017. It cited a solid pipeline but noted repayments on construction and commercial real estate loans and business-owner caution related to policy and regulatory uncertainty. No broader earnings or revenue guidance is provided in the filing text.
  • Interest-rate simulation estimated that an immediate 100- or 200-basis-point increase would reduce one-year net interest income by 0.04% or 0.08%, respectively; a 100-basis-point decrease would reduce it by 3.12%. Management cautioned that the model indicates trends, not actual expected results.
  • Unfunded commitments to extend credit were $670.4 million, including $17.0 million of standby letters of credit; the company had accrued $350,000 for inherent risks in these commitments. Management said pending legal claims were not expected to have a material adverse effect.
  • Management identified a slight elevation in classified loans and additional potential exposure in one pool of classified loans, prompting a higher qualitative allowance allocation. It also extended the historical loss look-back period from 24 to 28 quarters. The allowance estimate depends on management judgments and may change with conditions or regulatory review.
  • The filing states that disclosure controls and procedures were not effective as of June 30, 2017 because of a material weakness previously reported in the 2016 Form 10-K. Remediation was underway, including stronger control design and documentation and increased internal loan-review staffing; effectiveness had not yet been demonstrated for a sufficient period.
  • Other notable matters: securities had $2.7 million of aggregate unrealized losses, which management attributed to interest rates and did not consider other-than-temporary; the company reported no intention or likely need to sell before recovery. First-half dividends were $0.39 per share. There were no purchases under a publicly announced repurchase plan during the quarter.

Important facts for investors to verify

  • Whether second-half loan production supports the stated full-year mid-single-digit loan growth expectation, given the modest increase in loans since year-end.
  • Whether classified-loan trends, the identified loan-pool exposure, charge-offs, and the allowance remain consistent with management’s credit-quality assessment.
  • How deposit pricing, deposit outflows, short-term funding needs, and the post-July maturity of the $150 million FHLB advance affect liquidity and net interest margin.
  • Whether expense growth, especially compensation, technology, and other costs, can be managed while sustaining fee-income growth and efficiency.
  • Progress and evidence of remediation of the material weakness in internal controls, and the eventual effect of the CECL credit-loss standard, which management said would likely significantly affect credit-impairment accounting.