Table of Contents
G3
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2021
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-12669
SOUTH STATE CORPORATION
(Exact name of registrant as specified in its charter)
South Carolina
57-0799315
(State or other jurisdiction of incorporation)
(I.R.S. Employer Identification No.)
1101 First Street South, Suite 202
Winter Haven, Florida
33880
(Address of principal executive offices)
(Zip Code)
(863) 293-4710
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol
Name of each exchange on which registered:
Common Stock, $2.50 par value
SSB
The Nasdaq Global Select Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data file required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☒
Accelerated Filer ☐
Non-Accelerated Filer ☐
Smaller Reporting Company ☐
Emerging Growth Company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of issuer’s classes of common stock, as of the latest practicable date:
Class
Outstanding as of August 5, 2021
70,047,448
South State Corporation and Subsidiaries
June 30, 2021 Form 10-Q
INDEX
Page
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2021 and December 31, 2020
3
Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2021 and 2020
4
Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2021 and 2020
5
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended June 30, 2021 and 2020
6
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2021 and 2020
7
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2021 and 2020
8
Notes to Condensed Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
50
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
83
Item 4.
Controls and Procedures
PART II — OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
85
Defaults Upon Senior Securities
86
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
2
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
(Dollars in thousands, except par value)
June 30,
December 31,
2021
2020
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash and due from banks
$
529,434
363,306
Federal funds sold and interest-earning deposits with banks
5,460,600
3,582,410
Deposits in other financial institutions (restricted cash)
414,478
663,539
Total cash and cash equivalents
6,404,512
4,609,255
Trading securities, at fair value
89,925
10,674
Investment securities:
Securities held to maturity (fair value of $1,168,392 and $957,183)
1,189,265
955,542
Securities available for sale, at fair value
4,369,159
3,330,672
Other investments
160,607
160,443
Total investment securities
5,719,031
4,446,657
Loans held for sale
171,447
290,467
Loans:
Acquired - non-purchased credit deteriorated loans
7,457,950
9,458,869
Acquired - purchased credit deteriorated loans (formerly acquired credit-impaired loans)
2,434,259
2,915,809
Non-acquired
14,140,869
12,289,456
Less allowance for credit losses
(350,401)
(457,309)
Loans, net
23,682,677
24,206,825
Other real estate owned
5,039
11,914
Bank property held for sale
20,237
36,006
Premises and equipment, net
568,473
579,239
Bank owned life insurance (“BOLI”)
773,452
559,368
Deferred tax assets
36,714
110,946
Derivatives assets
526,145
813,899
Mortgage servicing rights
57,351
43,820
Core deposit and other intangibles
145,126
162,592
Goodwill
1,581,085
1,563,942
Other assets
594,655
344,269
Total assets
40,375,869
37,789,873
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing
11,176,338
9,711,338
Interest-bearing
22,066,031
20,982,544
Total deposits
33,242,369
30,693,882
Federal funds purchased
486,087
384,735
Securities sold under agreements to repurchase
376,342
394,931
Corporate and subordinated debentures
326,548
390,179
Other borrowings
25,000
—
Reserve for unfunded commitments
30,981
43,380
Derivative liabilities
518,221
804,832
Other liabilities
612,698
430,054
Total liabilities
35,618,246
33,141,993
Shareholders’ equity:
Common stock - $2.50 par value; authorized 160,000,000 shares; 70,382,728 and 70,973,477 shares issued and outstanding, respectively
175,957
177,434
Surplus
3,720,946
3,765,406
Retained earnings
836,584
657,451
Accumulated other comprehensive income
24,136
47,589
Total shareholders’ equity
4,757,623
4,647,880
Total liabilities and shareholders’ equity
The Accompanying Notes are an Integral Part of the Financial Statements.
Condensed Consolidated Statements of Net Income (Loss) (unaudited)
(In thousands, except per share data)
Three Months Ended
Six Months Ended
Interest income:
Loans, including fees
246,177
167,707
506,144
300,741
Taxable
17,347
10,920
32,755
22,835
Tax-exempt
2,667
1,505
4,779
2,904
Federal funds sold, securities purchased under agreements to resell and interest-bearing deposits with banks
1,350
432
2,339
1,884
Total interest income
267,541
180,564
546,017
328,364
Interest expense:
Deposits
9,537
12,624
20,795
27,061
Federal funds purchased and securities sold under agreements to repurchase
323
391
673
1,006
4,548
1,971
9,418
3,162
3,021
6,564
Total interest expense
14,411
18,007
30,889
37,793
Net interest income
253,130
162,557
515,128
290,571
(Recovery) provision for credit losses
(58,793)
151,474
(117,213)
188,007
Net interest income after (recovery) provision for credit losses
311,923
11,083
632,341
102,564
Noninterest income:
Fees on deposit accounts
23,936
16,679
49,218
34,820
Mortgage banking income
10,115
18,371
36,995
33,018
Trust and investment services income
9,733
7,138
18,311
14,527
Correspondent banking and capital market income
25,877
10,067
54,625
10,560
Securities gains, net
36
Other
9,323
2,092
16,120
5,554
Total noninterest income
79,020
54,347
175,305
98,479
Noninterest expense:
Salaries and employee benefits
137,379
81,720
277,740
142,698
Occupancy expense
22,844
15,959
46,175
28,246
Information services expense
19,078
12,155
37,867
21,462
OREO expense and loan related
240
1,107
1,242
1,694
Amortization of intangibles
8,968
4,665
18,132
7,672
Supplies, printing and postage expense
2,500
1,610
5,170
3,115
Professional fees
2,301
2,848
5,575
5,342
FDIC assessment and other regulatory charges
4,931
2,403
8,772
4,461
Advertising and marketing
1,659
531
3,399
1,345
Extinguishment of debt cost
11,706
Merger and branch consolidation related expense
32,970
40,279
42,979
44,408
18,807
11,835
33,337
21,917
Total noninterest expense
263,383
175,112
492,094
282,360
Earnings:
Income (loss) before provision for (benefit of) income taxes
127,560
(109,682)
315,552
(81,317)
Provision for (benefit of) income taxes
28,600
(24,747)
69,643
(20,492)
Net income (loss)
98,960
(84,935)
245,909
(60,825)
Earnings (loss) per common share:
Basic
1.40
(1.96)
3.47
(1.58)
Diluted
1.39
3.44
Weighted average common shares outstanding:
70,866
43,318
70,937
38,439
71,409
71,445
Condensed Consolidated Statements of Comprehensive Income (Loss) (unaudited)
(Dollars in thousands)
Other comprehensive income (loss):
Unrealized holding gains (losses) on available for sale securities:
Unrealized holding gains (losses) arising during period
33,055
6,208
(30,735)
46,658
Tax effect
(7,861)
(1,366)
7,309
(10,265)
Reclassification adjustment for gains included in net income
(36)
Net of tax amount
25,167
4,842
(23,453)
36,393
Unrealized losses on derivative financial instruments qualifying as cash flow hedges:
Unrealized holding losses arising during period
(4,359)
(34,315)
959
7,549
Reclassification adjustment for losses included in interest expense
1,964
2,686
(432)
(591)
(1,868)
(24,671)
Other comprehensive income (loss), net of tax
2,974
11,722
Comprehensive income (loss)
124,127
(81,961)
222,456
(49,103)
Condensed Consolidated Statements of Changes in Shareholders’ Equity (unaudited)
Three months ended June 30, 2021 and 2020
(Dollars in thousands, except for share data)
Accumulated
Common Stock
Retained
Comprehensive
Shares
Amount
Earnings
Income
Total
Balance, March 31, 2020
33,444,236
83,611
1,584,322
643,345
9,765
2,321,043
Comprehensive loss:
Net loss
Other comprehensive income, net of tax effects
Total comprehensive loss
Cash dividends declared on common stock at $0.47 per share
(15,733)
Employee stock purchases
6,901
17
368
385
Stock options exercised
5,056
13
143
156
Restricted stock awards (forfeitures)
8,330
21
(21)
Stock issued pursuant to restricted stock units
264,640
661
(661)
Common stock repurchased
(93,113)
(233)
(5,348)
(5,581)
Share-based compensation expense
11,727
Common stock issued for CenterState merger
37,271,069
93,178
2,153,149
2,246,327
Stock options and restricted stock acquired and converted pursuant to CenterState acquisition
15,487
Balance, June 30, 2020
70,907,119
177,268
3,759,166
542,677
12,739
4,491,850
Balance, March 31, 2021
71,060,446
177,651
3,772,248
770,952
(1,031)
4,719,820
Comprehensive income:
Net income
Total comprehensive income
Cash dividends declared at $0.47 per share
(33,305)
Cash dividend equivalents paid on restricted stock units
(23)
7,097
18
466
484
4,843
12
124
136
12,308
31
(31)
Common stock repurchased - buyback plan
(700,000)
(1,750)
(58,411)
(60,161)
(1,966)
(5)
(157)
(162)
6,707
Balance, June 30, 2021
70,382,728
Six months ended June 30, 2021 and 2020
Accumulated Other
Income (Loss)
Balance, December 31, 2019
33,744,385
84,361
1,607,740
679,895
1,017
2,373,013
Cash dividends declared on common stock at $0.94 per share
(31,573)
17,541
44
516
560
8,828
22
(22)
296,075
740
(740)
(320,000)
(800)
(23,915)
(24,715)
(117,680)
(294)
(7,151)
(7,445)
13,734
Cumulative change in accounting principle due to the adoption of ASU 2016-13
(44,820)
Balance, December 31, 2020
70,973,477
Other comprehensive loss, net of tax effects
(66,685)
(91)
42,697
106
1,801
1,907
71,770
180
(180)
(12,313)
(935)
(966)
12,799
Condensed Consolidated Statements of Cash Flows (unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization
31,387
18,252
Deferred income taxes
81,973
(21,442)
Gains on sale of securities, net
Accretion of discount related to acquired loans
(16,708)
(21,039)
(Gains) losses on disposal of premises and equipment
754
(239)
(Gains) losses on sale of bank properties held for sale and repossessed real estate
(1,311)
79
Net amortization of premiums on investment securities
19,668
5,523
Bank properties held for sale and repossessed real estate write downs
645
350
Fair value adjustment for loans held for sale
7,667
(11,621)
Originations and purchases of loans held for sale
(1,637,905)
(796,272)
Proceeds from sales of loans held for sale
1,795,391
737,760
Gains on sales of loans held for sale
(46,134)
(20,202)
Increase in cash surrender value of BOLI
(8,176)
(2,753)
Net change in:
Accrued interest receivable
8,014
(18,700)
Prepaid assets
3,517
(3,577)
Operating leases
1,779
2,858
Bank owned life insurance
(192)
13,567
Trading securities
(47,390)
(493)
Derivative assets
287,754
(65,552)
Miscellaneous other assets
(150,620)
26,318
Accrued interest payable
(2,329)
(1,554)
Accrued income taxes
(123,674)
(5,121)
(286,881)
98,885
Miscellaneous other liabilities
178,239
(6,075)
Net cash provided by operating activities
248,633
69,868
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale
15,405
Proceeds from maturities and calls of investment securities held to maturity
40,325
Proceeds from maturities and calls of investment securities available for sale
418,233
252,809
Proceeds from sales and redemptions of other investment securities
1,533
42,034
Purchases of investment securities available for sale
(1,519,851)
(295,652)
Purchases of investment securities held to maturity
(276,725)
Purchases of other investment securities
(1,698)
(28,744)
Net decrease (increase) in loans
637,095
(1,045,044)
Net cash received (paid in) acquisitions
(39,929)
2,566,376
Recoveries of loans previously charged off
6,944
4,933
Purchase of bank owned life insurance
(206,000)
Purchases of premises and equipment
(17,857)
(9,082)
Proceeds from redemption and payout of bank owned life insurance policies
284
Proceeds from sale of bank properties held for sale and repossessed real estate
26,244
2,862
Proceeds from sale of premises and equipment
3,759
Net cash provided by (used in) investing activities
(912,238)
1,490,501
Cash flows from financing activities:
Net increase in deposits
2,552,489
2,157,236
Net increase in federal funds purchased and securities sold under agreements to repurchase and other short-term borrowings
82,763
20,191
Proceeds from borrowings
500,000
Repayment of borrowings
(75,878)
(500,004)
Common stock issuance
Common stock repurchases
(61,127)
(32,160)
Dividends paid
(66,776)
Net cash provided by financing activities
2,458,862
2,114,635
Net increase in cash and cash equivalents
1,795,257
3,675,004
Cash and cash equivalents at beginning of period
688,704
Cash and cash equivalents at end of period
4,363,708
Supplemental Disclosures:
Cash Flow Information:
Cash paid for:
Interest
33,218
39,347
Income taxes
113,253
2,878
Recognition of operating lease assets in exchange for lease liabilities
1,298
5,121
Schedule of Noncash Investing Transactions:
Acquisitions:
Fair value of tangible assets acquired
34,838
18,910,560
Other intangible assets acquired
130,862
Liabilities assumed
2,343
17,380,016
Net identifiable assets acquired over liabilities assumed
15,816
600,483
Common stock issued in acquisition
Real estate acquired in full or in partial settlement of loans
1,631
4,054
Notes to Condensed Consolidated Financial Statements (unaudited)
Note 1 — Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, otherwise referred to as GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required for complete financial statements. In the opinion of Management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain prior period information has been reclassified to conform to the current period presentation, and these reclassifications had no impact on net income or equity as previously reported. Operating results for the three and six months ended June 30, 2021 and 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.
The condensed consolidated balance sheet at December 31, 2020 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by GAAP for complete financial statements.
Note 2 — Summary of Significant Accounting Policies
The information contained in the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2020, as filed with the Securities and Exchange Commission (the “SEC”) on February 26, 2021, should be referenced when reading these unaudited condensed consolidated financial statements. Unless otherwise mentioned or unless the context requires otherwise, references herein to “South State,” the “Company” “we,” “us,” “our” or similar references mean South State Corporation and its consolidated subsidiaries. References to the “Bank” means South State Corporation’s wholly owned subsidiary, South State Bank, National Association, a national banking association.
Allowance for Credit Losses (“ACL”)
On January 1, 2020, we adopted the requirements of Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, sometimes referred to herein as ASU 2016-13. Topic 326 was subsequently amended by ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments-Credit Losses; ASU No. 2019-05, Codification Improvements to Topic 326, Financial Instruments-Credit Losses; and ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This standard applies to all financial assets measured at amortized cost and off balance sheet credit exposures, including loans, investment securities and unfunded commitments. We applied the standard’s provisions using the modified retrospective method as a cumulative-effect adjustment to retained earnings as of January 1, 2020.
ACL – Investment Securities
Management uses a systematic methodology to determine its ACL for investment securities held to maturity. The ACL is a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the held-to-maturity portfolio. Management considers the effects of past events, current conditions, and reasonable and supportable forecasts on the collectability of the loan portfolio. The Company’s estimate of its ACL involves a high degree of judgment; therefore, Management’s process for determining expected credit losses may result in a range of expected credit losses. Management monitors the held-to-maturity portfolio to determine whether a valuation account would need to be recorded. As of June 30, 2021 and December 31, 2020, the Company had $1.2 billion and $955.5 million, respectively, of held-to-maturity securities and no related valuation account.
Management excludes the accrued interest receivable balance from the amortized cost basis in measuring expected credit losses on the investment securities and does not record an allowance for credit losses on accrued interest receivable. As of June 30, 2021 and December 31, 2020, the accrued interest receivables for all investment securities recorded in Other Assets were $16.0 million and $13.1 million, respectively.
Management no longer evaluates securities for other-than-temporary impairment, otherwise referred to herein as OTTI, as ASC Subtopic 326-30, Financial Instruments—Credit Losses—Available-for-Sale Debt Securities, changes the accounting for recognizing impairment on available-for-sale debt securities. Each quarter Management evaluates impairment where there has been a decline in fair value below the amortized cost basis of a security to determine whether there is a credit loss associated with the decline in fair value. Management considers the nature of the collateral, potential future changes in collateral values, default rates, delinquency rates, third-party guarantees, credit ratings, interest rate changes since purchase, volatility of the security’s fair value and historical loss information for financial assets secured with similar collateral among other factors. Credit losses are calculated individually, rather than collectively, using a discounted cash flow method, whereby Management compares the present value of expected cash flows with the amortized cost basis of the security. The credit loss component would be recognized through the provision for credit losses in the Statements of Income.
ACL - Loans
The ACL reflects Management’s estimate of losses that will result from the inability of our borrowers to make required loan payments. The Company established the incremental increase in the ACL at adoption through equity and subsequent adjustments through a provision for credit losses charged to earnings. The Company records loans charged off against the ACL and subsequent recoveries, if any, increase the ACL when they are recognized.
Management uses systematic methodologies to determine its ACL for loans held for investment and certain off-balance-sheet credit exposures. The ACL is a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the loan portfolio. Management considers the effects of past events, current conditions, and reasonable and supportable forecasts on the collectability of the loan portfolio. The Company’s estimate of its ACL involves a high degree of judgment; therefore, Management’s process for determining expected credit losses may result in a range of expected credit losses. The Company’s ACL recorded in the balance sheet reflects Management’s best estimate within the range of expected credit losses. The Company recognizes in net income the amount needed to adjust the ACL for Management’s current estimate of expected credit losses. The Company’s ACL is calculated using collectively evaluated and individually evaluated loans.
The Company merged with CenterState Bank Corporation (“CSFL” or “CenterState”) on June 7, 2020. For the second quarter ended June 30, 2020, given the proximity of the merger date to the quarter end, Management evaluated loans from each legacy loan portfolio utilizing pre-existing methodologies implemented prior to the merger and aggregated the result. Subsequently, during the third quarter 2020, Management consolidated the two methodologies into one.
The allowance for credit losses is measured on a collective pool basis when similar risk characteristics exist. Loans with similar risk characteristics are grouped into homogenous segments, or pools, for analysis. The Discounted Cash Flow (“DCF”) method is utilized for each loan in a pool, and the results are aggregated at the pool level. A periodic tendency to default and absolute loss given default are applied to a projective model of the loan’s cash flow while considering prepayment and principal curtailment effects. The analysis produces expected cash flows for each instrument in the pool by pairing loan-level term information (e.g., maturity date, payment amount, interest rate, etc.) with top-down pool assumptions (e.g., default rates and prepayment speeds). The Company has identified the following portfolio segments: Owner-Occupied Commercial Real Estate, Non Owner-Occupied Commercial Real Estate, Multifamily, Municipal, Commercial and Industrial, Commercial Construction and Land Development, Residential Construction, Residential Senior Mortgage, Residential Junior Mortgage, Revolving Mortgage, and Consumer and Other.
In determining the proper level of the ACL, Management has determined that the loss experience of the Bank provides the best basis for its assessment of expected credit losses. It therefore utilized its own historical credit loss experience by each loan segment over an economic cycle, while excluding loss experience from certain acquired institutions (i.e., failed banks). For most of the segment models for collectively evaluated loans, the Company incorporated two or more macroeconomic drivers using a statistical regression modeling methodology.
Management considers forward-looking information in estimating expected credit losses. The Company subscribes to a third-party service which provides a quarterly macroeconomic baseline outlook and alternative scenarios for the United States economy. The baseline, along with the evaluation of alternative scenarios, is used by Management to determine the best estimate within the range of expected credit losses. Management has evaluated the appropriateness
10
of the reasonable and supportable forecast scenarios and has made adjustments as needed. For the contractual term that extends beyond the reasonable and supportable forecast period, the Company reverts to the long term mean of historical factors within four quarters using a straight-line approach. The Company generally utilizes a four-quarter forecast and a four-quarter reversion period.
Included in its systematic methodology to determine its ACL, Management considers the need to qualitatively adjust expected credit losses for information not already captured in the loss estimation process. These qualitative adjustments either increase or decrease the quantitative model estimation (i.e., formulaic model results). Each period the Company considers qualitative factors that are relevant within the qualitative framework that includes the following: 1) Lending Policy; 2) Economic conditions not captured in models; 3) Volume and Mix of Loan Portfolio; 4) Past Due Trends; 5) Concentration Risk; 6) External Factors; and 7) Model Limitations.
