Southside Bancshares, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are to December 31, 2017. Southside is a Texas-based bank holding company. Results include the Diboll acquisition completed November 30, 2017, so year-over-year comparisons reflect both acquired operations and organic performance.
Financial results and condition
- Earnings: Net income was $16.3 million, up 8.4% from $15.0 million. Diluted EPS was $0.46, down from $0.51; average diluted shares increased to 35.2 million from 29.5 million. Quarterly dividends were $0.28 per share, versus $0.25.
- Interest income and margins: Net interest income rose 25.1% to $44.1 million. Fully taxable-equivalent net interest income was $46.3 million and net interest margin was 3.19%, compared with $39.7 million and 3.08% a year earlier. Interest income grew 27.4% to $57.2 million, while interest expense increased 35.9% to $13.1 million.
- Credit costs and other income: Provision for loan losses was $3.7 million, versus $1.1 million. Noninterest income was $9.6 million, approximately flat year over year; it included an $827,000 net securities-sale loss, compared with a $322,000 gain in Q1 2017.
- Expenses and taxes: Noninterest expense increased 22.5% to $31.7 million, reflecting Diboll-related operating costs, $832,000 of acquisition expense, and higher compensation and intangible amortization. Income tax expense fell to $2.1 million from $3.0 million; the effective tax rate was 11.4% versus 16.7%, primarily reflecting the federal corporate tax-rate reduction.
- Cash flow: Operating activities provided $41.7 million; investing activities provided $151.6 million; financing activities used $129.2 million. Cash and cash equivalents increased $64.1 million to $262.8 million.
- Balance sheet and funding: Total assets were $6.37 billion, down 1.9% from year-end. Loans were $3.31 billion, up 0.5%; deposits were $4.64 billion, up 2.8%. FHLB borrowings declined $245.2 million to $772.2 million. Total shareholders’ equity was $746.4 million, or 11.7% of assets. The filing reports consolidated CET1 of 14.76%, Tier 1 capital of 16.26%, and total capital of 19.45% of risk-weighted assets.
- Liquidity: Cash and cash equivalents were $262.8 million. The Bank reported approximately $1.12 billion of additional FHLB funding capacity, net of required FHLB stock purchases. Short-term investments were 6.4% of assets, down from 6.9% at year-end.
Material changes and unusual items
- Nonperforming assets rose to $42.4 million from $10.5 million at year-end; nonaccrual loans increased to $34.5 million from $2.9 million. Management attributed the increase principally to two commercial real estate relationships comprising three loans, with about $30 million placed on nonaccrual. Nonaccrual loans were 1.04% of total loans, and allowance coverage of nonaccrual loans was 70.11%.
- The allowance for loan losses increased to $24.2 million, or 0.73% of loans, from $20.8 million, or 0.63%, at year-end. Net charge-offs were $296,000 for the quarter.
- The securities portfolio declined $220.9 million, or 9.0%, to $2.23 billion as the Company sold lower-yielding securities and reduced FHLB funding. The sales produced the $827,000 net loss. The Company also reclassified approximately $743.4 million of held-to-maturity securities to available-for-sale under an early adoption transition election; this reclassification is not itself a sale.
- Accumulated other comprehensive loss worsened by $15.7 million during the quarter, largely reflecting securities valuation changes; comprehensive income was $579,000 despite $16.3 million of net income.
- Adoption of revenue-recognition guidance changed presentation of debit-card and brokerage-related costs to net presentation; prior periods were not adjusted and are not directly comparable for those lines. Adoption of financial-instrument guidance also changed equity-investment accounting and produced an $85,000 cumulative retained-earnings adjustment.
Outlook, risks, and contingencies
- No specific earnings or growth guidance was provided. Management described balance-sheet and securities positioning as dynamic, subject to interest rates, funding costs, loan and deposit growth, and market conditions.
- Interest-rate simulations projected next-12-month net interest income changes versus the base case of +1.63% for an immediate 100-basis-point increase and +0.41% for a 200-basis-point increase; decreases of 100 and 200 basis points projected -0.94% and -4.78%, respectively. These are model estimates dependent on assumptions.
- Key risks include credit deterioration, particularly in commercial real estate; Texas and energy-related economic conditions; interest rates, yield-curve changes and mortgage-security prepayments; deposit and wholesale funding costs; liquidity; cybersecurity; regulation; and execution of acquisitions. Energy loans were 1.66% of the portfolio at quarter-end.
- Off-balance-sheet commitments to extend credit and standby letters of credit totaled $821.2 million. Management stated that ordinary-course litigation is not expected to materially affect financial position, results, or liquidity. The Company planned to close a Tyler retail branch on June 29, 2018.
- Management said it met applicable capital requirements and that disclosure controls were effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether the two large commercial real estate relationships become current, are resolved through collateral recovery, or require additional provisions or charge-offs.
- Subsequent-quarter trends in nonaccrual loans, criticized/classified credits, allowance coverage, and loan growth.
- Whether improved net interest income and margin persist as deposit costs rise and the Company adjusts securities and FHLB funding.
- Effects of securities sales, unrealized valuation losses, and the HTM-to-AFS transition on reported equity and future flexibility.
- How much of year-over-year growth and expense reflects Diboll, and whether acquisition integration costs and expected benefits develop as anticipated.
- Potential effects of pending accounting standards, including expected 2019 callable-security premium amortization expense of approximately $3.4 million after tax, as estimated by management.