Southstate Bank Corp quarterly report, Q3 FY2015

Business context and reporting period

South State Corporation, a South Carolina bank holding company, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. It provides banking, mortgage, trust and investment services. Amounts below are in U.S. dollars; financial statement figures are generally shown in millions.

Financial performance and condition

• Margins and returns: Taxable-equivalent net interest margin was 4.52% in Q3, down from 4.65% a year earlier and 4.75% in Q2. Reported non-taxable-equivalent margin was 4.47%, versus 4.60% a year earlier. Q3 return on average assets was 1.20%, and return on average equity was 9.61%. The efficiency ratio was 64.4%, compared with 71.0% a year earlier; excluding nonrecurring expenses, it was 61.7% versus 64.5%.
• Balance sheet at September 30: Total assets were $8.50 billion; net loans were $5.84 billion; deposits were $7.08 billion; and shareholders’ equity was $1.05 billion. Total cash and cash equivalents were $889.4 million.
• Funding and debt: Federal funds purchased and repurchase agreements were $260.5 million, and other borrowings were $55.1 million. Other borrowings had declined from $101.1 million at September 30, 2014, following the redemption of $46.3 million of trust preferred debt in January 2015.
• Cash flow: For the first nine months, operating cash flow was $149.9 million, investing cash flow was $167.5 million and financing cash flow was $154.1 million. Cash and cash equivalents increased $471.5 million from year-end 2014; the BOA branch acquisition included $428.6 million in cash.
• Capital and liquidity: At September 30, consolidated CET1, Tier 1 risk-based, total risk-based and leverage ratios were 11.82%, 12.68%, 13.36% and 9.32%, respectively. The Bank’s corresponding ratios were 12.29%, 12.29%, 12.97% and 9.04%. Both were reported well above applicable minimums and within the “well capitalized” classification. The Bank reported $376.0 million in federal funds credit lines and $995.7 million in FHLB credit facilities, with no federal funds advances outstanding.

Material changes versus comparable periods

• Q3 net income increased 30.1% year over year. Higher noninterest income, lower interest expense and lower loan-loss provision contributed; the effective tax rate also rose to 34.73% from 30.16%.
• Noninterest income rose 21.8% in Q3, reflecting lower FDIC indemnification-asset amortization, higher deposit fees, trust income and mortgage banking income. Noninterest expense fell 2.5%, chiefly because prior-year merger costs exceeded current branch acquisition and consolidation costs.
• Non-acquired loans grew to $3.99 billion from $3.30 billion a year earlier, while acquired loans continued to run off. Non-acquired loans represented 68.1% of total loans, versus 58.3% a year earlier.
• Credit indicators improved: total nonperforming assets, including acquired assets, were $60.0 million versus $88.2 million a year earlier; non-acquired annualized net charge-offs were 0.09% versus 0.26%. The allowance was 0.88% of non-acquired loans and covered non-acquired nonperforming loans 1.47 times.
• Deposits increased 8.6% year over year, substantially reflecting the August BOA branch acquisition. The transaction added 12 South Carolina branches and one Georgia branch, approximately $438.3 million of deposits, and $25.0 million of goodwill-related consideration in the form of a deposit premium.

Outlook, commentary, risks and unusual items

• No formal earnings or financial guidance is provided. Management expected the investment portfolio to continue increasing as a share of assets through the rest of 2015.
• Management anticipated lower acquired-loan yields in Q4 2015 and 2016 as certain acquired loans were renewed and their expected cash flows extended. It also expected lower FDIC indemnification-asset amortization in subsequent periods, though not at the same year-over-year pace.
• On October 1–7, 2015, severe storms and flooding affected South Carolina; the Bank had offices in 11 counties later designated federal disaster areas. Management’s initial assessment was that material losses were not expected. The Bank introduced loan programs for affected customers.
• FDIC loss-share arrangements for CBT and Cape Fear had expired; the Habersham commercial agreement was scheduled to expire March 31, 2016. Expiration reduces future FDIC protection on covered losses. The FDIC indemnification asset was $7.9 million, down from $31.0 million a year earlier.
• Commitments to extend credit and standby letters of credit totaled $1.5 billion. Management did not anticipate material losses from these commitments. The filing also describes ordinary-course litigation and acquired-bank litigation exposure; management did not expect material financial statement effects.
• Key risks include credit and interest-rate risk, liquidity and funding costs, acquisition integration, regulatory changes, cybersecurity, and changes in economic conditions. The filing says market-risk disclosures had no material change from the 2014 Form 10-K.
• In October, the company sold two branches and received a stated 3.5% deposit premium on approximately $0.9 million of 30-day average deposits, subject to reduction for unamortized core deposit intangibles. The company also extended its $20 million unsecured credit line through November 15, 2015 and expected a renewal the next day; there were no outstanding borrowings.

Important facts for investors to verify

1. Review whether strong non-acquired loan growth is being maintained without weakening underwriting or credit quality, particularly in real estate lending.
2. Track net interest margin, deposit pricing and the effect of excess cash and acquired-loan runoff on interest income.
3. Assess the sustainability of earnings excluding branch acquisition/consolidation costs and other unusual items, and reconcile reported and non-GAAP measures.
4. Monitor acquired-loan cash-flow estimates, FDIC indemnification-asset amortization and the approaching loss-share expiration dates.
5. Confirm subsequent effects of the South Carolina flooding, branch transactions and the expected renewal of the unsecured credit line.