When a loan no longer shares similar risk characteristics with its segment, the asset is assessed to determine whether it should be included in another pool or should be individually evaluated. During the third quarter of 2020, the Company consolidated the ACL models and due to the size of the combined company elected to increase the threshold for individually-evaluated loans to all non-accrual loans with a net book balance in excess of $1.0 million. Management will monitor the credit environment and make adjustments to this threshold in the future if warranted. Based on the threshold above, consumer financial assets will generally remain in pools unless they meet the dollar threshold. The expected credit losses on individually-evaluated loans will be estimated based on discounted cash flow analysis unless the loan meets the criteria for use of the fair value of collateral, either by virtue of an expected foreclosure or through meeting the definition of collateral-dependent. Financial assets that have been individually evaluated can be returned to a pool for purposes of estimating the expected credit loss insofar as their credit profile improves and that the repayment terms were not considered to be unique to the asset.
Management measures expected credit losses over the contractual term of a loan. When determining the contractual term, the Company considers expected prepayments but is precluded from considering expected extensions, renewals, or modifications, unless the Company reasonably expects it will execute a troubled debt restructuring (“TDR”) with a borrower. In the event of a reasonably-expected TDR, the Company factors the reasonably-expected TDR into the current expected credit losses estimate. For consumer loans, the point at which a TDR is reasonably expected is when the Company approves the borrower’s application for a modification (i.e., the borrower qualifies for the TDR) or when the Credit Administration department approves loan concessions on substandard loans. For commercial loans, the point at which a TDR is reasonably expected is when the Company approves the loan for modification or when the Credit Administration department approves loan concessions on substandard loans. The Company uses a discounted cash flow methodology for a TDR to calculate the effect of the concession provided to the borrower within the ACL.
A restructuring that results in only a delay in payments that is insignificant is not considered an economic concession. In accordance with the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, the Company implemented loan modification programs in response to the COVID-19 pandemic in order to provide borrowers with flexibility with respect to repayment terms. The Company’s payment relief assistance includes forbearance, deferrals, extension and re-aging programs, along with certain other modification strategies. The Company elected the accounting policy in the CARES Act to not apply TDR accounting to loans modified for borrowers impacted by the COVID-19 pandemic if the concession meets the criteria as defined under the CARES Act.
For purchased credit-deteriorated, otherwise referred to herein as PCD, assets are defined as acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by the Company’s assessment. The Company records acquired PCD loans by adding the expected credit losses (i.e., allowance for credit losses) to the purchase price of the financial assets rather than recording through the provision for credit losses in the income statement. The expected credit loss, as of the acquisition day, of a PCD loan is added to the allowance for credit losses. The non-credit discount or premium is the difference between the unpaid principal balance and the amortized cost basis as of the acquisition date. Subsequent to the acquisition date, the change in the ACL on PCD loans is recognized through the provision for credit losses. The non-credit discount or premium is accreted or amortized, respectively, into interest income over the remaining life of the PCD loan on a level-yield basis. In accordance with the transition requirements within the standard, the Company’s acquired credit-impaired loans (i.e., ACI or Purchased Credit Impaired) were treated as PCD loans.
11
The Company follows its nonaccrual policy by reversing contractual interest income in the income statement when the Company places a loan on nonaccrual status. Therefore, Management excludes the accrued interest receivable balance from the amortized cost basis in measuring expected credit losses on the portfolio and does not record an allowance for credit losses on accrued interest receivable. As of June 30, 2021 and December 31, 2020, the accrued interest receivables for loans recorded in Other Assets were $82.8 million and $93.9 million, respectively.
The Company has a variety of assets that have a component that qualifies as an off-balance sheet exposure. These primarily include undrawn portions of revolving lines of credit and standby letters of credit. The expected losses associated with these exposures within the unfunded portion of the expected credit loss will be recorded as a liability on the balance sheet with an offsetting income statement expense. Management has determined that a majority of the Company’s off-balance-sheet credit exposures are not unconditionally cancellable. As part of the new combined ACL methodology implemented during the third quarter 2020, Management completes funding studies based on historical data to estimate the percentage of unfunded loan commitments that will ultimately be funded to calculate the reserve for unfunded commitments. Management applies this funding rate, along with the loss factor rate determined for each pooled loan segment, to unfunded loan commitments, excluding unconditionally cancellable exposures and letters of credit, to arrive at the reserve for unfunded loan commitments. Prior to the implementation of the new combined ACL methodology, the Company applied a utilization rate instead of a funding rate to the South State legacy portfolio to determine the reserve for unfunded commitments. As of June 30, 2021 and December 31, 2020, the liabilities recorded for expected credit losses on unfunded commitments were $31.0 million and $43.4 million, respectively. The current adjustment to the ACL for unfunded commitments is recognized through the provision for credit losses in the Statements of Income.
Note 3 — Recent Accounting and Regulatory Pronouncements
Accounting Standards Adopted in 2020
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This standard was subsequently updated with ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, ASU No. 2019-05, Targeted Transition Relief (Topic 326 – Financial Instruments-Credit Losses), and ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss (“CECL”) model to estimate its lifetime “expected credit loss” and record an ACL that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in earlier recognition of credit losses for loans, investment securities portfolio, and purchased financial assets with credit deterioration. See Note 2 – Summary of Significant Account Policies – Allowance for Credit Losses for further discussion. We adopted the new standard as of January 1, 2020. This standard did not have a material impact on our investment securities portfolio at implementation. Related to the implementation of ASU 2016-13, we recorded additional ACL for loans of $54.4 million, deferred tax assets of $12.6 million, an additional reserve for unfunded commitments of $6.4 million and an adjustment to retained earnings of $44.8 million. See table the below for impact of ASU 2016-13 on the Company’s consolidated balance sheet. See Note 2 - Summary of Significant Accounting Policies for further discussion.
January 1, 2020
As Reported Under
Pre-ASC 326
Impact of ASC 326
Dollars in thousands
ASC 326
Adoption
Assets:
Allowance for Credit Losses on Debt Securities
Investment Securities - Available for Sale
1,956,047
A
Investment Securities - Held to Maturity
Loans
Non - Acquired Loans
9,252,831
Acquired Loans
2,118,940
2,117,209
1,723
B
Allowance for Credit Losses on Loans
(111,365)
(56,927)
(54,438)
C
Deferred Tax Asset
43,955
31,316
12,639
D
Accrued Interest Receivable - Loans
30,009
28,332
1,677
Liabilities:
Reserve for Loan Losses - Unfunded Commitments
6,756
335
6,421
E
Equity:
Retained Earnings
635,075
F
A – The Company did not have any held-to maturity securities as of January 1, 2020. Per our analysis we determined that no ACL was necessary for investment securities – available for sale.
B – Accrued interest receivable from acquired credit impaired loans of $1,677 was reclassified to other assets and was offset by the reclassification of the grossed up credit discount on acquired credit impaired loans of $3,408 that was moved to the ACL for the purchased credit deteriorated loans.
C – This is the calculated adjustment to the ACL related to the adoption of ASC 326. Additional reserve related to non-acquired loans was $34,049, to acquired loans was $16,981 and to purchased credit deteriorated loans was $3,408.
D – This is the effect of deferred tax assets related to the adjustment to the ACL from the adoption of ASC 326 using a 22% tax rate.
E – This is the adjustment to the reserve for unfunded commitments related to the adoption of ASC 326.
F – This is the net adjustment to retained earnings related to the adoption of ASC 326.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes. The amendments in this update simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying the amending existing guidance. Some of the simplification items included are 1) simplification for intraperiod tax allocations where entities will determine the tax effect of pre-tax income or loss from continuing operations without consideration of the tax effect of other items that are not included in continuing operations, 2) simplification for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year allowing an entity to record a benefit for year-to-date loss in excess of its forecasted loss, and 3) simplify the accounting for income taxes by requiring that an entity recognize a franchise tax (or similar tax) that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax. This guidance is effective for interim and annual reporting periods beginning after December 15, 2020. Early adoption is permitted. The amendments related to franchise taxes that are partially based on income should be applied on either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. All other amendments should be applied on a prospective basis. This update did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-14, Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans (Subtopic 715-20. ASU 2018-14 amends ASC 715-20 to add, remove, and clarify disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. For public business entities, ASU 2018-14 is effective for fiscal years ending after December 15, 2020 and requires entities to apply the amendment on a retrospective basis. Early adoption is permitted. This update did not have a material impact on our consolidated financial statements.
Issued But Not Yet Adopted Accounting Standards
In March 2020, FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848 – Facilitation of the Effects of Reference Rate Reform on Financial Reporting and subsequently expanded the scope of ASU No. 2020-04 with the issuance of ASU No. 2021-01. This update provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. The amendments in this Update provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this update were effective for all entities as of March 12, 2020 through December 31, 2022. An entity may elect to apply the amendments in this update to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020 and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. An entity may elect to apply the amendments for contract modifications as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected, the amendments in this update must be applied prospectively for all eligible contract modifications and hedging relationships. The Company has established a LIBOR Committee and various subcommittees which are continuing to evaluate the impact of adopting ASU 2020-04 on the consolidated financial statements including evaluating all of its contracts, hedging relationships and other transactions that will be effected by reference rates that are being discontinued.
Note 4 — Mergers and Acquisitions
CenterState Bank Corporation (“CSFL”)
On June 7, 2020, the Company acquired all of the outstanding common stock of CSFL, of Winter Haven, Florida, the bank holding company for CenterState Bank, N.A. (“CSB”), in a stock transaction. Pursuant to the Merger Agreement, (i) CSFL merged with and into the Company, with the Company continuing as the surviving corporation (the “Merger”), and (ii) immediately following the Merger, South State Bank (“SSB”), a South Carolina banking corporation and wholly owned bank subsidiary of the Company, merged with and into CSB, a national banking association and wholly owned bank subsidiary of CSFL, with CSB continuing as the surviving bank (the “Bank Merger”). In connection with the Bank Merger, CSB changed its name to “South State Bank, National Association” (hereinafter referred to as the “Bank”). CSFL common shareholders received 0.3001 shares of the Company’s common stock in exchange for each share of CSFL stock resulting in the Company issuing 37,271,069 shares of its common stock. In total, the purchase price for CSFL was $2.26 billion including the value of the conversion of CSFL’s outstanding warrants, stock options and restricted stock units totaling $10.3 million. During the fourth quarter 2020, the purchase price (consideration transferred) decreased by $5.2 million due to an update to the value for stock options assumed and converted in the merger from $15.5 million to $10.3 million. The stock options assumed reflect their intrinsic value based upon a Black Scholes valuation.
In the acquisition, the Company acquired $13.0 billion of loans, including PPP loans, at fair value, net of $239.5 million, or 1.82%, estimated discount, including a fair value adjustment of $29.8 million recorded during the third quarter 2020, to the outstanding principal balance, representing 113.9% of the Company’s total loans at December 31, 2019. Of the total loans acquired, Management identified $3.1 billion that had more than insignificantly deteriorated since origination and were thus determined to be PCD loans.
In its assumption of the deposit liabilities, the Company believed the deposits assumed from the acquisition have an intangible value. The Company applied ASC Topic 805, which prescribes the accounting for goodwill and other intangible assets such as core deposit intangibles, in a business combination. The Company determined the estimated fair value of the core deposit intangible asset totaled $125.9 million, which will be amortized utilizing a sum-of-the-years’-digit method over an estimated economic life not to exceed ten years. In determining the valuation amount, deposits were analyzed based on factors such as type of deposit, deposit retention, interest rates and age of deposit relationships. During the third quarter 2020, the Company identified an additional intangible related to its correspondent banking business acquired in the CSFL merger of approximately $10.0 million. As a result of the various measurement period adjustments identified during 2020 and 2021, goodwill was reduced by $38.1 million to $562.4 million.
During the three and six months ended June 30, 2021 and 2020, the Company incurred approximately $33.0 million and $43.0 million, respectively, and $40.2 million and $44.3 million, respectively, of acquisition costs related to this transaction. These acquisition costs are reported in merger and branch consolidation related expenses on the Company’s Consolidated Statements of Income.
14
The CSFL transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the acquisition date. Fair values are preliminary and subject to refinement for up to a year after the closing date of the acquisition.
Initial
Subsequent
As Recorded
Fair Value
As Recorded by
by CSFL
Adjustments
the Company
Assets
Cash and cash equivalents
2,566,450
Investment securities
1,188,403
5,507
(a)
1,193,910
453,578
Loans, net of allowance and mark
12,969,091
(48,342)
(b)
29,834
12,950,583
Premises and equipment
308,150
2,392
(c)
2,893
313,435
Intangible assets
1,294,211
(1,163,349)
(d)
10,000
140,862
OREO and repossessed assets
10,849
(791)
(e)
(49)
10,009
333,053
Deferred tax asset
54,123
(8,681)
(f)
(7,820)
37,622
967,059
(604)
(g)
(1,069)
965,386
20,144,967
(1,213,868)
33,789
18,964,888
Liabilities
5,291,443
10,312,370
19,702
(h)
10,332,072
15,603,813
15,623,515
401,546
278,900
(7,401)
(i)
271,499
977,725
(4,592)
(j)
857
973,990
17,261,984
7,709
17,270,550
Net identifiable assets acquired over (under) liabilities assumed
2,882,983
(1,221,577)
32,932
1,694,338
(38,113)
562,370
Net assets acquired over liabilities assumed
(621,094)
(5,181)
2,256,708
Consideration:
South State Corporation common shares issued
Purchase price per share of the Company's common stock
60.27
Company common stock issued ($2,246,327) and cash exchanged for fractional shares ($74)
2,246,401
Stock option conversion
2,900
Restricted stock conversion
7,407
Fair value of total consideration transferred
(k)
Explanation of fair value adjustments
(a)— Represents the reversal of CSFL's existing fair value adjustments of $40.7 million and the adjustment to record securities at fair value (premium) totaling $46.2 million (includes reclassification of all securities held as HTM to AFS totaling $175.7 million).
(b)— Represents approximately 2.04%, or $269.1 million, total mark of the loan portfolio including a 1.97%, or $259.7 million credit mark, based on a third party valuation. Also, includes the reversal of CSFL's ending allowance for credit losses of $158.2 million and fair value adjustments of $62.6 million. Fair value was subsequently adjusted by $29.8 million due to a reduction in the loan mark (discount).
(c)— Represents the MTM adjustment of $4.0 million on leased assets partially offset by the write-off of deminimus fixed assets of $1.6 million. Subsequently, the fair value on certain bank premises was adjusted by $2.9 million based on updated appraisals received.
(d)— Represents approximately a 1.28% core deposit intangible, or $125.9 million from a third party valuation. This amount is net of $84.9 million existing core deposit intangible and $1.2 billion of existing goodwill from CSFL’s prior transactions that was reversed. Approximately $10.0 million in a customer list intangible related to the correspondent banking business was subsequently identified and recorded in the third quarter of 2020.
(e)— Represents the reversal of prior valuation reserves of $878,000 and recorded new valuation reserves of $1.7 million on both OREO and other repossessed assets. The fair value was subsequently adjusted based on gains and losses recognized from sales of OREO and other repossessed assets.
(f)— Represents deferred tax assets related to fair value adjustments measured using an estimated tax rate of 22.0%. This includes an adjustment from the CSFL tax rate to our tax rate. The difference in tax rates relates to state income taxes. Additional deferred tax liability related to subsequent fair value adjustments identified and an updated estimated tax rate of 23.78% was approximately $7.8 million.
(g)— Represents a valuation reserve of bank property held for sale of $4.4 million, a fair value adjustment of a lease receivable of $116,000 and a fair value adjustment of interest receivable of $501,000. These amounts are offset by positive fair value adjustment for investment in low income housing of $3.3 million.
15
(h)— Represents estimated premium for fixed maturity time deposits of $20.2 million partially offset by the reversal of existing CSFL fair value adjustments related to time deposit marks from other merger transactions of $546,000.
(i)— Represents the recording of a discount of $12.5 million on TRUPs from a third party valuation partially offset by the reversal of the existing CSFL discount on TRUPs and other debt of $5.1 million.
(j)— Represents the reversal of an existing $7.1 million unfunded commitment reserve at purchase date partially offset by a fair value adjustment to increase lease liabilities associated with leased facilities totaling $2.5 million. The discount rate applied to the bank owned life insurance split dollar liability was subsequently adjusted resulting in an increase in the other liability of $857,000.
(k)— The purchase price, or the fair value of total consideration transferred, decreased by $5.2 million to $2.9 million for stock options assumed and converted in the merger. The stock options assumed reflect their intrinsic value based upon a Black Sholes valuation.
Comparative and Pro Forma Financial Information for the CSFL Acquisition
Pro-forma data for the three and six month periods ending June 30, 2020 listed in the table below presents pro-forma information as if the CSFL acquisition occurred at the beginning of 2020. These results combine the historical results of CSFL in the Company’s Consolidated Statement of Net Income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2020.
Merger-related costs of $40.2 million and $44.3 million, respectively, from the CSFL acquisition were incurred during the three and six months periods ending June 30, 2020 and were excluded from pro forma information below. No adjustments have been made to reduce the impact of any OREO write downs, investment securities sold or repayment of borrowings recognized by CSFL in 2020. The Company recorded expenses related to systems conversions and other costs of integration during the year 2020 and 2021 for the CSFL merger. The core system conversion for the CSFL merger was completed during second quarter of 2021. The expenses related to other costs of integration are expected to continue during the latter half of 2021. The Company expects to achieve further operating cost savings and other business synergies as a result of the acquisitions which are not reflected in the pro forma amounts below. The total revenues presented below represent pro-forma net interest income plus pro-forma noninterest income:
Pro Forma
June 30, 2020
Total revenues (net interest income plus noninterest income)
415,540
789,681
266,922
541,141
Net adjusted income available to the common shareholder
25,626
115,616
EPS - basic
0.36
1.63
EPS - diluted
1.62
The disclosures regarding the results of operations for CSFL subsequent to the acquisition date are omitted as this information is not practical to obtain. The majority of the fixed costs and purchase accounting entries were booked on the Company’s core system making it impractical to determine CSFL’s results of operation on a stand-alone basis.
Duncan-Williams, Inc. (“Duncan-Williams”)
On February 1, 2021, the Company completed its previously announced acquisition of Duncan-Williams, a 52-year-old family- and employee-owned registered broker-dealer, headquartered in Memphis, Tennessee, serving primarily institutional clients across the U.S. in the fixed income business. Duncan-Williams firm became an operating subsidiary of South State Bank immediately following the transaction.
In total, the purchase price for Duncan-Williams was $48.3 million, including an additional premium of $8.0 million that is payable after three years from the date of acquisition. The acquisition was accounted for under the acquisition method of accounting in accordance with ASC Topic 805. The Company recognized goodwill on this acquisition of $15.8 million. The goodwill is calculated based on the fair values of the assets acquired and liabilities assumed as of the acquisition date.
16
Note 5 — Investment Securities
The following is the amortized cost and fair value of investment securities held-to-maturity:
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
June 30, 2021:
U.S. Government agencies
49,988
(937)
49,051
Residential mortgage-backed securities issued by U.S. government
agencies or sponsored enterprises
728,027
(13,263)
714,764
Residential collateralized mortgage-obligations issued by U.S. government
97,164
(2,457)
94,707
Commercial mortgage-backed securities issued by U.S. government
249,933
56
(3,950)
246,039
Small Business Administration loan-backed securities
64,153
(322)
63,831
(20,929)
1,168,392
December 31, 2020:
1
25,001
632,269
1,827
(1,032)
633,064
75,767
405
76,172
174,506
300
174,715
48,000
231
48,231
2,764
(1,123)
957,183
The following is the amortized cost and fair value of investment securities available for sale:
49,300
(1,163)
48,137
1,669,659
9,990
(13,522)
1,666,127
657,315
13,218
(3,756)
666,777
805,707
11,476
(4,570)
812,613
State and municipal obligations
677,226
17,289
(1,387)
693,128
464,553
5,492
(1,560)
468,485
Corporate securities
13,535
357
13,892
4,337,295
57,822
(25,958)
29,882
(642)
29,256
1,351,506
16,657
1,367,132
739,797
16,579
(825)
755,551
229,219
10,939
(50)
240,108
502,575
17,491
(27)
520,039
401,496
4,978
(1,590)
404,884
13,562
140
13,702
3,268,037
66,800
(4,165)
During the three and six months ended June 30, 2021, the Company recognized gains of $69,000 and losses of $33,000 (a net gain of $36,000 from the sale of available for sale securities). During the three and six months ended June 30, 2020, there were no realized gains or losses from the sale of securities.
The following is the amortized cost and carrying value of other investment securities:
Carrying
Federal Home Loan Bank stock
16,283
Federal Reserve Bank stock
129,716
Investment in unconsolidated subsidiaries
3,563
Other nonmarketable investment securities
11,045
15,083
129,871
4,941
10,548
Our other investment securities consist of non-marketable equity securities that have no readily determinable market value. Accordingly, when evaluating these securities for impairment, Management considers the ultimate
recoverability of the par value rather than recognizing temporary declines in value. As of June 30, 2021, we determined that there was no impairment on other investment securities.
The amortized cost and fair value of debt securities at June 30, 2021, by contractual maturity are detailed below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Securities
Held to Maturity
Available for Sale
Due in one year or less
10,578
10,642
Due after one year through five years
90,138
92,882
Due after five years through ten years
103,514
101,198
680,007
691,269
Due after ten years
1,085,751
1,067,194
3,556,572
3,574,366
Information pertaining to our securities with gross unrealized losses at June 30, 2021 and December 31, 2020, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position is as follows:
Less Than
Twelve Months
or More
Securities Held to Maturity
937
13,263
2,457
3,950
168,822
322
20,929
1,091,175
Securities Available for Sale
1,163
13,457
743,915
65
3,887
3,756
137,487
4,570
289,674
1,383
74,127
3,938
794
67,342
766
108,103
25,123
1,360,682
835
115,928
1,032
213,146
91
27,445
1,123
240,591
642
24,358
1,031
260,411
825
140,333
46
13,594
871
27
8,620
573
94,981
104,254
3,144
542,297
1,021
105,125
Management evaluates securities for impairment where there has been a decline in fair value below the amortized cost basis of a security to determine whether there is a credit loss associated with the decline in fair value on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Credit losses are calculated individually, rather than collectively, using a discounted cash flow method, whereby Management compares the present value of expected cash flows with the amortized cost basis of the security. The credit loss component would be recognized through the provision for credit losses. Consideration is given to (1) the financial condition and near-term prospects of the issuer including looking at default and delinquency rates, (2) the outlook for receiving the contractual cash flows of the investments, (3) the length of time and the extent to which the fair value has been less than cost, (4) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that we will be required to sell the debt security prior to recovering its fair value, (5) the anticipated outlook for changes in the general level of interest rates, (6) credit ratings, (7) third party guarantees, and (8) collateral values. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition, and the issuer’s anticipated ability to pay the contractual cash flows of the investments. The Company performed an analysis that determined that the following securities have a zero expected credit loss: U.S. Treasury Securities, Agency-Backed
19
Securities including securities issued by GNMA, FNMA, FHLB, FFCB and SBA. All of the U.S. Treasury and Agency-Backed Securities have the full faith and credit backing of the United States Government or one of its agencies. Municipal securities and all other securities that do not have a zero expected credit loss are evaluated quarterly to determine whether there is a credit loss associated with a decline in fair value. All debt securities in an unrealized loss position as of June 30, 2021 continue to perform as scheduled and we do not believe there is a credit loss or a provision for credit losses is necessary.
Also, as part of our evaluation of our intent and ability to hold investments for a period of time sufficient to allow for any anticipated recovery in the market, we consider our investment strategy, cash flow needs, liquidity position, capital adequacy and interest rate risk position. We do not currently intend to sell the securities within the portfolio and it is not more-likely-than-not that we will be required to sell the debt securities. See Note 2 – Summary of Significant Account Policies for further discussion.
Management continues to monitor all of our securities with a high degree of scrutiny. There can be no assurance we will not conclude in future periods that conditions existing at that time indicate some or all of its securities may be sold or would require a charge to earnings as a provision for credit losses in such periods.
Note 6 — Loans
The following is a summary of total loans:
Construction and land development (1)
1,947,646
1,890,846
Commercial non-owner occupied (3)
6,285,808
6,152,246
Commercial owner occupied real estate
4,895,189
4,832,697
Consumer owner occupied (2, 3)
3,549,330
3,682,667
Home equity loans
1,199,362
1,292,141
Commercial and industrial
4,440,261
5,046,310
Other income producing property (3)
808,302
854,900
Consumer
897,083
894,334
Other loans
10,097
17,993
Total loans
24,033,078
24,664,134
In accordance with the adoption of ASU 2016-13, the above table reflects the loan portfolio at the amortized cost basis for the periods June 30, 2021 and December 31, 2020, to include net deferred fee of $16.7 million and $35.6 million, respectively, and unamortized discount total related to loans acquired of $81.0 million and $97.7 million, respectively. Accrued interest receivables (AIR) of $82.8 million and $93.9 million are accounted for separately and reported in other assets for the periods June 30, 2021 and December 31, 2020.
20
The Company purchased loans through its acquisition of CSFL in the second quarter of 2020, for which there was, at acquisition, evidence of more than insignificant deterioration of credit quality since origination. The carrying amount of those loans, at acquisition, is as follows:
June 7, 2020
Book value of acquired loans at acquisition
3,091,264
Allowance for credit losses at acquisition
(149,404)
Non-credit discount at acquisition
(14,283)
Carrying value or book value of acquired loans at acquisition
2,927,577
As part of the ongoing monitoring of the credit quality of our loan portfolio, Management tracks certain credit quality indicators, including trends related to (i) the level of classified loans, (ii) net charge-offs, (iii) non-performing loans (see details below), and (iv) the general economic conditions of the markets that we serve.
We utilize a risk grading matrix to assign a risk grade to each commercial loan. Classified loans are assessed at a minimum every six months. A description of the general characteristics of the risk grades is as follows:
Construction and land development loans in the following table are on commercial and speculative real estate. Consumer owner occupied loans are collateralized by 1-4 family owner occupied property with a business intent. As noted previously, as a result of the conversion of legacy CenterState’s core system to the Company’s core system completed during the second quarter of 2021, several loans were reclassified to conform with the Company’s current loan segmentation, most notably residential investment loans which were reclassed from Consumer Owner Occupied to Other Income Producing Property, and some multi-family loans that were reclassified from Other Income Producing Property to Commercial Non-Owner Occupied. Prior period disclosures presented in the following tables for the commercial and consumer loan segments were revised to conform with the current loan segmentation.
The following table presents the credit risk profile by risk grade of commercial loans by origination year:
Term Loans
Amortized Cost Basis by Origination Year
As of June 30, 2021
2019
2018
2017
Prior
Revolving
Construction and land development
Risk rating:
Pass
$239,413
$448,306
$372,639
$74,918
$28,630
$67,812
$75,705
$1,307,423
Special mention
22,367
2,753
583
1,638
3,743
492
31,576
Substandard
376
1,622
2,377
427
590
3,440
369
9,201
Doubtful
Total Construction and land development
$239,789
$472,295
$377,769
$75,928
$30,858
$75,002
$76,566
$1,348,207
Commercial non-owner occupied
$669,540
$829,779
$1,022,515
$766,938
$581,521
$1,683,052
$99,263
$5,652,608
10,307
40,607
61,898
105,146
45,641
150,085
413,711
611
292
86,084
16,052
31,392
85,012
219,443
Total Commercial non-owner occupied
$680,458
$870,678
$1,170,497
$888,136
$658,554
$1,918,195
$99,290
$6,285,808
Commercial Owner Occupied
$384,233
$801,899
$962,111
$654,487
$527,857
$1,283,611
$80,560
$4,694,758
3,212
6,062
4,412
12,070
14,619
70,757
81
111,213
2,761
3,737
9,801
2,924
18,095
51,840
34
89,192
25
26
Total commercial owner occupied
$390,206
$811,699
$976,324
$669,481
$560,571
$1,406,233
$80,675
$4,895,189
$1,218,098
$1,211,954
$448,298
$322,304
$213,355
$262,198
$711,366
$4,387,573
2,179
2,399
975
1,428
6,205
5,776
6,052
25,014
510
2,802
4,580
5,476
8,532
27,632
42
Total commercial and industrial
$1,220,787
$1,217,155
$450,029
$328,314
$224,541
$273,484
$725,951
$4,440,261
Other income producing property
$45,814
$87,126
$82,371
$91,073
$67,379
$139,784
$59,066
$572,613
914
2,312
1,243
1,131
444
15,070
211
21,325
470
700
506
365
12,840
47
15,488
Total other income producing property
$47,198
$90,138
$84,174
$92,710
$68,188
$167,700
$59,324
$609,432
Consumer owner occupied
$897
$6,726
$2,861
$187
$70
$2,144
$14,905
$27,790
1,248
115
2,472
100
4,028
102
241
316
659
145
146
Total Consumer owner occupied
$2,145
$6,943
$5,574
$274
$2,612
$15,005
$32,623
$10,097
$—
Total other loans
Total Commercial Loans
$2,568,092
$3,385,790
$2,890,795
$1,909,907
$1,418,812
$3,438,601
$1,040,865
$16,652,862
17,860
73,862
73,753
120,444
68,547
245,438
6,963
606,867
4,728
9,255
99,817
24,489
55,420
158,924
8,982
361,615
263
273
$2,590,680
$3,468,908
$3,064,367
$2,054,843
$1,542,782
$3,843,226
$1,056,811
$17,621,617
As of December 31, 2020
2016
$457,425
$410,075
$127,187
$79,345
$41,018
$52,889
$15,502
$1,183,441
20,912
5,668
707
1,757
1,815
7,293
38,152
389
2,800
763
2,087
201
3,669
9,909
$478,726
$418,543
$128,657
$83,189
$43,034
$63,859
$1,231,510
$838,646
$1,108,164
$878,172
$677,803
$723,745
$1,253,710
$58,021
$5,538,261
42,492
76,890
111,466
44,790
38,983
131,015
445,636
1,351
49,662
7,497
27,224
39,424
43,187
168,345
$882,489
$1,234,716
$997,135
$749,817
$802,152
$1,427,916
$6,152,246
$804,895
$957,412
$719,111
$601,471
$455,065
$1,041,668
$42,239
$4,621,861
6,993
15,984
13,021
14,457
13,597
48,775
112,848
5,729
4,185
4,690
20,122
15,093
48,127
97,982
$817,618
$977,581
$736,822
$636,050
$483,755
$1,138,575
$42,296
$4,832,697
$2,723,320
$595,310
$450,238
$308,442
$223,532
$419,555
$247,169
$4,967,566
1,566
3,273
3,031
7,165
2,496
25,727
9,368
52,626
347
1,070
6,202
7,718
2,808
5,723
2,240
26,108
$2,725,233
$599,655
$459,472
$323,328
$228,839
$451,006
$258,777
$5,046,310
$94,660
$106,282
$106,366
$82,796
$49,528
$135,696
$37,616
$612,944
3,531
2,645
1,901
789
1,417
13,492
24,067
1,071
1,046
997
264
472
16,705
20,620
$99,262
$109,973
$109,264
$83,849
$51,417
$165,899
$37,973
$657,637
$7,590
$3,527
$356
$339
$1,076
$1,290
$29,680
130
3,581
249
62
338
4,484
113
387
142
326
973
$7,833
$7,495
$747
$401
$1,081
$1,740
$15,840
$35,137
$17,993
$4,944,529
$3,180,770
$2,281,430
$1,750,196
$1,493,964
$2,904,808
$416,049
$16,971,746
75,624
108,041
130,375
69,020
58,308
226,426
10,019
677,813
9,000
59,150
20,291
57,415
58,003
117,737
2,341
323,937
24
$5,029,154
$3,347,963
$2,432,097
$1,876,634
$1,610,278
$3,248,995
$428,409
$17,973,530
23
For the consumer segment, delinquency of a loan is determined by past due status. Consumer loans are automatically placed on nonaccrual status once the loan is 90 days past due. Construction and land development loans are on 1-4 properties and lots.
The following tables present the credit risk profile by past due status of consumer loans by origination year:
Days past due:
Current
$531,163
$761,217
$530,378
$349,872
$311,006
$1,006,612
$17
$3,490,265
30 days past due
122
127
566
600
294
16,066
17,775
60 days past due
148
412
2,155
2,728
90 days past due
308
517
580
4,525
5,939
$531,285
$761,652
$531,609
$350,893
$311,893
$1,029,358
$3,516,707
$4,561
$6,844
$6,468
$4,769
$982
$31,176
$1,137,449
$1,192,249
121
1,213
1,225
2,572
118
28
51
393
40
74
160
54
3,475
138
3,941
Total Home equity loans
$4,682
$6,894
$6,542
$5,060
$1,064
$35,915
$1,139,205
$1,199,362
$181,548
$211,685
$159,386
$88,607
$48,164
$174,340
$28,502
$892,232
237
112
152
435
730
37
1,718
70
182
89
569
924
73
129
342
1,586
2,209
Total consumer
$181,563
$212,065
$159,809
$89,190
$48,684
$177,225
$28,547
$897,083
$159,606
$336,762
$55,042
$16,507
$11,006
$19,995
$162
$599,080
82
94
39
150
$55,081
$16,589
$11,017
$20,222
$599,439
$13,953
$12,942
$17,881
$17,501
$19,164
$98,303
$17,932
$197,676
293
446
340
786
$19,725
$98,936
$198,870
Total Consumer Loans
$890,831
$1,329,450
$769,155
$477,256
$390,322
$1,330,426
$1,184,062
$6,371,502
258
364
678
765
729
18,417
1,262
22,473
80
330
701
168
2,787
395
421
759
511
1,164
10,026
144
13,025
$891,089
$1,330,315
$770,922
$479,233
$392,383
$1,361,656
$1,185,863
$6,411,461
Total Loans
$3,481,769
$4,799,223
$3,835,289
$2,534,076
$1,935,165
$5,204,882
$2,242,674
$24,033,078
$759,525
$615,142
$471,224
$446,996
$351,859
$960,330
$3,605,076
7,744
2,776
2,070
3,203
9,294
30,020
1,222
486
103
2,710
4,871
176
994
875
5,254
7,563
$764,458
$623,412
$475,486
$450,546
$356,040
$977,588
$3,647,530
$7,654
$6,694
$7,670
$658
$398
$30,039
$1,284,623
134
52
272
2,324
2,861
116
418
534
155
93
157
1,886
1,502
4,123
$7,943
$6,839
$894
$728
$32,313
$1,235,754
$1,292,141
$291,305
$201,330
$115,203
$62,485
$38,272
$147,101
$32,874
$888,570
105
473
454
224
29
1,043
2,351
68
61
195
185
1,663
2,588
$291,551
$202,141
$116,022
$62,955
$38,438
$150,183
$33,044
$894,334
$370,457
$163,728
$63,521
$18,530
$4,497
$25,399
$646,132
6,172
3,660
161
2,255
184
12,432
282
438
720
$376,911
$167,388
$64,120
$6,752
$25,635
$659,336
$13,407
$18,886
$18,991
$22,516
$15,335
$93,093
$13,209
$195,437
278
761
1,079
135
451
296
$19,031
$22,929
$94,466
$197,263
$1,442,348
$1,005,780
$676,609
$551,185
$410,361
$1,255,962
$1,277,593
$6,619,838
11,344
11,929
3,431
2,651
5,487
11,554
2,347
48,743
493
1,753
682
3,518
465
7,401
228
464
536
1,336
1,305
9,151
1,602
14,622
$1,454,270
$1,018,666
$682,329
$555,854
$417,293
$1,280,185
$1,282,007
$6,690,604
$6,483,424
$4,366,629
$3,114,426
$2,432,488
$2,027,571
$4,529,180
$1,710,416
$24,664,134
The following table presents an aging analysis of past due accruing loans, segregated by class. As noted previously, prior period loan balances presented below reflect the loan reclassifications resulting from the system’s conversion completed during the second quarter of 2021.
30 - 59 Days
60 - 89 Days
90+ Days
Non-
Past Due
Accruing
June 30, 2021
2,160
370
2,530
1,943,053
2,063
5,420
667
6,087
6,267,844
11,877
Commercial owner occupied
3,067
92
3,922
4,868,751
22,516
3,090
1,037
4,127
3,521,683
23,520
1,493
452
1,945
1,187,843
9,574
17,510
3,793
467
21,770
4,412,452
6,039
1,598
1,601
801,583
5,118
1,482
820
2,302
890,370
4,411
10,091
35,822
7,909
559
44,290
23,903,670
85,118
December 31, 2020
520
1,142
1,662
1,886,763
2,421
188
372
471
6,145,745
5,470
840
3,740
4,802,898
26,059
1,165
3,294
4,493
3,649,697
28,477
1,805
481
2,286
1,279,929
9,926
10,979
22,089
10,864
43,932
4,993,160
9,218
897
1,513
845,844
7,543
818
2,540
885,720
6,074
17,974
20,185
29,380
11,651
61,216
24,507,730
95,188
The following table is a summary of information pertaining to nonaccrual loans by class, including restructured loans. Prior period loan balances presented below reflect the loan reclassifications resulting from the system’s conversion completed during the second quarter of 2021.
Greater than
Non-accrual
90 Days Accruing(1)
with no allowance(1)
11,687
206
309
Total loans on nonaccrual status
12,358
There is no interest income recognized during the period on nonaccrual loans. The Company follows its nonaccrual policy by reversing contractual interest income in the income statement when the Company places a loan on nonaccrual status. Loans on nonaccrual status in which there is no allowance assigned are individually evaluated loans that do not carry a specific reserve. See Note 2 – Summary of Significant Accounting Policies for further detailed on individually evaluated loans.
The following is a summary of collateral dependent loans, by type of collateral, and the extent to which they are collateralized during the period:
Collateral
Coverage
%
Office
1,076
1,485
138%
100%
Retail
4,849
5,490
113%
4,566
5,760
126%
1,010
1,075
106%
4,824
114%
Total collateral dependent loans
6,935
8,050
10,142
12,002
The Bank designates individually evaluated loans (excluding TDRs) on non-accrual with a net book balance exceeding the designated threshold as collateral dependent loans. Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. These loans do not share common risk characteristics and are not included within the
collectively evaluated loans for determining ACL. Under ASC 326-20-35-6, the Bank has adopted the collateral maintenance practical expedient to measure the ACL based on the fair value of collateral. The ACL is calculated on an individual loan basis based on the shortfall between the fair value of the loan's collateral, which is adjusted for selling costs, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required. During the second quarter of 2020, the Bank increased the threshold limit for loans individually evaluated from $500,000 to $1.0 million. The significant changes above in collateral percentage are due to appraisal value updates or changes in the number of loans within the asset class and collateral type. Overall collateral dependent loans increased $3.2 million during the six months ended June 30, 2021.
In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. Any loans that are modified are reviewed by the Bank to determine if a TDR, sometimes referred to herein as a restructured loan, has occurred. The Bank designates loan modifications as TDRs when it grants a concession to a borrower that it would not otherwise consider due to the borrower experiencing financial difficulty (FASB ASC Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. See Note 2 – Summary of Significant Accounting Policies for how such modifications are factored into the determination of the ACL.
Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the note is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).
The Company elected the accounting policy in the CARES Act to not apply TDR accounting to loans modified for borrowers impacted by the COVID-19 pandemic if the concession meets the criteria stipulated in the CARES Act. Details in regards to the Company’s implemented loan modification programs in response to the COVID-19 pandemic under the CARES Act is disclosed under the Note 2 – Summary of Significant Accounting Policies.
The following table presents loans designated as TDRs segregated by class and type of concession that were restructured during the three and six month periods ending June 30, 2021 and 2020.
Three Months Ended June 30,
Pre-Modification
Post-Modification
Number
of loans
Interest rate modification
1,215
Total interest rate modifications
Term modification
475
Total term modifications
1,690
Six Months Ended June 30,
652
298
2,338
527
276
854
3,192
At June 30, 2021 and 2020, the balance of accruing TDRs was $15.1 million and $11.9 million, respectively. The Company had $720,000 and $1.0 million remaining availability under commitments to lend additional funds on restructured loans at June 30, 2021 and 2020. The amount of specific reserve associated with restructured loans was $1.9 million and $925,000 at June 30, 2021 and 2020, respectively.
The following table presents the changes in status of loans restructured within the previous 12 months as of June 30, 2021 by type of concession. The subsequent default noted below increased reserves on the individually evaluated loan $300,000.
Paying Under
Restructured Terms
Converted to Nonaccrual
Foreclosures and Defaults
of Loans
$ 6,086
$300
782
$ 6,868
Note 7 — Allowance for Credit Losses (ACL)
See Note 2 - Summary of Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance for credit losses.
The following table presents a disaggregated analysis of activity in the allowance for credit losses as follows:
Residential
CRE Owner
Non Owner
Mortgage Sr.
Mortgage Jr.
HELOC
Construction
C&D
Multifamily
Municipal
Occupied
Occupied CRE
C & I
Three Months Ended June 30, 2021
Allowance for credit losses:
Balance at end of period March 31, 2021
63,042
1,190
16,003
3,892
55,337
27,883
5,884
1,544
90,660
107,559
33,466
406,460
Charge-offs
(69)
(517)
(77)
(1,486)
(2,021)
(341)
(1,151)
(5,662)
Recoveries
343
229
131
411
1,084
3,548
Net (charge offs) recoveries
274
(955)
(1,890)
(67)
(2,114)
(Recovery) provision (1)
(7,496)
(415)
(1,702)
596
(10,001)
(1,231)
(4)
(481)
(13,278)
(17,225)
(2,708)
(53,945)
Balance at end of period June 30, 2021
55,820
14,550
4,488
45,488
25,697
5,883
1,063
75,492
90,404
30,691
350,401
Quantitative allowance
Collectively evaluated
50,424
12,350
4,438
45,472
21,195
72,212
85,044
25,195
323,558
Individually evaluated
88
1,140
333
1,885
Total quantitative allowance
50,512
13,490
72,545
25,503
325,443
Qualitative allowance
5,308
1,060
4,502
543
2,947
5,360
5,188
24,958
Three Months Ended June 30, 2020
Allowance for loan losses:
Balance at beginning of period March 31, 2020
18,214
239
12,092
2,135
16,777
8,999
4,557
1,889
23,792
41,302
14,789
144,785
Impact of merger on provision for non-PCD loans
16,712
226
4,227
4,893
7,673
3,836
1,212
919
25,393
35,067
9,284
109,442
Initial PCD Allowance
29,906
804
5,119
1,302
6,035
6,120
902
1,003
35,332
45,785
18,638
150,946
Adjusted CECL balance
64,832
1,269
21,438
30,485
18,955
6,671
3,811
84,517
122,154
42,711
405,173
(79)
(24)
(1,122)
(308)
(708)
(2,431)
315
55
428
32
377
2,330
236
500
(694)
(331)
(101)
Provision (recovery) (1)
2,418
(219)
5,040
996
2,927
1,909
1,118
5,657
8,711
715
29,536
Balance at end of period June 30, 2020
67,486
1,081
26,622
9,295
33,912
20,170
7,792
4,075
90,206
130,874
43,095
434,608
59,101
1,143
23,579
8,922
30,750
15,828
4,556
2,641
78,715
101,998
28,954
356,187
210
299
76
5,319
3,890
1,110
10,904
59,311
23,878
30,826
84,034
105,888
30,064
367,091
8,175
(62)
2,744
373
3,086
4,342
3,236
1,434
24,986
13,031
67,517
Six Months Ended June 30, 2021
Balance at end of period December 31, 2020
63,561
1,238
16,698
4,914
67,197
26,562
7,887
1,510
97,104
124,421
46,217
457,309
(189)
(686)
(87)
(3,635)
(2,048)
(535)
(1,856)
(9,036)
771
1,183
430
1,041
732
2,235
6,943
Net recoveries (charge offs)
582
497
(2,594)
(1,584)
197
379
(2,093)
Provision (benefit) (1)
(8,323)
(496)
(2,645)
(427)
(22,052)
1,729
(2,007)
(447)
(20,028)
(34,214)
(15,905)
(104,815)
Six Months Ended June 30, 2020
Balance at beginning of period January 1, 2020
6,128
4,327
815
6,211
4,350
1,557
956
10,879
15,219
6,470
56,927
Impact of Adoption
5,455
3,849
779
5,588
3,490
1,391
9,505
13,898
6,150
51,030
406
289
351
669
97
898
656
3,408
Adjusted CECL balance, January 1, 2020
11,989
8,465
1,594
12,150
8,509
3,045
1,870
21,282
29,773
12,659
111,365
(383)
(681)
(174)
(2,908)
(623)
(807)
(5,654)
591
623
849
896
575
4,239
Net charge offs
208
(58)
675
(2,012)
(195)
53
(232)
(1,415)
8,671
(100)
8,869
1,537
7,379
3,717
2,578
283
8,394
20,196
2,746
64,270
Note 8 — Other Real Estate Owned and Bank Premises Held for Sale
The following is a summary of information pertaining to OREO and Bank Premises Held for Sale:
47,920
Measurement period adjustment pertaining to CSFL acquisition
(1,226)
Additions
4,160
Writedowns
(645)
Sold
(24,933)
25,276
Other Real Estate Owned at June 30, 2021
Bank Premises Held for Sale at June 30, 2021
11,964
Acquired in the CSFL acquisition
28,379
6,505
(350)
(2,941)
43,557
Other Real Estate Owned at June 30, 2020
18,016
Bank Premises Held for Sale at June 30, 2020
25,541
At June 30, 2021, there were a total of 24 properties included in OREO compared to 42 properties at December 31, 2020. At June 30, 2021, there were a total of 22 properties included in bank premises held for sale which compares to 33 properties included in premises held for sale, at December 31, 2020. During the second quarter of 2020, a reclassification was made so that bank property held for sale is now separately disclosed on the balance sheet. At June 30, 2021, we had $433,000 in residential real estate included in OREO and $4.4 million in residential real estate consumer mortgage loans in the process of foreclosure.
Note 9 — Leases
As of June 30, 2021 and December 31, 2020, we had operating right-of-use (“ROU”) assets of $109.4 million and $113.4 million, respectively, and operating lease liabilities of $114.7 million and $118.3 million, respectively. We maintain operating leases on land and buildings for our operating centers, branch facilities and ATM locations. Most leases include one or more options to renew, with renewal terms extending up to 23 years. The exercise of renewal options is based on the sole judgment of Management and what they consider to be reasonably certain given the environment today. Factors in determining whether an option is reasonably certain of exercise include, but are not limited to, the value of leasehold improvements, the value of renewal rate compared to market rates, and the presence of factors that would cause a significant economic penalty to us if the option is not exercised. Leases with an initial term of 12 months or less are not recorded on the balance sheet and instead are recognized in lease expense on a straight-line basis over the lease term.
30
The Company also holds a small number of finance leases assumed in connection to the CSFL merger. These leases are all real estate leases. Terms and conditions are similar to those real estate operating leases described above. Lease classifications from the acquired institutions were retained.
Lease Cost Components:
Amortization of ROU assets - finance leases
117
233
Interest on lease liabilities - finance leases
Operating lease cost (cost resulting from lease payments)
3,058
8,685
5,316
Short-term lease cost
75
99
Variable lease cost (cost excluded from lease payments)
643
203
1,291
Total lease cost
5,191
3,412
10,449
5,934
Supplemental Cash Flow and Other Information Related to Leases:
Finance lease - operating cash flows
Finance lease - financing cash flows
213
Operating lease - operating cash flows (fixed payments)
4,173
2,784
8,313
4,456
Operating lease - operating cash flows (net change asset/liability)
(3,255)
(2,409)
(6,475)
(2,678)
New ROU assets - operating leases
39,278
39,736
New ROU assets - finance leases
5,374
Weighted - average remaining lease term (years) - finance leases
6.91
10.63
Weighted - average remaining lease term (years) - operating leases
11.14
11.81
Weighted - average discount rate - finance leases
1.7%
1.9%
Weighted - average discount rate - operating leases
3.3%
Operating lease payments due:
2021 (excluding the six months ended June 30, 2021)
8,045
2022
14,992
2023
14,290
2024
12,552
2025
11,016
Thereafter
79,220
Total undiscounted cash flows
140,115
Discount on cash flows
(25,366)
Total operating lease liabilities
114,749
As of June 30, 2021, we determined that the number and dollar amount of our equipment leases was immaterial. As of June 30, 2021, we have additional operating leases that have not yet commenced of $5.1 million. These operating leases will commence in the third quarter of 2021 with a lease term of 10 years.
Note 10 — Deposits
Our total deposits are comprised of the following:
Non-interest bearing checking
Interest-bearing checking
7,651,433
6,955,575
Savings
3,051,229
2,694,011
Money market
8,024,117
7,584,353
Time deposits
3,339,252
3,748,605
At June 30, 2021 and December 31, 2020, we had $720.3 million and $814.2 million in certificates of deposits of $250,000 and greater, respectively. At June 30, 2021 and December 31, 2020, the Company held $475.0 million and $600.0 in traditional, out-of-market brokered deposits, respectively.
Note 11 — Retirement Plans
The Company sponsors an employees’ savings plan under the provisions of the Internal Revenue Code Section 401(k). Electing employees are eligible to participate in the employees’ savings plan after attaining age 21. Plan participants elect to contribute portions of their annual base compensation as a before tax contribution. Employer contributions may be made from current or accumulated net profits. Participants may elect to contribute 1% to 50% of annual base compensation as a before tax contribution. Employees participating in the plan received a 100% match of their 401(k) plan contribution from the Company, up to 4% of their salary. The employees were also eligible for an additional 2% discretionary matching contribution contingent upon certain of our annual financial goals which would be paid in the first quarter of the following year. Based on our financial performance in 2020, we did not pay a discretionary matching contribution in the first quarter of 2021. Currently, we expect the same terms in the employees’ savings plan for 2021. As a result of the recent CSFL merger, all former CSFL employees became eligible to participate in the Company’s 401(k) plan as of legal close in June 2020. CSFL’s existing 401(k) plan balances merged into the Company’s 401(k) plan at the end of the year 2020. We expensed $3.8 million and $8.1 million, respectively, for the three and six months ended June 30, 2021 and $2.4 million and $4.2, respectively, for the three and six months ended June 30, 2020 related to the Company’s savings plan.
Employees can enter the savings plan on or after the first day of each month. The employee may enter into a salary deferral agreement at any time to select an alternative deferral amount or to elect not to defer in the plan. If the employee does not elect an investment allocation, the plan administrator will select a retirement-based portfolio according to the employee’s number of years until normal retirement age. The plan’s investment valuations are generally provided on a daily basis.
Note 12 — Earnings Per Share
Basic earnings per shares are calculated by dividing net income (loss) by the weighted-average shares of common stock outstanding during each period, excluding non-vested restricted shares. Our diluted earnings per share are based on the weighted-average shares of common stock outstanding during each period plus the maximum dilutive effect of common stock issuable upon exercise of stock options or vesting of restricted shares. Stock options and unvested restricted stock units are considered to common stock equivalents and are only included in the calculation of diluted earnings per common share when their effect is dilutive. The weighted-average number of shares and equivalents are determined after giving retroactive effect to stock dividends and stock splits.
The following table sets forth the computation of basic and diluted earnings per common share:
(Dollars and shares in thousands, except for per share amounts)
Basic earnings (loss) per common share:
Weighted-average basic common shares
Basic earnings (loss) per common share
Diluted earnings (loss) per common share:
Effect of dilutive securities
508
Weighted-average dilutive shares
Diluted earnings (loss) per common share
The calculation of diluted earnings per common share excludes outstanding stock options for which the results would have been anti-dilutive under the treasury stock method as follows:
Number of shares
62,235
296,178
Range of exercise prices
87.30
to
91.35
16.66
Note 13 — Share-Based Compensation
Our 2004, 2012, 2019 and 2020 share-based compensation plans are long-term retention plans intended to attract, retain, and provide incentives for key employees and non-employee directors in the form of incentive and non-qualified stock options, restricted stock, and restricted stock units (“RSUs”). Our 2020 plan was adopted by our shareholders at our annual meeting on October 29, 2020. The Company assumed the obligations of CSFL under various equity incentive plans pursuant to the merger of CSFL on June 7, 2020.
Stock Options
With the exception of non-qualified stock options granted to directors under the 2004 and 2012 plans, which in some cases may be exercised at any time prior to expiration and in some other cases may be exercised at intervals less than a year following the grant date, incentive stock options granted under our 2004, 2012, 2019 and 2020 plans may not be exercised in whole or in part within a year following the date of the grant, as these incentive stock options become exercisable in 25% increments pro ratably over the four-year period following the grant date. The options are granted at an exercise price at least equal to the fair value of the common stock at the date of grant and expire ten years from the date of grant. No options were granted under the 2004 plan after January 26, 2012, and the 2004 plan is closed other than for any options still unexercised and outstanding. No options were granted under the 2012 plan after February 1, 2019, and the 2012 plan is closed other than for any options still unexercised and outstanding. No options were granted under the 2019 plan after October 29, 2020, and the 2019 plan is closed other than for any options still unexercised and outstanding. The 2020 plan is the only plan from which new share-based compensation grants may be issued. It is the Company’s policy to grant options out of the 2,072,245 shares registered under the 2020 plan.
33
Activity in our stock option plans for 2004, 2012, 2019 and 2020 as well as stock options and warrants assumed from the CSFL merger is summarized in the following table. All information has been retroactively adjusted for stock dividends and stock splits.
Weighted
Average
Aggregate
Remaining
Intrinsic
Price
(Yrs.)
(000's)
Outstanding at January 1, 2021
256,425
59.01
Exercised
(42,697)
44.68
Outstanding at June 30, 2021
213,728
61.88
4.36
4,832
Exercisable at June 30, 2021
The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options’ vesting periods. There have been no stock options issued during the first six months of 2021. Because all outstanding stock options had vested as of December 31, 2020, there was no unrecognized compensation cost related to nonvested stock option grants under the plans or fair value of shares vested for the six months ended June 30, 2021.
Restricted Stock
We, from time-to-time, grant shares of restricted stock to key employees and non-employee directors. These awards help align the interests of these employees and directors with the interests of our shareholders by providing economic value directly related to increases in the value of our stock. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. We recognize expenses, equal to the total value of such awards, ratably over the vesting period of the stock grants. Restricted stock grants to employees typically “cliff vest” after four years. Grants to non-employee directors typically vest within a 12-month period.
All restricted stock agreements are conditioned upon continued employment, or service in the case of directors. Termination of employment prior to a vesting date, as described below, would terminate any interest in non-vested shares. Prior to vesting of the shares, as long as employed by the Company, the key employees and non-employee directors will have the right to vote such shares and to receive dividends paid with respect to such shares. All restricted shares will fully vest in the event of change in control of the Company or upon the death of the recipient.
Nonvested restricted stock for 2021 is summarized in the following table. All information has been retroactively adjusted for stock dividends and stock splits.
Weighted-
Grant-Date
Nonvested at January 1, 2021
11,004
59.42
Vested
(4,168)
52.95
Nonvested at June 30, 2021
6,836
63.37
As of June 30, 2021, there was $269,000 of total unrecognized compensation cost related to nonvested restricted stock granted under the plans. This cost is expected to be recognized over a weighted-average period of 1.98 years as of June 30, 2021. The total fair value of shares vested during the six months ended June 30, 2021 was $221,000.
Restricted Stock Units (“RSUs”)
We, from time-to-time, grant performance RSUs and time-vested RSUs to employees. These awards help align the interests of these employees with the interests of our shareholders by providing economic value directly related to our performance. Some performance RSU grants contain a three-year performance period while others contain a one to two-year performance period and a time-vested requirement (generally two to four years from the grant date). We communicate threshold, target, and maximum performance RSU awards and performance targets to the applicable employees at the beginning of a performance period. Due to the merger with CSFL, all legacy and assumed performance based restricted stock units converted to a time-vesting requirement. With respect to some long-term incentive awards, dividend equivalents are accrued at the same rate as cash dividends paid for each share of the
Company’s common stock during the performance or time-vested period, and subsequently paid when the shares are issued on the vesting date. The value of the RSUs awarded is established as the fair market value of the stock at the time of the grant. We recognize expenses on a straight-line basis typically over the performance and vesting/or time-vesting periods based upon the probable performance target, as applicable, that will be met.
Outstanding RSUs for the six months ended June 30, 2021 is summarized in the following table.
Restricted Stock Units
750,821
60.88
Granted
297,138
81.20
(71,826)
60.39
Forfeited
(5,362)
62.15
970,771
67.22
As of June 30, 2021, there was $39.0 million of total unrecognized compensation cost related to nonvested RSUs granted under the plan. This cost is expected to be recognized over a weighted-average period of 2.3 years as of June 30, 2021. The total fair value of RSUs vested and released during the six months ended June 30, 2021 was $4.3 million.
Note 14 — Commitments and Contingent Liabilities
In the normal course of business, we make various commitments and incur certain contingent liabilities, which are not reflected in the accompanying financial statements. The commitments and contingent liabilities include guarantees, commitments to extend credit, and standby letters of credit. At June 30, 2021, commitments to extend credit and standby letters of credit totaled $6.7 billion. As of June 30, 2021, the liability recorded for expected credit losses on unfunded commitments, excluding unconditionally cancellable exposures and letters of credit, was $31.0 million and recorded on the Balance Sheet. See Note 2 – Summary of Significant Accounting Policies for discussion of liability recorded for expected credit losses on unfunded commitments.
We have been named as defendant in various legal actions, arising from its normal business activities, in which damages in various amounts are claimed. We are also exposed to litigation risk related to the prior business activities of banks acquired through whole bank acquisitions. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of Management, as of June 30, 2021, any such liability is not expected to have a material effect on our consolidated financial statements.
Note 15 — Fair Value
FASB ASC Topic 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under GAAP, and enhances disclosures about fair value measurements. FASB ASC Topic 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale and trading securities, derivative contracts, mortgage loans held for sale, and mortgage servicing rights (“MSRs”) are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, OREO, and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
FASB ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
Level 1
Observable inputs such as quoted prices in active markets;
Level 2
Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
35
Level 3
Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
The following is a description of valuation methodologies used for assets recorded at fair value.
Trading Securities
The fair values of trading securities are determined as follows: (1) for those securities that have traded prior to the date of the consolidated balance sheet but have not settled (date of sale) until after such date, the sales price is used as the fair value; and, (2) for those securities which have not traded as of the date of the consolidated balance sheet, the fair value was determined by broker price indications of similar or same securities.
Investment Securities
Securities available for sale are valued on a recurring basis at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange and The NASDAQ Stock Market. Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds and corporate debt securities, or U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Securities held to maturity are valued at quoted market prices or dealer quotes similar to securities available for sale. The carrying value of FHLB and FRB stock approximates fair value based on the redemption provisions.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at fair value with changes in fair value recognized in current period earnings. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans held for sale are recurring Level 2.
We do not record loans at fair value on a recurring basis. However, from time to time, a loan may be individually evaluated for impairment if it no longer shares similar risk characteristics with other pooled loans and an ACL may be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, Management measures impairment using estimated fair value methodologies. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2021, approximately one third of the impaired loans were evaluated based on the fair value of the collateral because such loans were considered collateral dependent. Impaired loans, where an allowance is established based on the fair value of collateral; require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we consider the impaired loan as nonrecurring Level 2. When an appraised value is not available or Management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we consider the impaired loan as nonrecurring Level 3.
Other Real Estate Owned (“OREO”)
OREO, consisting of properties obtained through foreclosure or in satisfaction of loans, is typically reported at fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2). However, OREO is considered Level 3 in the fair value hierarchy because Management has qualitatively applied a discount due to the size, supply of inventory, and the incremental discounts applied to the appraisals. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time of foreclosure, any
excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the ACL. Gains or losses on sale and generally any subsequent adjustments to the value are recorded as a component of OREO expense.
Bank Property Held for Sale
Bank property held for sale consists of locations that management has identified as no longer needed and reclassified from Bank Property. These properties are typically reported at fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2). However, Bank Property Held for Sale is considered Level 3 in the fair value hierarchy because Management has qualitatively applied a discount due to the size, supply of inventory, restrictions and the incremental discounts applied to the appraisals. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time a property is identified as held for sale, any excess of the book balance over the fair value of the real estate is treated as a charge against earnings. Gains or losses on sale and generally any subsequent write-downs to the value are recorded as a component other noninterest income or expense.
Derivative Financial Instruments
Fair value is estimated using pricing models of derivatives with similar characteristics or discounted cash flow models where future floating cash flows are projected and discounted back; and accordingly, these derivatives are classified within Level 2 of the fair value hierarchy. (See Note 17—Derivative Financial Instruments for additional information).
Mortgage Servicing Rights (“MSRs”)
The estimated fair value of MSRs is obtained through an independent derivatives dealer analysis of future cash flows. The evaluation utilizes assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, as well as the market’s perception of future interest rate movements. MSRs are classified as Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis:
Quoted Prices
In Active
Significant
Markets
for Identical
Observable
Unobservable
Inputs
(Level 1)
(Level 2)
(Level 3)
Derivative financial instruments
Securities available for sale:
Total securities available for sale
5,214,027
5,156,676
4,489,532
4,445,712
Changes in Level 1, 2 and 3 Fair Value Measurements
When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the gains and losses below include changes in fair value due in part to observable factors that are part of the valuation methodology.
38
There were no changes in hierarchy classifications of Level 3 assets or liabilities for the six months ended June 30, 2021. A reconciliation of the beginning and ending balances of Level 3 assets and liabilities recorded at fair value on a recurring basis for the six months ended June 30, 2021 is as follows:
Fair value, January 1, 2021
Servicing assets that resulted from transfers of financial assets
15,496
Changes in fair value due to valuation inputs or assumptions
3,243
Changes in fair value due to decay
(5,208)
Fair value , June 30, 2021
There were no unrealized losses included in accumulated other comprehensive income related to Level 3 financial assets and liabilities at June 30, 2021.
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis:
OREO
Impaired loans
8,891
17,609
Quantitative Information about Level 3 Fair Value Measurement
Weighted Average
Valuation Technique
Unobservable Input
Nonrecurring measurements:
Discounted appraisals and discounted cash flows
Collateral discounts
OREO and premises held for sale
Discounted appraisals
Collateral discounts and estimated costs to sell
Fair Value of Financial Instruments
We used the following methods and assumptions in estimating our fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those models are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to Management as of June 30, 2021 and December 31, 2020. Such amounts have not been revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value.
Trading Securities — The fair values of trading securities are determined as follows: (1) for those securities that have traded prior to the date of the consolidated balance sheet but have not settled (date of sale) until after such date, the sales price is used as the fair value; and, (2) for those securities which have not traded as of the date of the consolidated balance sheet, the fair value was determined by broker price indications of similar or same securities.
Investment Securities — Securities available for sale are valued at quoted market prices or dealer quotes. Securities held to maturity are valued at quoted market prices or dealer quotes similar to securities available for sale. The carrying value of FHLB and FRB stock approximates fair value based on the redemption provisions. The carrying value of our investment in unconsolidated subsidiaries approximates fair value. See Note 5—Investment Securities for additional information, as well as page 36 regarding fair value.
Loans held for sale — The fair values disclosed for loans held for sale are based on commitments from investors for loans with similar characteristics.
Loans — ASU 2016-01 - Financial Instruments – Overall – Recognition and Measurement of Financial Assets and Financial Liabilities became effective for us on January 1, 2018. This accounting standard requires us to calculate the fair value of our loans for disclosure purposes based on an estimated exit price. With ASU 2016-01, to estimate an exit price, all loans (fixed and variable) are being valued with a discounted cash flow analyses for loans that includes our estimate of future credit losses expected to be incurred over the life of the loans. Fair values for certain mortgage loans (e.g., one-to-four family residential) and other consumer loans are estimated using discounted cash flow analyses based on our current rates offered for new loans of the same type, structure and credit quality. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses-using interest rates we currently offer for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using a discounted cash flow analysis.
Deposit Liabilities — The fair values disclosed for demand deposits (e.g., interest and noninterest bearing checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts, and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase — The carrying amount of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values.
Other Borrowings — The fair value of other borrowings is estimated using discounted cash flow analysis on our current incremental borrowing rates for similar types of instruments.
Accrued Interest — The carrying amounts of accrued interest approximate fair value.
Derivative Financial Instruments — The fair value of derivative financial instruments (including interest rate swaps) is estimated using pricing models of derivatives with similar characteristics or discounted cash flow models where future floating cash flows are projected and discounted back.
Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees — The fair values of commitments to extend credit are estimated taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated costs to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
The estimated fair value, and related carrying amount, of our financial instruments are as follows:
Financial assets:
5,698,158
5,537,551
Loans, net of allowance for loan losses
23,845,019
99,138
16,015
83,123
Interest rate swap - non-designated hedge
516,632
Other derivative financial instruments (mortgage banking related)
9,513
Financial liabilities:
33,254,282
862,429
351,548
350,466
4,774
Off balance sheet financial instruments:
Commitments to extend credit
45,968
4,448,300
4,287,857
24,757,859
107,601
12,952
94,649
802,763
11,136
30,719,416
779,666
386,126
7,103
136,726
41
Note 16 — Accumulated Other Comprehensive Income (Loss)
The changes in each component of accumulated other comprehensive income (loss), net of tax, were as follows:
Unrealized Gains
and Losses
Gains and
on Securities
Losses on
Benefit
Available
Cash Flow
Plans
for Sale
Hedges
Balance at March 31, 2021
(151)
(880)
Other comprehensive income before reclassifications
25,194
Amounts reclassified from accumulated other comprehensive income
Net comprehensive income
Balance at June 30, 2021
24,287
Balance at March 31, 2020
(149)
43,473
(33,559)
Other comprehensive income (loss) before reclassifications
(3,400)
1,442
1,532
Net comprehensive income (loss)
Balance at June 30, 2020
48,315
(35,427)
Balance at December 31, 2020
47,740
Other comprehensive loss before reclassifications
(23,426)
Net comprehensive loss
Balance at December 31, 2019
11,922
(10,756)
(26,766)
9,627
2,095
The table below presents the reclassifications out of accumulated other comprehensive income (loss), net of tax:
Amount Reclassified from Accumulated Other Comprehensive Income (Loss)
For the Three Months Ended June 30,
For the Six Months Ended June 30,
Accumulated Other Comprehensive Income (Loss) Component
Income StatementLine Item Affected
Losses on cash flow hedges:
Interest rate contracts
Interest expense
Provision for income taxes
Gains on sales of available for sale securities:
Securities gains (losses), net
Total reclassifications for the period
Note 17 — Derivative Financial Instruments
We use certain derivative instruments to meet the needs of customers as well as to manage the interest rate risk associated with certain transactions. The following table summarizes the derivative financial instruments utilized by the Company:
Balance Sheet
Notional
Estimated Fair Value
Location
Gain
Loss
Fair value hedge of interest rate risk:
Pay fixed rate swap with counterparty
Other Liabilities
16,175
1,583
16,439
2,086
Not designated hedges of interest rate risk:
Customer related interest rate contracts:
Matched interest rate swaps with borrowers
Other Assets and Other Liabilities
9,906,849
46,982
9,324,359
802,717
Matched interest rate swaps with counterparty
9,915,172
469,656
802,700
Not designated hedges of interest rate risk - mortgage banking activities:
Contracts used to hedge mortgage servicing rights
170,000
586
149,000
119
Contracts used to hedge mortgage pipeline
Other Assets
386,500
8,927
528,500
11,017
Total derivatives
20,394,696
19,342,657
Cash Flow Hedge of Interest Rate Risk
The Company is exposed to interest rate risk in the course of its business operations and manages a portion of this risk through the use of derivative financial instruments, in the form of interest rate swaps. We account for interest rate swaps that are classified as cash flow hedges in accordance with FASB ASC 815, Derivatives and Hedging, which requires that all derivatives be recognized as assets or liabilities on the balance sheet at fair value. We had no cash flow hedges as of June 30, 2021 and December 31, 2020. For more information regarding the fair value of our derivative financial instruments, see Note 17 to these financial statements.
For derivatives designated as hedging exposure to variable cash flows of a forecasted transaction (cash flow hedge), the derivative’s entire gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings or when the hedge is terminated. For derivatives that are not designated as hedging instruments, changes in the fair value of the derivatives are recognized in earnings immediately.
For designated hedging relationships, we have a third party perform retrospective and prospective effectiveness testing on a quarterly basis using quantitative methods to determine if the hedge is still highly effective. Hedge accounting ceases on transactions that are no longer deemed highly effective, or for which the derivative has been terminated or de-designated.
Balance Sheet Fair Value Hedge
As of June 30, 2021 and December 31, 2020, the Company maintained loan swaps, with an aggregate notional amount of $16.2 million and $16.4 million, respectively, accounted for as fair value hedges in accordance with ASC 815, Derivatives and Hedging. This derivative protects us from interest rate risk caused by changes in the LIBOR curve in relation to a certain designated fixed rate loan. The derivative converts the fixed rate loan to a floating rate. Settlement occurs in any given period where there is a difference in the stated fixed rate and variable rate and the difference is recorded in net interest income. The fair value of this hedge is recorded in either other assets or in other liabilities depending on the position of the hedge with the offset recorded in loans. There was no gain or loss recorded on these derivatives the three and six months ended June 30, 2021
Non-designated Hedges of Interest Rate Risk
Customer Swap
We maintain interest rate swap contracts with customers that are classified as non-designated hedges and are not speculative in nature. These agreements are designed to convert customer’s variable rate loans with the Company to fixed rate. These interest rate swaps are executed with loan customers to facilitate a respective risk Management
43
strategy and allow the customer to pay a fixed rate of interest to the Company. These interest rate swaps are simultaneously hedged by executing offsetting interest rate swaps with unrelated market counterparties to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to receive a variable rate of interest. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR plus credit spread, with payments being calculated on the notional amount. The interest rate swaps are settled monthly with varying maturities.
As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of June 30, 2021 and December 31, 2020, the interest rate swaps had an aggregate notional amount of approximately $19.8 billion and $18.6 billion, respectively. At June 30, 2021 the fair value of the interest rate swap derivatives are recorded in other assets at $516.6 million and in other liabilities at $516.6 million for a net liability position of $6,000. At December 31, 2020, the fair value of the interest rate swap derivatives was recorded in other assets at $802.8 million and other liabilities at $802.7 million for a net asset position of $17,000. Changes in the fair market value of these interest rate swaps is recorded through earnings. As of June 30, 2021, we provided $414.5 million of cash collateral on the customer swaps which is included in cash and cash equivalents on the balance sheet as deposits in other financial institutions (restricted cash). We also provided $443.0 million in investment securities at market value as collateral on the customer swaps which is included in investment securities – available for sale.
Foreign Exchange
We also enter into foreign exchange contracts with customers to accommodate their need to convert certain foreign currencies into to U.S. Dollars. To offset the foreign exchange risk, we have entered into substantially identical agreements with an unrelated market counterparty to hedge these foreign exchange contracts. At June 30, 2021 and December 31, 2020, there were no outstanding contracts or agreements related to foreign currency. If there were foreign currency contracts outstanding at June 30, 2021, the fair value of these contracts would be included in other assets and other liabilities in the accompanying balance sheet. All changes in fair value are recorded as other noninterest income. There was no gain or loss recorded related to the foreign exchange derivative for the three months ended June 30, 2021 and 2020.
Mortgage Banking
We also have derivatives contracts that are classified as non-designated hedges. These derivatives contracts are a part of our risk Management strategy for our mortgage banking activities. These instruments may include financial forwards, futures contracts, and options written and purchased, which are used to hedge MSRs; while forward sales commitments are typically used to hedge the mortgage pipeline. Such instruments derive their cash flows, and therefore their values, by reference to an underlying instrument, index or referenced interest rate. We do not elect hedge accounting treatment for any of these derivative instruments and as a result, changes in fair value of the instruments (both gains and losses) are recorded in our Consolidated Statements of Income in mortgage banking income.
Mortgage Servicing Rights
Derivatives contracts related to MSRs are used to help offset changes in fair value and are written in amounts referred to as notional amounts. Notional amounts provide a basis for calculating payments between counterparties but do not represent amounts to be exchanged between the parties, and are not a measure of financial risk. On June 30, 2021, we had derivative financial instruments outstanding with notional amounts totaling $170.0 million related to MSRs, compared to $149.0 million on December 31, 2020. The estimated net fair value of the open contracts related to the MSRs was recorded as a gain of $586,000 million at June 30, 2021, compared to a gain of $603,000 at June 30, 2020.
Mortgage Pipeline
The following table presents our notional value of forward sale commitments and the fair value of those obligations along with the fair value of the mortgage pipeline related to the held for sale portfolio.
Mortgage loan pipeline
402,636
510,730
Expected closures
348,530
411,273
Fair value of mortgage loan pipeline commitments
9,426
15,328
Forward sales commitments
Fair value of forward commitments
(500)
(4,311)
Note 18 — Capital Ratios
We are subject to regulations with respect to certain risk-based capital ratios. These risk-based capital ratios measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The values of both balance sheet and off-balance sheet items are adjusted based on the rules to reflect categorical credit risk. In addition to the risk-based capital ratios, the regulatory agencies have also established a leverage ratio for assessing capital adequacy. The leverage ratio is equal to Tier 1 capital divided by total consolidated on-balance sheet assets (minus amounts deducted from Tier 1 capital). The leverage ratio does not involve assigning risk weights to assets.
Under current regulations, the Company and the Bank are subject to a minimum ratio of common equity Tier 1 capital (“CET1”) to risk-weighted assets of 4.5%. and a minimum required ratio of Tier 1 capital to risk-weighted assets of 6%. The minimum required leverage ratio is 4%. The minimum required total capital to risk-weighted assets ratio is 8%.
In order to avoid restrictions on capital distributions and discretionary bonus payments to executives, under the new rules a covered banking organization is also required to maintain a “capital conservation buffer” in addition to its minimum risk-based capital requirements. This buffer is required to consist solely of CET1, and the buffer applies to all three risk-based measurements (CET1, Tier 1 capital and total capital). The capital conservation buffer became fully phased-in on January 1, 2019 and consists of an additional amount of Tier 1 common equity equal to 2.5% of risk-weighted assets.
The Bank is also subject to the regulatory framework for prompt corrective action, which identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) and is based on specified thresholds for each of the three risk-based regulatory capital ratios (CET1, Tier 1 capital and total capital) and for the leverage ratio.
45
The following table presents actual and required capital ratios as of June 30, 2021 and December 31, 2020 for the Company and the Bank under the current capital rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations.
Required to be
Minimum Capital
Considered Well
Actual
Required - Basel III
Capitalized
Ratio
Capital Amount
Common equity Tier 1 to risk-weighted assets:
Consolidated
3,102,963
12.14
1,789,798
7.00
1,661,955
6.50
South State Bank (the Bank)
3,308,073
12.98
1,784,618
1,657,145
Tier 1 capital to risk-weighted assets:
2,173,326
8.50
2,045,483
8.00
2,167,036
2,039,563
Total capital to risk-weighted assets:
3,609,452
14.12
2,684,696
10.50
2,556,854
10.00
3,486,562
13.68
2,676,927
2,549,454
Tier 1 capital to average assets (leverage ratio):
8.13
1,526,815
4.00
1,908,518
5.00
8.69
1,522,405
1,903,006
3,010,174
11.77
1,789,984
1,662,128
3,157,098
12.39
1,784,120
1,656,683
2,173,552
2,045,696
2,166,432
2,038,994
3,642,039
14.24
2,684,976
2,557,120
3,397,463
13.33
2,676,180
2,548,743
8.27
1,455,135
1,818,919
8.71
1,450,600
1,813,250
In June 2021, the Company completed the previously announced redemption of $25 million of subordinated debentures and $38.5 million of trust preferred securities that were treated as Tier 2 capital for regulatory capital purposes, resulting in a total reduction of Tier 2 capital of $63.5 million during the period ending June 30, 2021. As of June 30, 2021 and December 31, 2020, the capital ratios of the Company and the Bank were well in excess of the minimum regulatory requirements and exceeded the thresholds for the “well capitalized” regulatory classification.
In June 2016, the FASB issued ASU No. 2016-13 which required an entity to utilize a new impairment model known as the CECL model to estimate its lifetime “expected credit loss.” This standard was adopted and became effective on January 1, 2020 and the Company applied the provisions of the standard using the modified retrospective method as a cumulative-effect adjustment to retained earnings. Related to the implementation of ASU 2016-13, we recorded additional allowance for credit losses for loans of $54.4 million, deferred tax assets of $12.6 million, an additional reserve for unfunded commitments of $6.4 million and an adjustment to retained earnings of $44.8 million. Instead of recognizing the effects from ASU 2016-13 at adoption, the standard included a transitional method option for recognizing the Day 1 effects on the Company’s regulatory capital calculations over a three year phase-in. In March 2020, in response to the COVID-19 pandemic, the regulatory agencies provided an additional transitional method option of a two-year deferral for the start of the three year phase-in of the recognition of the Day 1 effects of ASU 2016-13 along with an option to defer the current impact on regulatory capital calculations of ASU 2016-13 during the first two years (“5 year method”). Under this 5-year method, the Company would recognize an estimate of the previous incurred loss method for determining the allowance for credit losses in regulatory capital calculations and the difference from the CECL method would be deferred for two years. After two years, the effects from Day 1 and the deferral difference from the first two years of applying CECL would be phased-in over three years using the straight-line method. The regulatory rules provided a one-time opportunity at the end of the first quarter of 2020 for covered banking organizations to choose its transition option for CECL. The Company chose the 5-year method and is deferring the recognition of the effects from Day 1 and the CECL difference from the first two years of application.
Note 19 — Goodwill and Other Intangible Assets
The carrying amount of goodwill was $1.6 billion at June 30, 2021 and December 31, 2020. The Company added $15.8 million in goodwill related to the DWI acquisition in the first quarter of 2021. The Company made
subsequent fair value adjustments related to the CSFL merger in the second quarter of 2021 that increased goodwill by $1.3 million.
The Company last completed its annual valuation of the carrying value of its goodwill as of April 30, 2020. We updated this analysis as of November 30, 2020. We determined that no impairment charge was necessary for each period end. During the second quarter of 2021, we changed our annual goodwill valuation date to October 31 each year in order for the valuation to be closer to our year end audit date. We will continue to monitor the impact of the COVID-19 pandemic on the Company’ business, operating results, cash flows and/or financial condition.
Our other intangible assets, consisting of core deposit intangibles, noncompete intangibles, and client list intangibles are included on the face of the balance sheet. The following is a summary of gross carrying amounts and accumulated amortization of other intangible assets:
Gross carrying amount
258,532
258,554
Accumulated amortization
(113,406)
(95,962)
Amortization expense totaled $9.0 million and $18.1 million, for the three and six months ended June 30, 2021, compared to $4.7 million and $7.7 million for the three and six months ended June 30, 2020. The increase compared to the three and six months ended June 30, 2020 was due to the intangibles added from the CSFL merger in the second quarter of 2020. Other intangibles are amortized using either the straight-line method or an accelerated basis over their estimated useful lives, with lives generally between two and 15 years. Estimated amortization expense for other intangibles for each of the next five quarters is as follows:
Quarter ending:
September 30,2021
8,201
December 31,2022
8,200
March 31,2022
7,931
June 30,2022
7,666
September 30,2022
7,230
105,898
Note 20 — Loan Servicing, Mortgage Origination, and Loans Held for Sale
As of June 30, 2021 and December 31, 2020, the portfolio of residential mortgages serviced for others, which is not included in the accompanying balance sheets, was $5.8 billion and $5.1 billion, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts and disbursing payments to investors. The amount of contractually specified servicing fees we earned during the three and six months ended June 30, 2021 and June 30, 2020 were $3.5 million, $6.8 million, $2.1 million and $4.2 million, respectively. Servicing fees are recorded in mortgage banking income in our Condensed Consolidated Statements of Income.
At June 30, 2021 and December 31, 2020, MSRs were $57.4 million and $43.8 million on our consolidated balance sheets, respectively. MSRs are recorded at fair value with changes in fair value recorded as a component of mortgage banking income in the Condensed Consolidated Statements of Income. The market value adjustments related to MSRs recorded in mortgage banking income for the three and six months ended June 30, 2021 and June 30, 2020 were losses of $2.2 million and gains of $5.9 million, compared with losses of $5.2 million and $10.1 million, respectively. We used various free-standing derivative instruments to mitigate the income statement effect of changes in fair value due to changes in market value adjustments and to changes in valuation inputs and assumptions related to MSRs.
See Note 15 — Fair Value for the changes in fair value of MSRs. The following table presents the changes in the fair value of the MSR and offsetting hedge.
Increase (decrease) in fair value of MSRs
(2,192)
(5,179)
(10,098)
Decay of MSRs
(3,288)
(1,994)
(7,849)
(3,198)
Loss related to derivatives
689
(3,601)
10,296
Net effect on statements of income
(6,484)
(5,567)
(3,000)
The fair value of MSRs is highly sensitive to changes in assumptions and fair value is determined by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates and other assumptions validated through comparison to trade information, industry surveys and with the use of independent third-party appraisals. Changes in prepayment speed assumptions have the most significant impact on the fair value of MSRs. Generally, as interest rates increase, mortgage loan prepayments decelerate due to decreased refinance activity, which results in an increase in the fair value of the MSRs. Measurement of fair value is limited to the conditions existing and the assumptions utilized as of a particular point in time, and those assumptions may not be appropriate if they are applied at a different time. See Note 15 — Fair Value for additional information regarding fair value.
The characteristics and sensitivity analysis of the MSRs are included in the following table.
Composition of residential loans serviced for others
Fixed-rate mortgage loans
99.9
Adjustable-rate mortgage loans
0.1
100.0
Weighted average life
6.95
years
6.10
Constant Prepayment rate (CPR)
9.4
12.3
Weighted average discount rate
9.0
Effect on fair value due to change in interest rates
25 basis point increase
3,798
50 basis point increase
7,363
5,520
25 basis point decrease
(4,141)
(2,497)
50 basis point decrease
(8,096)
(4,114)
The sensitivity calculations in the previous table are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the changes in assumptions to fair value may not be linear. Also, the effects of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumptions, while in reality, changes in one factor may result in changing another, which may magnify or contract the effect of the change.
Custodial escrow balances maintained in connection with the loan servicing were $54.7 million and $26.6 million at June 30, 2021 and December 31, 2020, respectively.
Whole loan sales were $974.8 million and $1.7 billion for the three and six months ended June 30, 2021, compared to $489.3 million and $717.6 million for the three and six months ended June 30, 2020. For the three and six months ended June 30, 2021, $767.2 million and $1.4 billion, or 78.7% and 79.4% were sold with the servicing rights retained by the Company, compared to $412.4 million and $606.9 million, or 84.3% and 84.6%, for the three and six months ended June 30, 2020.
Loans held for sale have historically been comprised of residential mortgage loans awaiting sale in the secondary market, which generally settle in 15 to 45 days. Loans held for sale were $171.4 million and $290.5 million at June 30, 2021 and December 31, 2020, respectively.
48
Note 21 — Repurchase Agreements
Securities sold under agreements to repurchase (“repurchase agreements”) represent funds received from customers, generally on an overnight or continuous basis, which are collateralized by investment securities owned or, at times, borrowed and re-hypothecated by the Company. Repurchase agreements are subject to terms and conditions of the master repurchase agreements between the Company and the client and are accounted for as secured borrowings. Repurchase agreements are included in federal funds purchased and securities sold under agreements to repurchase on the condensed consolidated balance sheets.
At June 30, 2021 and December 31, 2020, our repurchase agreements totaled $376.3 million and $394.9 million, respectively. All of our repurchase agreements were overnight or continuous (until-further-notice) agreements at June 30, 2021 and December 31, 2020. These borrowings were collateralized with government, government-sponsored enterprise, or state and political subdivision-issued securities with a carrying value of $466.5 million and $515.9 million at June 30, 2021 and December 31, 2020, respectively. Declines in the value of the collateral would require us to increase the amounts of securities pledged.
Note 22 — Stock Repurchase Program
On January 27, 2021, the Company’s Board of Directors approved a stock repurchase program (“2021 Stock Repurchase Plan”) authorizing the Company to repurchase up to 3,500,000 of the Company’s common shares. During the second quarter of 2021, the Company repurchased a total of 700,000 shares at a weighted average price of $85.94 per share pursuant to the 2021 Stock Repurchase Plan.
Note 23 — Subsequent Events
On July 23, 2021, the Company and Atlantic Capital Bancshares, Inc., a Georgia corporation (“Atlantic Capital”) entered into an Agreement and Plan of Merger (the “Merger Agreement”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Atlantic Capital will merge with and into the Company (the “Merger”), with the Company continuing as the surviving corporation in the Merger (the “Surviving Entity”). Immediately following the Merger, Atlantic Capital’s wholly owned banking subsidiary, Atlantic Capital Bank, N.A. will merge with and into the Company’s wholly owned banking subsidiary, South State Bank, N.A. (the “Bank Merger”), which will continue as the surviving bank in the Bank Merger (the “Surviving Bank”). The Merger Agreement was unanimously approved by the Board of Directors of the Company and Atlantic Capital, and is subject to the approval by Atlantic Capital’s shareholders, as well as regulatory approvals and other customary closing conditions. Under the terms of the Merger Agreement, shareholders of Atlantic Capital will receive 0.36 shares of the Company’s common stock for each share of Atlantic Capital common stock they own. The transaction is expected to close during the first quarter of 2022. At June 30, 2021, Atlantic Capital reported $3.8 billion in total assets, $2.3 billion in loans and $3.3 billion in deposits.
On July 28, 2021, the Company announced that the Board of Directors of the Company increased its quarterly cash dividend on its common stock from $0.47 per share to $0.49 per share. The dividend is payable on August 19, 2021 to shareholders of record as of August 12, 2021.
As of August 5, 2021, the Company repurchased an additional 353,403 shares of the Company’s common stock pursuant to the 2021 Stock Repurchase Plan at a weighted average price of $76.17 per share. Total stock repurchases to date equal 1,053,403 shares at a weighted average price of $82.66 per share. The Company may repurchase up to an additional 2.4 million shares of common stock under the 2021 Stock Repurchase Plan.
49
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) relates to the financial statements contained in this Quarterly Report beginning on page 3. For further information, refer to the MD&A appearing in the Annual Report on Form 10-K for the year ended December 31, 2020. Results for the three and six months ended June 30, 2021 are not necessarily indicative of the results for the year ending December 31, 2021 or any future period.
Unless otherwise mentioned or unless the context requires otherwise, references to “South State,” the “Company” “we,” “us,” “our” or similar references mean South State Corporation and its consolidated subsidiaries. References to the “Bank” means South State Corporation’s wholly owned subsidiary, South State Bank, National Association, a national banking association.
Overview
South State Corporation is a financial holding company headquartered in Winter Haven, Florida, and was incorporated under the laws of South Carolina in 1985. We provide a wide range of banking services and products to our customers through our Bank. The Bank operates South State Advisory, Inc., a wholly owned registered investment advisor. The Bank also operates Duncan-Williams, Inc. (“Duncan-Williams”), which it acquired on February 1, 2021. Duncan-Williams is a registered broker-dealer, headquartered in Memphis, Tennessee, that serves primarily institutional clients across the U.S. in the fixed income business. The Bank also owns CBI Holding Company, LLC (“CBI”), which in turn owns Corporate Billing, LLC (“Corporate Billing”), a transaction-based finance company headquartered in Decatur, Alabama that provides factoring, invoicing, collection and accounts receivable management services to transportation companies and automotive parts and service providers nationwide. The holding company also owns SSB Insurance Corp., a captive insurance subsidiary pursuant to Section 831(b) of the U.S. Tax Code and R4ALL, Inc., which manages a troubled loan purchased from the Bank.
At June 30, 2021, we had approximately $40.4 billion in assets and 5,203 full-time equivalent employees. Through our Bank branches, ATMs and online banking platforms, we provide our customers with a full range of commercial and consumer loan and deposit products through a six (6) state footprint in Alabama, Florida, Georgia, North Carolina, South Carolina and Virginia. Through Corporate Billing, we provide factoring, invoicing, collection and accounts receivable management services nationwide. We also operate a correspondent banking and capital markets division within our national bank subsidiary, of which the majority of its bond salesmen, traders and operational personnel are housed in facilities located in Birmingham, Alabama and Atlanta, Georgia. This division’s primary revenue generating activities are related to its capital markets division, which includes commissions earned on fixed income security sales, fees from hedging services, loan brokerage fees and consulting fees for services related to these activities; and its correspondent banking division, which includes spread income earned on correspondent bank deposits (i.e., federal funds purchased) and correspondent bank checking account deposits and fees from safe-keeping activities, bond accounting services for correspondents, asset/liability consulting related activities, international wires, and other clearing and corporate checking account services. The correspondent banking and capital markets division was further expanded with the addition of Duncan-Williams on February 1, 2021.
We have pursued, and continue to pursue, a growth strategy that focuses on organic growth, supplemented by acquisitions of select financial institutions, or branches in certain market areas.
The following discussion describes our results of operations for the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020 and also analyzes our financial condition as of June 30, 2021 as compared to December 31, 2020. Like most financial institutions, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we may pay interest. Consequently, one of the key measures of our success is the amount of our net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
Of course, there are risks inherent in all loans, as such we maintain an allowance for credit losses, otherwise referred to herein as ACL, to absorb probable losses on existing loans that may become uncollectible. We establish and
maintain this allowance by charging a provision for credit losses against our operating earnings. In the following discussion, we have included a detailed discussion of this process.
In addition to earning interest on our loans and investments, we earn income through fees and other services we charge to our customers. We incur costs in addition to interest expense on deposits and other borrowings, the largest of which is salaries and employee benefits. We describe the various components of this noninterest income and noninterest expense in the following discussion.
The following sections also identify significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.
Recent Events
COVID-19
The COVID-19 pandemic has severely restricted the level of economic activity in our markets. Specifically due to the COVID-19 pandemic, the federal and state governments in which we have financial centers and of most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of some businesses that have been deemed to be non-essential.
While our business has been designated an essential business, which allows us to continue to serve our customers, we serve many customers that were deemed, or who were employed by businesses that were deemed, to be non-essential. Although states in our market area have allowed businesses to reopen in the second and third quarters of 2020 that were deemed non-essential, there are still many restrictions, and our customers are still being adversely effected by the COVID-19 pandemic. In many of the states in our market area, as the economies have been allowed to reopen, there has been an increase in cases of COVID-19 and some restrictions have been reinstated.
The impact of the COVID-19 pandemic is fluid and continues to evolve. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and increased volatility and disruption in financial markets, and has had an adverse effect on our business, financial condition and results of general operations, with a more limited impact to our mortgage and correspondent banking and capital markets business lines. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our customers, employees and vendors.
Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and in the United States as a whole. The COVID-19 pandemic has had a significant impact on our business and operations. As part of our efforts to practice social distancing, in March 2020, we closed all of our banking lobbies and began conducting most of our business through drive-thru tellers and through electronic and online means. To support the health and well-being of our employees, we allowed a majority of our non-customer facing workforce to work from home. In October 2020, we reopened our banking lobbies in our branch locations, but a majority of our support staff is still working from home. To support our customers or to comply with law, we deferred loan payments from 90 to 360 days for consumer and commercial customers. For customers directly impacted by the COVID-19 pandemic, we suspended residential property foreclosure sales and involuntary automobile repossessions through October 1, 2020, which was the latest moratorium expiration for states in our footprint. Eviction actions remained suspended through December 31, 2020 per Centers for Disease Control and Prevention Agency Order 2020-19654. Additionally, we offered fee waivers, payment deferrals, and other expanded assistance for automobile, mortgage, small business and personal lending customers.
Future governmental actions may require more of these and other types of customer-related responses. We are awaiting a final ruling from the CFPB as to its proposal of a nationwide moratorium on foreclosures for all residential mortgages, which if enacted will have an effective date of August 31, 2021.
As of June 30, 2021, we have deferrals of $120 million, or 0.53%, of our total loan portfolio, excluding loans held for sale and Paycheck Protection Program (“PPP”) loans. For commercial loans, the standard deferral was 90 days for both principal and interest, 120 days of principal only payments or 180 days of interest only payments. We have actively reached out to our customers to provide guidance and direction on these deferrals. In terms of available lines of credit, the Company has not experienced an increase in borrowers drawing down on their lines.
Also, we have extended credit to both customers and non-customers related to the PPP. As of June 30, 2021, we have produced approximately 28,000 loans totaling approximately $3.2 billion through the PPP. While deferrals have been decreasing materially since the third quarter of 2020, given the fluidity of the pandemic and the risk there may be new lockdowns or restrictions on business activities to slow the spread of the virus, there is no guarantee that some loans not currently on deferral might return to deferral status.
A restructuring that results in only a delay in payments that is insignificant is not considered an economic concession. In accordance with the CARES Act, the Company implemented loan modification programs in response to the COVID-19 pandemic in order to provide borrowers with flexibility with respect to repayment terms. The Company’s payment relief assistance includes forbearance, deferrals, extension and re-aging programs, along with certain other modification strategies. The Company elected the accounting policy in the CARES Act to suspend TDR accounting to loans modified for borrowers impacted by the COVID-19 pandemic if the concession met the criteria defined under the CARES Act.
We are continuously monitoring the impact of the COVID-19 pandemic on our results of operations and financial condition. With the adoption of ASU 2016-13 on January 1, 2020, the Company changed its method for calculating its ACL for loans, investments, unfunded commitments and other financial assets. As a result of the new accounting standard, the Company changed its method for calculating its ACL for loans from an incurred loss method to a life of loan method. See Note 2 – Significant Accounting Policies, Note 7 – Allowance for Credit Losses, and the caption “Allowance for Credit Losses” in the MD&A section of this Quarterly Report on Form 10-Q for further details. We also adjust our investment securities portfolio to market each period end and review for any impairment that would require a provision for credit losses. At this time, we have determined there is no need for a provision for credit losses related to our investment securities portfolio. Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments in the future on the securities we hold, as well as reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.
We also are monitoring the impact of the COVID-19 pandemic on the valuation of goodwill. Additional detail in regards to the goodwill analysis is disclosed below under the “Goodwill and Other Intangible Assets” section under “Critical Accounting Policies”.
Atlantic Capital Bancshares, Inc. Proposed Merger
On July 23, 2021, South State and Atlantic Capital announced the two companies had entered into a Merger Agreement, upon the terms and subject to the conditions set forth in the Merger Agreement, whereby Atlantic Capital will merge with and into South State, with South State continuing as the surviving entity. The Merger Agreement was unanimously approved by the Board of Directors of the Company and Atlantic Capital, and is subject to the approval by Atlantic Capital’s shareholders, as well as regulatory approvals and other customary closing conditions.
Under the terms of the Merger Agreement, shareholders of Atlantic Capital will receive 0.36 shares of South State’s common stock for each share of Atlantic Capital common stock they own. The transaction is expected to close during the first quarter of 2022. At June 30, 2021, Atlantic Capital reported $3.8 billion in total assets, $2.3 billion in loans and $3.3 billion in deposits.
Critical Accounting Policies
Our consolidated financial statements are prepared based on the application of accounting policies in accordance with GAAP and follow general practices within the banking industry. Our financial position and results of operations are affected by Management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses. Differences in the application of these policies could result in material changes in our consolidated financial position and consolidated results of operations and related disclosures. Understanding our accounting policies is fundamental to understanding our consolidated financial position and consolidated results of operations. Accordingly, our significant accounting policies and changes in accounting principles and effects of new accounting pronouncements are discussed in Note 2 and Note 3 of our consolidated financial statements in this Quarterly Report on Form 10-Q and in Note 1 of our Annual Report on Form 10-K for the year ended December 31, 2020.
The following is a summary of our critical accounting policies that are highly dependent on estimates, assumptions and judgments.
Allowance for Credit Losses or ACL
The ACL reflects Management’s estimate of losses that will result from the inability of our borrowers to make required loan payments. Due to the Merger between the Company and CSFL, effective June 7, 2020, Management adopted one combined methodology during the third quarter of 2020. Management used the one systematic methodology to determine its ACL for loans held for investment and certain off-balance-sheet credit exposures. Management considers the effects of past events, current conditions, and reasonable and supportable forecasts on the collectability of the loan portfolio. The Company’s estimate of its ACL involves a high degree of judgment; therefore, Management’s process for determining expected credit losses may result in a range of expected credit losses. It is possible that others, given the same information, may at any point in time reach a different reasonable conclusion. The Company’s ACL recorded in the balance sheet reflects Management’s best estimate within the range of expected credit losses. The Company recognizes in net income the amount needed to adjust the ACL for Management’s current estimate of expected credit losses. See Note 2 - Summary of Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the ACL. See also Note 7 — Allowance for Credit Losses in this Quarterly Report on Form 10-Q, and “Allowance for Credit Losses” in this MD&A.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed in a business combination. As of June 30, 2021 and December 31, 2020, the balance of goodwill was $1.6 billion. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.
During the second quarter of 2021, we changed the annual impairment date to October 31; however, our most recent evaluation of goodwill was performed as of November 30, 2020, and after considering the effects of COVID-19 on the economy, we determined that no impairment charge was necessary. Our stock price has historically traded above
its book value, however, our stock price fell below book value and remained below book value through much of 2020 in reaction to the COVID-19 pandemic, which affected stock prices of companies in almost all industries. In November 2020, our stock price rose back above book value as the economy slowly began to recover and there was positive news on vaccines for COVID-19. Our stock price closed on December 31, 2020 at $72.30. Our stock price has continued to trade above book value and tangible book value in the first and second quarters of 2021. Our stock price closed on June 30, 2021 at $81.76, which was above book value of $67.60 and tangible book value of $43.07. We will continue to monitor the impact of COVID-19 on the Company’s business, operating results, cash flows and financial condition. If the COVID-19 pandemic continues, the economy deteriorates and our stock price falls below current levels, we will have to reevaluate the impact on our financial condition and potential impairment of goodwill.
Core deposit intangibles and client list intangibles consist primarily of amortizing assets established during the acquisition of other banks. This includes whole bank acquisitions and the acquisition of certain assets and liabilities from other financial institutions. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. Client list intangibles represent the value of long-term client relationships for the correspondent banking and wealth and trust management business. These costs are amortized over the estimated useful lives, such as deposit accounts in the case of core deposit intangible, on a method that we believe reasonably approximates the anticipated benefit stream from this intangible. The estimated useful lives are periodically reviewed for reasonableness.
Income Taxes and Deferred Tax Assets
Income taxes are provided for the tax effects of the transactions reported in our condensed consolidated financial statements and consist of taxes currently due plus deferred taxes related to differences between the tax basis and accounting basis of certain assets and liabilities, including available-for-sale securities, ACL, write downs of OREO properties, bank properties held for sale, accumulated depreciation, net operating loss carry forwards, accretion income, deferred compensation, intangible assets, mortgage servicing rights, and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is recorded in situations where it is “more likely than not” that a deferred tax asset is not realizable. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred tax assets as of June 30, 2021 were $36.7 million which was down from $110.9 as of December 31, 2020. The decrease in deferred tax assets during the first six months of 2021 was mostly attributable to a decrease in the fair value of loans and securities, as well as the release of allowance for credit losses recorded during the period.
The Company and its subsidiaries file a consolidated federal income tax return. Additionally, income tax returns are filed by the Company or its subsidiaries in Alabama, California, Colorado, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, Texas, New York, New York City and Virginia. We evaluate the need for income tax reserves related to uncertain income tax positions but had no material reserves at June 30, 2021 or 2020.
Other Real Estate Owned and Bank Property Held For Sale
Other real estate owned (“OREO”) consists of properties obtained through foreclosure or through a deed in lieu of foreclosure in satisfaction of loans. Prior to the merger with CSFL, we classified former branch sites as held for sale OREO. During the second quarter of 2020 and with the merger with CSFL, the Company elected to reclassify these assets as bank property held for sale and report on a separate line within the balance sheet. Both OREO and bank property held for sale are recorded at the lower of cost or fair value and the fair value was determined on the basis of current valuations obtained principally from independent sources and adjusted for estimated selling costs. At the time of foreclosure or initial possession of collateral, for OREO, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the ACL. At the time a bank property is no longer in service and is moved to held for sale, any excess of the current book value over fair value is recorded as an expense in the Statements of Net Income. Subsequent adjustments to this value are described below in the following paragraph.
We report subsequent declines in the fair value of OREO and bank properties held for sale below the new cost basis through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of these properties, and the period of time within which such estimates can be considered current is significantly
shortened during periods of market volatility. In response to market conditions and other economic factors, Management may utilize liquidation sales as part of its problem asset disposition strategy. As a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from sales transactions could differ significantly from the current valuations used to determine the fair value of these properties. Management reviews the value of these properties periodically and adjusts the values as appropriate. Revenue and expenses from OREO operations, as well as gains or losses on sales and any subsequent adjustments to the value, are recorded as OREO and Loan Related expense, a component of Noninterest Expense in the Statements of Net Income.
Results of Operations
We reported consolidated net income of $99.0 million, or diluted earnings per share (“EPS”) of $1.39, for the second quarter of 2021 as compared to consolidated net loss of ($84.9) million, or diluted EPS of ($1.96), in the comparable period of 2020, a 216.5% increase in consolidated net income and a 170.9% increase in diluted EPS. The $183.9 million increase in consolidated net income was the net result of the following items:
Our quarterly efficiency ratio declined slightly to 76.3% in the second quarter of 2021 compared to 78.4% in the second quarter of 2020. The decrease in the efficiency ratio compared to the second quarter of 2020 was the result of a 49.3% increase in noninterest expense (excluding amortization of intangibles) being less than the 53.4% increase in the total of tax-equivalent (“TE”) net interest income and noninterest income. The elevated efficiency ratios for the three months ended June 30, 2021 and 2020 are due to the one-time expenses that occurred in each quarter. In the second quarter of 2021, total expense included merger and branch consolidation expense of $33.0 million and extinguishment of debt cost of $11.7 million. In the second quarter of 2020, total expense included merger and branch consolidation expense of $43.0 million.
Diluted and basic EPS were $1.39 and $1.40, respectively, for the second quarter of 2021, compared to a loss of ($1.96) for both diluted and basic EPS for the second quarter of 2020. The increase of 216.5% in net income in the second quarter of 2021 was greater than the increase in average common shares of 63.6% compared to the same period in 2020. The second quarter of 2021 includes the effect of net income from CSFL for the entire quarter while the second quarter of 2020 includes a partial month. The weighted average common shares increased to 70.9 million shares, or 63.6%, due to the merger with CSFL compared to 43.3 million weighted average shares outstanding during the quarter ended June 30, 2020. The Company issued 37.3 million shares as a result of the merger with CSFL during the second quarter of 2020.
Selected Figures and Ratios
Return on average assets (annualized)
1.00
(1.49)
1.27
(0.63)
Return on average equity (annualized)
8.38
(11.78)
10.52
(4.67)
Return on average tangible equity (annualized)*
(19.71)
17.59
(7.52)
Dividend payout ratio **
33.65
N/M
27.12
Equity to assets ratio
11.78
11.91
Average shareholders’ equity
4,739,241
2,900,443
4,713,339
2,618,395
* - Denotes a non-GAAP financial measure. The section titled “Reconciliation of GAAP to non-GAAP” below provides a table that reconciles GAAP measures to non-GAAP measures.
** - For the three and six months ended June 30, 2020, the calculation of this ratio was not meaningful due to the net loss during the periods. See explanation of the dividend payout ratio below for the comparative period calculations.
Net Interest Income and Margin
Non-TE net interest income increased $90.6 million, or 55.7%, to $253.1 million in the second quarter of 2021 compared to $162.6 million in the same period in 2020. Interest earning assets averaged $35.6 billion during the three months period ended June 30, 2021 compared to $20.3 billion for the same period in 2020, an increase of $15.4 billion, or 75.9%. Interest bearing liabilities averaged $23.1 billion during the three months period ended June 30, 2021 compared to $13.8 billion for the same period in 2020, an increase of $9.4 billion, or 67.9%. Some key highlights are outlined below:
57
The tables below summarize the analysis of changes in interest income and interest expense for the three and six months ended June 30, 2021 and 2020 and net interest margin on a tax equivalent basis.
Balance
Earned/Paid
Yield/Rate
Interest-Earning Assets:
Federal funds sold, reverse repo, and time deposits
$ 5,670,674
$ 1,350
0.10%
$ 2,033,910
$ 432
0.09%
Investment securities (taxable) (1)
4,825,832
1.44%
2,109,609
2.08%
Investment securities (tax-exempt)
546,153
1.96%
197,862
3.06%
281,547
1,977
2.82%
203,267
1,498
2.96%
Acquired loans, net
10,564,735
115,937
4.40%
5,270,857
66,561
5.08%
Non-acquired loans
13,742,664
128,263
3.74%
10,446,530
99,648
3.84%
Total interest-earning assets
35,631,605
3.01%
20,262,035
3.58%
Noninterest-Earning Assets:
478,298
285,989
4,128,583
2,564,844
Allowance for non-acquired loan losses
(405,734)
(213,943)
Total noninterest-earning assets
4,201,147
2,636,890
Total Assets
$ 39,832,752
$ 22,898,925
Interest-Bearing Liabilities:
Transaction and money market accounts
$ 15,453,940
$ 4,513
0.12%
$ 8,132,276
$ 5,096
0.25%
Savings deposits
2,995,871
453
0.06%
1,699,377
336
0.08%
Certificates and other time deposits
3,408,778
4,571
0.54%
2,321,684
7,192
1.25%
Federal funds purchased and repurchase agreements
914,641
0.14%
415,304
0.38%
368,622
4.95%
188,062
4.22%
275
4.38%
1,028,822
1.18%
Total interest-bearing liabilities
23,142,127
13,785,525
0.53%
Noninterest-Bearing Liabilities:
Demand deposits
11,037,617
5,586,817
913,767
626,140
Total noninterest-bearing liabilities ("Non-IBL")
11,951,384
6,212,957
Shareholders' equity
Total Non-IBL and shareholders' equity
16,690,625
9,113,400
Total Liabilities and Shareholders' Equity
Net Interest Income and Margin (Non-Tax Equivalent)
$ 253,130
2.85%
$ 162,557
3.23%
Net Interest Margin (Tax Equivalent)
2.87%
3.24%
Total Deposit Cost (without debt and other borrowings)
0.29%
Overall Cost of Funds (including demand deposits)
0.17%
0.37%
58
$ 5,216,717
$ 2,339
$ 1,286,110
$ 1,884
4,518,471
1.46%
1,996,068
2.30%
511,001
1.89%
169,031
3.45%
290,210
3,969
2.76%
122,539
1,829
3.00%
11,163,517
250,699
4.53%
3,643,249
102,359
5.65%
13,235,717
251,476
3.83%
9,935,357
196,553
3.98%
34,935,633
3.15%
17,152,354
3.85%
429,259
264,954
4,109,765
2,219,190
(431,191)
(160,569)
4,107,833
2,323,575
$ 39,043,466
$ 19,475,929
$ 15,068,237
$ 9,901
0.13%
$ 7,054,524
$ 12,778
0.36%
2,888,712
887
1,513,955
986
3,540,069
10,007
0.57%
1,979,835
13,297
1.35%
883,631
0.15%
371,838
379,274
5.01%
151,981
4.18%
900,176
1.47%
22,760,061
0.27%
11,972,309
0.63%
10,543,604
4,429,092
1,026,462
456,133
11,570,066
4,885,225
16,283,405
7,503,620
$ 515,128
2.97%
$ 290,571
3.41%
2.99%
3.42%
Total deposit cost ( without debt and other borrowings)
0.19%
0.46%
Interest earned on investment securities was higher in the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020. This is a result of the Bank carrying a higher average balance in investment securities in 2021 compared to the same periods in 2020. The average balance of investment securities for the three and six months ended June 30, 2021 increased $3.1 billion and $2.9 billion, respectively, from the comparable period in 2020. With the excess liquidity from the growth in deposits during 2020 and the first six months of 2021, the Bank used a portion of the excess funds to strategically increase the size of its investment securities. The increase in the average balance was also due to the acquired investment portfolio of $1.2 billion from the merger with CSFL. The acquired portfolio was only outstanding for 23 days in the three and six months ended June 30, 2020. The yield on the investment securities declined 67 basis points and 89 basis points, respectively, during the three and six months ended June 30, 2021 compared to the same periods in 2020. The decline in the yield was due to the falling interest rate environment resulting from the drop in the federal funds rate made by the Federal Reserve in March 2020 and the impact of this reduction on overall interest rates. The securities purchased during the last quarter of 2020 and the first six months of 2021 have a lower interest rate than the existing portfolio.
Interest earned on loans held for investment increased $78.0 million to $244.2 million and $203.3 million to $502.2 million, respectively, in the three and six months ended June 30, 2021 from the comparable periods in 2020. Interest earned on loans held for investment included loan accretion income recognized during the three and six months ended June 30, 2021 of $6.3 million and $16.7 million, respectively, and $10.1 million and $21.0 million during the
59
three and six months ended June 30, 2020, respectively, a decrease of $3.8 million between the comparable quarters and a decrease of $4.3 million between the two six-month periods ended. Some key highlights for the quarter ended June 30, 2021 are outlined below:
Interest-Bearing Liabilities
The quarter-to-date average balance of interest-bearing liabilities increased $9.4 billion, or 67.9%, in the second quarter of 2021 compared to the same period in 2020. Overall cost of funds, including demand deposits, decreased by 20 basis points to 0.17% in the second quarter of 2021, compared to the same period in 2020. Some key highlights for the quarter ended June 30, 2021 compared to the same period in 2020 include:
60
We continue to monitor and adjust rates paid on deposit products as part of our strategy to manage our net interest margin. Interest-bearing liabilities include interest-bearing transaction accounts, savings deposits, CDs, other time deposits, federal funds purchased, and other borrowings. Interest-bearing transaction accounts include NOW, HSA, IOLTA, and Market Rate checking accounts.
Noninterest-Bearing Deposits
Noninterest-bearing deposits are transaction accounts that provide our Bank with “interest-free” sources of funds. Average noninterest-bearing deposits increased $5.5 billion, or 97.6%, to $11.0 billion in the second quarter of 2021 compared to $5.6 billion during the same period in 2020. The increase in average noninterest-bearing deposits was mainly due to the noninterest-bearing deposits of $5.3 billion assumed from the merger with CSFL in June 2020. The completion of the merger with CSFL was on June 7th, 2020. As a result, for the second quarter of 2020, the assumed noninterest-bearing deposits from the merger with CSFL were only outstanding for 23 days, which lead to a lower average balance compared to the period-end balance at June 30, 2020.
Noninterest Income
Noninterest income provides us with additional revenues that are significant sources of income. For the three months ended June 30, 2021 and 2020, noninterest income comprised 23.8%, and 25.1%, respectively, of total net interest income and noninterest income. For the six months ended June 30, 2021 and 2020, noninterest income comprised 25.4%, and 25.3%, respectively, of total net interest income and noninterest income.
Service charges on deposit accounts
14,806
30,900
22,419
Debit, prepaid, ATM and merchant card related income
9,130
18,318
12,401
Bank owned life insurance income
5,047
1,381
8,347
3,911
4,276
711
7,773
1,643
Noninterest income increased by $24.7 million, or 45.4%, during the second quarter of 2021 compared to the same period in 2020. This quarterly change in total noninterest income resulted from the following:
Noninterest income increased by $76.8 million, or 78.0%, during the six months ended June 30, 2021 compared to the same period in 2020. This change in total noninterest income resulted from the following:
Noninterest Expense
Business development and staff related expense
4,305
1,447
7,676
3,691
Supplies and printing
971
624
1,087
Postage expense
1,529
3,100
2,028
14,502
10,388
25,661
18,226
Noninterest expense increased by $88.3 million, or 50.4%, in the second quarter of 2021 as compared to the same period in 2020. The quarterly increase in total noninterest expense primarily resulted from the following:
Noninterest expense increased by $209.7 million, or 74.3%, during the six months ended June 30, 2021 compared to the same period in 2020. The categories and explanations for the increases year-to-date are similar to the ones noted above in the quarterly comparison.
Income Tax Expense
Our effective tax rate was 22.42% and 22.07% for the three and six months ended June 30, 2021 compared to 22.56% and 25.20% for the three and six months ended June 30, 2020. The decrease in the effective tax rate for the quarter was driven by increased pre-tax book income in the current quarter compared to the same period of 2020. In the second quarter of 2020, the Company acquired CSFL in a merger of equals and incurred significant acquisition costs that resulted in a pre-tax loss for the quarter. In addition to the acquisition costs, the Company recorded $119 million in non-
63
PCD provision for credit losses as part of the merger. This loss led to an income tax benefit being recorded in the second quarter of 2020.
The decrease in the year-to-date effective tax rate compared to the second quarter of 2020 was driven by the increase in pre-tax book income that was recorded in the current quarter compared to the pre-tax book loss that was generated during the second quarter of 2020. This along with an increase in federal tax credits available and an increase in tax-exempt income through the first six months of 2021 compared to 2020 also led to a decrease in the year-to-date effective tax rate.
Analysis of Financial Condition
Summary
Our total assets increased approximately $2.6 billion, or 6.8%, from December 31, 2020 to June 30, 2021, to approximately $40.4 billion. Within total assets, cash and cash equivalents increased $1.8 billion, or 38.9%, investment securities increased $1.3 billion, or 28.6%, and loans decreased $631.1 million, or 0.3%, during the period. Within total liabilities, deposit growth was $2.5 billion, or 8.3%, and federal funds purchased and securities sold under agreements to repurchased growth was $82.8 million, or 10.5%. Total borrowings decreased $38.6 million, or 9.9%. Total shareholder’s equity increased $109.7 million, or 2.4%. Our loan to deposit ratio was 72% and 80% at June 30, 2021 and December 31, 2020, respectively.
We use investment securities, our second largest category of earning assets, to generate interest income through the deployment of excess funds, provide liquidity, fund loan demand or deposit liquidation, and pledge as collateral for public funds deposits, repurchase agreements and as collateral for derivative exposure. At June 30, 2021, investment securities totaled $5.7 billion, compared to $4.4 billion at December 31, 2020, an increase of $1.3 billion, or 28.6%. We continue to increase our investment securities strategically primarily with excess funds due to continued deposit growth. During the six months ended June 30, 2021, we purchased $1.8 billion of securities, $276.7 million classified as held to maturity and $1.5 billion classified as available for sale. These purchases were partially offset by maturities, paydowns, sales and calls of investment securities totaling $475.5 million. Net amortization of premiums were $19.7 million in the first six months of 2021. The decrease in fair value in the available for sale investment portfolio of $30.8 million in the first six months of 2021 compared to December 31, 2020 was mainly due to an increase in short and long term interest rates during the six period ending June 30, 2021.
The following is the combined amortized cost and fair value of investment securities available for sale and held for maturity, aggregated by credit quality indicator:
Net Gain
BB or
(Loss)
AAA - A
BBB
Lower
Not Rated
99,288
97,188
(2,100)
2,397,686
2,380,891
(16,795)
98
2,397,588
754,479
761,484
7,005
1,055,640
1,058,652
3,012
13,770
1,041,870
15,902
675,788
1,438
528,706
532,316
3,610
5,526,560
10,991
1,317,650
4,208,910
* Agency mortgage-backed securities (“MBS”), agency collateralized mortgage-obligations (CMO) and agency commercial mortgage-backed securities (“CMBS”) are guaranteed by the issuing government-sponsored enterprise (“GSE”) as to the timely payments of principal and interest. Except for Government National Mortgage Association securities, which have the full faith and credit backing of the United States Government, the GSE alone is responsible for making payments on this guaranty. While the rating agencies have not rated any of the MBS, CMO and CMBS issued, senior debt securities issued by GSEs are rated consistently as “Triple-A.” Most market participants consider agency MBS, CMOs and CMBSs as carrying an implied Aaa rating (S&P rating of AA+) because of the guarantees of timely payments and selection criteria of mortgages backing the securities. We do not own any private label mortgage-
64
backed securities. The balances presented under the ratings above reflect the amortized cost of the investment securities.
At June 30, 2021, we had 156 investment securities (including both available for sale and held to maturity) in an unrealized loss position, which totaled $46.9 million. At December 31, 2020, we had 86 investment securities (including both available for sale and held to maturity) in an unrealized loss position, which totaled $5.3 million. The total number of investment securities with an unrealized loss position increased by 70 securities, while the total dollar amount of the unrealized loss increased by $41.6 million. The increase in both the number of investment securities in a loss position and the total unrealized loss from December 31, 2020 is due to an increase in short and long term interest rates during the first six months of 2021.
All investment securities in an unrealized loss position as of June 30, 2021 continue to perform as scheduled. We have evaluated the securities and have determined that the decline in fair value, relative to its amortized cost, is not due to credit-related factors. In addition, we have the ability to hold these securities within the portfolio until maturity or until the value recovers, and we believe that it is not likely that we will be required to sell these securities prior to recovery. We continue to monitor all of our securities with a high degree of scrutiny. There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some or all of its securities may be sold or would require a charge to earnings as a provision for credit losses in such periods. Any charges as a provision for credit losses related to investment securities could impact cash flow, tangible capital or liquidity. See Note 2 – Summary of Significant Account Policies and Note 5 – Investment securities for further discussion on the application of ASU 2016-13 on the investment securities portfolio.
As securities held for investment are purchased, they are designated as held to maturity or available for sale based upon our intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. Although securities classified as available for sale may be sold from time to time to meet liquidity or other needs, it is not our normal practice to trade this segment of the investment securities portfolio. While Management generally holds these assets on a long-term basis or until maturity, any short-term investments or securities available for sale could be converted at an earlier point, depending partly on changes in interest rates and alternative investment opportunities.
Other Investments
Other investment securities include primarily our investments in FHLB and FRB stock with no readily determinable market value. Accordingly, when evaluating these securities for impairment, Management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value. As of June 30, 2021, we determined that there was no impairment on our other investment securities. As of June 30, 2021, other investment securities represented approximately $160.6 million, or 0.40% of total assets and primarily consists of FHLB and FRB stock which totals $146.0 million, or 0.36% of total assets. There were no gains or losses on the sales of these securities for three and six months ended June 30, 2021 and 2020, respectively.
Through its Correspondent Banking Department and its wholly-owned broker dealer Duncan-Williams Inc., the Company will occasionally purchase trading securities and subsequently sell them to their customers to take advantage of market opportunities, when presented, for short-term revenue gains. Securities purchased for this portfolio are primarily municipals, treasuries and mortgage-backed agency securities and are held for short periods of time. This portfolio is carried at fair value and realized and unrealized gains and losses are included in trading securities revenue, a component of Correspondent Banking and Capital Market Income in our Consolidated Statements of Net Income. At June 30, 2021, we had $89.9 million of trading securities.
Loans Held for Sale
The balance of mortgage loans held for sale decreased $119.0 million from December 31, 2020 to $171.4 million at June 30, 2021. Total mortgage production remained strong at $1.4 billion during the second quarter; however a higher percentage of mortgage production was booked to portfolio compared to previous quarters, 43% for the second quarter of 2021 compared to 33% in the previous quarter and 28% during the fourth quarter of 2020. This resulted in a lower percentage of mortgage production being allocated to the secondary market. The allocation of mortgage
production between portfolio and secondary market depends on the Company’s liquidity, market spreads and rate changes during each period and will fluctuate over time.
The following table presents a summary of the loan portfolio by category (excludes loans held for sale):
LOAN PORTFOLIO (ENDING BALANCE)
% of
Acquired loans:
Acquired - non-purchased credit deteriorated loans:
290,692
1.2
495,638
2.0
2,314,756
9.7
2,623,838
10.6
1,688,142
7.0
1,819,129
7.4
935,854
3.9
1,129,618
4.6
489,110
609,709
2.5
1,182,113
4.9
2,112,514
8.6
389,150
1.6
461,357
1.9
Consumer non real estate
167,880
0.7
206,812
0.8
253
-
254
Total acquired - non-purchased credit deteriorated loans
31.0
38.4
Acquired - purchased credit deteriorated loans (PCD):
77,851
0.3
115,146
0.5
1,022,771
4.3
1,185,472
4.8
656,347
2.7
746,976
3.0
313,240
1.3
380,170
1.5
64,801
81,238
115,119
178,070
119,160
148,449
0.6
64,970
80,288
Total acquired - purchased credit deteriorated loans (PCD)
10.2
11.7
Total acquired loans
9,892,209
41.2
12,374,678
50.1
Non-acquired loans:
1,579,103
6.6
1,280,062
5.2
2,948,281
2,342,936
9.5
2,550,700
2,266,592
9.2
2,300,236
9.6
2,172,879
8.8
645,451
601,194
2.4
3,143,029
13.1
2,755,726
11.2
299,992
245,094
1.0
664,233
607,234
9,844
17,739
Total non-acquired loans
58.8
49.9
Total loans (net of unearned income)
* As a result of the conversion of legacy CenterState’s core system to the Company’s core system, completed during the second quarter of 2021, several loans were reclassified to conform with the Company’s current loan segmentation, most notably residential investment loans which were reclassed from Consumer Owner Occupied to Other Income Producing Property, and some multi-family loans that were reclassified from Other Income Producing Property to Commercial Non-Owner Occupied. Prior period loan balances presented above were revised to conform with the current loan segmentation.
Total loans, net of deferred loan costs and fees (excluding mortgage loans held for sale), decreased by $631.1 million, or 5.2% annualized, to $24.0 billion at June 30, 2021. Our non-acquired loan portfolio increased by $1.9 billion, or 30.4% annualized, driven by growth in all categories except other loans. Commercial non-owner occupied loans, commercial and industrial loans, construction and land development loans and commercial owner occupied loans led the way with $605.3 million, $387.3 million, $299.0 million and $284.1 million in year-to-date loan growth, respectively, or 52.1%, 28.3%, 47.1% and 25.3% annualized growth, respectively. The acquired loan portfolio decreased by $2.5 billion, or 40.5% annualized, from paydowns and payoffs in both the PCD and NonPCD loan
66
categories. Acquired loans as a percentage of total loans decreased to 41.2% and non-acquired loans as a percentage of the overall portfolio increased to 58.8% at June 30, 2021.
Management considers forward-looking information in estimating expected credit losses. The Company subscribes to a third-party service which provides a quarterly macroeconomic baseline outlook and alternative scenarios for the United States economy. The baseline, along with the evaluation of alternative scenarios, is used by Management to determine the best estimate within the range of expected credit losses. Management has evaluated the appropriateness of the reasonable and supportable forecast scenarios and has made adjustments as needed. For the contractual term that extends beyond the reasonable and supportable forecast period, the Company reverts to the long term mean of historical factors within four quarters using a straight-line approach. The Company generally utilizes a four-quarter forecast and a four-quarter reversion period.
As stated above, Management evaluates the appropriateness of the reasonable and supportable forecast scenarios and takes into consideration the scenarios in relation to actual economic and other data (such as COVID-19 epidemiological data and federal stimulus), as well as the volatility and magnitude of changes within those scenarios quarter over quarter, and consideration of condition within the bank’s operating environment and geographic area. Additional forecast scenarios may be weighed along with the baseline forecast to arrive at the final reserve estimate. While periods of relative economic stability should generally lead to stability in forecast scenarios and weightings to estimate credit losses, periods of instability can likewise require Management to adjust the selection of scenarios and weightings, in accordance with the accounting standards.
67
The COVID-19 pandemic has created increased volatility and uncertainties within the economy and economic forecasts. Accordingly, during the fourth quarter of 2020, Management used a blended forecast scenario (two-thirds baseline and one-third more severe scenario) to determine the allowance for credit losses as of December 31, 2020. At the height of lockdowns and uncertainties around the path of the epidemic and efficacy of vaccination efforts during the first quarter of 2021, Management adjusted the blended forecast scenario to an equal weight between the baseline and the more adverse scenario to determine the allowance for credit losses as of March 31, 2021. In recognition of positive developments including suppression of the virus through continued vaccinations, widespread reopening of the economy, and an improved economic outlook, Management returned to the blended forecast scenario of two-thirds baseline and one-third more severe scenario to determine the allowance for credit losses as of June 30, 2021. The resulting release was approximately $59 million. If the economic forecast weighting had not been adjusted, this would have resulted in a smaller release of approximately $12 million, which Management did not deem appropriate given the pace of economic recovery.
When a loan no longer shares similar risk characteristics with its segment, the asset is assessed to determine whether it should be included in another pool or should be individually evaluated. During the third quarter of 2020, we consolidated the ACL models and due to the size of the combined company elected to increase the threshold for individually-evaluated loans to all non-accrual loans with a net book balance in excess of $1.0 million. We will monitor the credit environment and make adjustments to this threshold in the future if warranted. Based on the threshold above, consumer financial assets will generally remain in pools unless they meet the dollar threshold. The expected credit losses on individually-evaluated loans will be estimated based on discounted cash flow analysis unless the loan meets the criteria for use of the fair value of collateral, either by virtue of an expected foreclosure or through meeting the definition of collateral-dependent. Financial assets that have been individually evaluated can be returned to a pool for purposes of estimating the expected credit loss insofar as their credit profile improves and that the repayment terms were not considered to be unique to the asset.
A restructuring that results in only a delay in payments that is insignificant is not considered an economic concession. In accordance with the CARES Act, the Company implemented loan modification programs in response to the COVID-19 pandemic in order to provide borrowers with flexibility with respect to repayment terms. The Company’s payment relief assistance includes forbearance, deferrals, extension and re-aging programs, along with certain other modification strategies. The Company elected the accounting policy in the CARES Act to not apply TDR accounting to loans modified for borrowers impacted by the COVID-19 pandemic if the concession met the criteria as defined under the CARES Act.
For purchased credit-deteriorated, otherwise referred to herein as PCD, assets are defined as acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by the Company’s assessment. The Company records PCD loans by adding the expected credit losses (i.e., allowance for credit losses) to the purchase price of the financial assets rather than recording through the provision for credit losses in the income statement. The expected credit loss, as of the acquisition day, of a PCD loan is added to the allowance for credit
losses. The non-credit discount or premium is the difference between the unpaid principal balance and the amortized cost basis as of the acquisition date. Subsequent to the acquisition date, the change in the ACL on PCD loans is recognized through the provision for credit losses. The non-credit discount or premium is accreted or amortized, respectively, into interest income over the remaining life of the PCD loan on a level-yield basis. In accordance with the transition requirements within the standard, the Company’s acquired credit-impaired loans (i.e., ACI or Purchased Credit Impaired) were treated as PCD loans.
The Company follows its nonaccrual policy by reversing contractual interest income in the income statement when the Company places a loan on nonaccrual status. Therefore, Management excludes the accrued interest receivable balance from the amortized cost basis in measuring expected credit losses on the portfolio and does not record an allowance for credit losses on accrued interest receivable. As of June 30, 2021, the accrued interest receivable for loans recorded in Other Assets was $82.8 million.
The Company has a variety of assets that have a component that qualifies as an off-balance sheet exposure. These primarily include undrawn portions of revolving lines of credit and standby letters of credit. The expected losses associated with these exposures within the unfunded portion of the expected credit loss will be recorded as a liability on the balance sheet with an offsetting income statement expense. Management has determined that a majority of the Company’s off-balance-sheet credit exposures are not unconditionally cancellable. As part of the new combined ACL methodology implemented during the third quarter of 2020, Management completes funding studies based on historical data to estimate the percentage of unfunded loan commitments that will ultimately be funded to calculate the reserve for unfunded commitments. Management applies this funding rate, along with the loss factor rate determined for each pooled loan segment, to unfunded loan commitments, excluding unconditionally cancellable exposures and letters of credit, to arrive at the reserve for unfunded loan commitments. Prior to the third quarter, the Company applied a utilization rate instead of a funding rate to the South State legacy portfolio to determine the reserve for unfunded commitments. As of June 30, 2021, the liability recorded for expected credit losses on unfunded commitments was $31.0 million. The current adjustment to the ACL for unfunded commitments is recognized through the provision for credit losses in the Condensed Consolidated Statements of Income.
With the adoption of ASU 2016-13 on January 1, 2020, the Company changed its method for calculating it’s allowance for loans from an incurred loss method to a life of loan method. See Note 2 – Significant Accounting Policies and Note 7 – Allowance for Credit Losses for further details. As of June 30, 2021, the balance of the ACL was $350.4 million or 1.46% of total loans. The ACL decreased $56.1 million from the balance of $406.5 million recorded at March 31, 2021. This decrease during the second quarter of 2021 included a $53.9 million release or decline in the provision for credit losses in addition to $2.1 million in net charge-offs. In the first and second quarter of 2021, with the improvement in the economy and the increased availability of the COVID-19 vaccine, the Company has released $104.8 million of its allowance for credit losses based on improvements in forecasts. Since the prior comparative period, the ACL has decreased $84.2 million from the balance of $434.6 million recorded at June 30, 2020. This decrease included a net release of the provision for credit losses of $79.2 million since June 30, 2020 related to an improvement in the economy and forecasts during the first half of 2021 along with net charge-offs of $3.5 million.
At June 30, 2021, the Company had a reserve on unfunded commitments of $31.0 million which was recorded as a liability on the Balance Sheet, compared to $35.8 million at March 31, 2021. During three and six months ended June 30, 2021, the Company recorded a release of the allowance, or negative provision for credit losses, on unfunded commitments of $4.8 million and $12.4 million, respectively. With the improvement in the economy and the increased availability of the COVID-19 vaccine, the Company began to release some of this allowance for credit losses based on improvements in forecasts. This amount was recorded in (Recovery) Provision for Credit Losses on the Condensed Consolidated Statements of Net Income. For the prior comparative period, the Company had a reserve on unfunded commitments of $21.1 million recorded at June 30, 2020. With the adoption of ASU 2016-13 on January 1, 2020, the Company increased its reserve on unfunded commitments by $6.5 million. During the three and six months ended June 30, 2020, the provision for credit losses on unfunded commitments was $12.5 million and $14.3 million, respectively. Of these amounts, $9.6 million was related to the merger with CSFL during the second quarter of 2020. The Company did not have an allowance for credit losses or record a provision for credit losses on investment securities or other financials asset during the first six months of 2021.
At June 30, 2021, the allowance for credit losses was $350.4 million, or 1.46%, of period-end loans. The ACL provides 4.09 times coverage of nonperforming loans at June 30, 2021. Net charge-offs to the total average loans during three and six months ended June 30, 2021 were 0.03% and 0.02%, respectively. We continued to show solid and stable asset quality numbers and ratios as of June 30, 2021. The following table provides the allocation, by segment, for
69
expected credit losses. Because PPP loans are government guaranteed and management implemented additional reviews and procedures to help mitigate potential losses, Management does not expect to recognize credit losses on this loan portfolio and as a result, did not record an ACL for PPP loans within the C&I loan segment presented in the table below.
The following table provides the allocation, by segment, for expected credit losses.
%*
Residential Mortgage Senior
18.0
Residential Mortgage Junior
Revolving Mortgage
5.7
Residential Construction
Other Construction and Development
6.1
Owner Occupied Commercial Real Estate
21.3
Non Owner Occupied Commercial Real Estate
26.0
Commercial and Industrial
12.2
* Loan balance in each category expressed as a percentage of total loans, excluding PPP loans.
The following tables present a summary of three and six months ended June 30, 2021 and 2020:
Non-PCD
PCD
Balance at beginning of period
284,257
122,203
137,376
7,409
Allowance Adjustment - FMV for CSFL merger
Loans charged-off
(5,076)
(586)
(2,366)
(65)
1,647
773
Net (charge-offs) recoveries
(3,175)
1,061
(809)
708
(35,714)
(18,231)
143,734
(4,756)
138,978
Balance at end of period
245,368
105,033
280,301
154,307
Total loans, net of unearned income:
At period end
25,499,147
24,307,399
15,717,387
Net charge-offs as a percentage of average loans (annualized)
0.03
Allowance for credit losses as a percentage of period end loans
1.46
1.70
Allowance for credit losses as a percentage of period end non-performing loans (“NPLs”)
408.98
352.53
Allowance for credit losses at January 1
315,470
141,839
Adjustment for implementation of CECL
54,438
Allowance Adjustment - FMV for CenterState merger
(7,593)
(1,443)
(4,697)
(957)
3,881
3,062
2,397
1,842
(3,712)
1,619
(2,300)
885
(66,390)
(38,425)
174,644
(932)
173,712
24,399,234
13,578,606
0.02
71
Nonperforming Assets (“NPAs”)
The following table summarizes our nonperforming assets for the past five quarters:
March 31,
September 30,
Non-acquired:
Nonaccrual loans
14,221
16,956
16,035
18,078
19,011
Accruing loans past due 90 days or more
853
9,586
636
419
Restructured loans - nonaccrual
1,844
3,225
3,550
3,749
3,453
Total non-acquired nonperforming loans
16,624
21,034
29,171
22,463
22,883
Other real estate owned (“OREO”) (2) (6)
490
552
726
1,181
Other nonperforming assets (3)
251
164
Total non-acquired nonperforming assets
17,319
21,688
29,859
23,288
24,572
Acquired:
Nonaccrual loans (1)
69,053
79,919
75,603
89,067
99,346
2,065
907
1,053
Total acquired nonperforming loans
80,024
77,668
89,974
100,399
Acquired OREO and other nonperforming assets:
Acquired OREO (2) (7)
4,595
10,981
11,362
12,754
16,836
Other acquired nonperforming assets (3)
311
151
Total acquired nonperforming assets
73,830
91,316
89,236
102,878
117,386
Total nonperforming assets
91,149
113,004
119,095
126,166
141,958
Excluding Acquired Assets
Total nonperforming assets as a percentage of total loans and repossessed assets (4)
0.12
0.16
0.24
0.20
0.23
Total nonperforming assets as a percentage of total assets (5)
0.04
0.05
0.08
0.06
0.07
Nonperforming loans as a percentage of period end loans (4)
0.19
0.22
Including Acquired Assets
0.38
0.46
0.48
0.50
0.56
Total nonperforming assets as a percentage of total assets
0.28
0.32
0.33
0.41
0.43
0.45
Total nonperforming assets were $91.1 million, or 0.38% of total loans and repossessed assets, at June 30, 2021, a decrease of $27.9 million, or 23.5%, from December 31, 2020. Total nonperforming loans were $85.7 million, or 0.36%, of total loans, at June 30, 2021, a decrease of $21.2 million, or 19.8%, from December 31, 2020. Non-acquired nonperforming loans declined by $12.5 million from December 31, 2020. The decline in non-acquired nonperforming loans was driven primarily by a decline in accruing loans past due 90 days or more of $9.0 million, a decrease in restructured nonaccrual loans of $1.7 million and a decrease in primarily commercial nonaccrual loans of $1.8 million. The accruing loans past due 90 days or more at December 31, 2020 were a group of similar loans that were deemed to be low risk and almost all of these loans were brought current in January 2021. Acquired nonperforming loans declined $8.6 million from December 31, 2020. The decline in the acquired nonperforming loan balances was due to a decrease in consumer nonaccrual loans of approximately $7.7 million, a decrease in accruing loans past due 90 days or more of $2.1 million, offset by an increase in commercial nonaccruing loans of $1.2 million.
At June 30, 2021, OREO totaled $5.0 million, which included $444,000 in non-acquired OREO and $4.6 million in acquired OREO. Total OREO decreased $6.9 million from December 31, 2020. At June 30, 2021, non-acquired OREO consisted of 3 properties with an average value of $148,000. This compared to 7 properties with an average value of $79,000 at December 31, 2020. In the second quarter of 2021, we added no new properties into non-acquired OREO, while selling 1 property with an aggregate value of $25,000. On the property sold, we recorded a net loss of $8,000. At June 30, 2021, acquired OREO consisted of 21 properties with an average value of $219,000. This compared to 35 properties with an average value of $325,000 at December 31, 2020. In the second quarter of 2021, we added no new properties into acquired OREO, while selling 21 properties with an aggregate value of $6.3 million during the current quarter. On the properties sold, we recorded a net gain of $6.0 million.
72
Potential Problem Loans
Potential problem loans, which are not included in nonperforming loans, related to non-acquired loans were approximately $20.2 million, or 0.14%, of total non-acquired loans outstanding, at June 30, 2021, compared to $5.9 million, or 0.05%, of total non-acquired loans outstanding, at December 31, 2020. Potential problem loans related to acquired loans totaled $18.5 million, or 0.19%, of total acquired loans outstanding, at June 30, 2021, compared to $13.4 million, or 0.11% of total acquired loans outstanding, at December 31, 2020. All potential problem loans represent those loans where information about possible credit problems of the borrowers has caused Management to have concern about the borrower’s ability to comply with present repayment terms.
Interest-bearing liabilities include interest-bearing transaction accounts, savings deposits, CDs, other time deposits, federal funds purchased, securities sold under agreements to repurchase and other borrowings. Interest-bearing transaction accounts include NOW, HSA, IOLTA, and Market Rate checking accounts.
Total deposits increased $2.5 billion or 16.7% annualized to $33.2 billion at June 30, 2021 from $30.7 billion at December 31, 2020. We continue to focus on increasing core deposits (excluding certificates of deposits and other time deposits), which increased $3.0 billion during the six months ended June 30, 2021 as these funds are normally lower cost funds. Federal funds purchased related to the correspondent bank division and repurchase agreements were $862.4 million at June 30, 2021 up $82.8 million from December 31, 2020. Corporate and subordinated debentures declined by $63.6 million to $326.5 million as the Company redeemed during the second quarter of 2021 some of the debt assumed in the merger with CSFL. Some key highlights are outlined below:
Noninterest-bearing deposits are transaction accounts that provide our Bank with “interest-free” sources of funds. At June 30, 2021, the period end balance of noninterest-bearing deposits was $11.2 billion exceeding the December 31, 2020 balance by $1.5 billion. We continue to focus on increasing the noninterest-bearing deposits to try and limit our funding costs. This increase was also partially driven by the federal government stimulus programs in the first half of 2021 which pushed funds into the economy.
Capital Resources
Our ongoing capital requirements have been met primarily through retained earnings, less the payment of cash dividends. As of June 30, 2021, shareholders’ equity was $4.8 billion, an increase of $109.7 million, or 2.4%, from December 31, 2020. The change from year-end was mainly attributable to the increase in equity through net income less dividends paid, common stock repurchased pursuant to our stock repurchase plan and a decline in the market value of investment securities available for sale.
The following table shows the changes in shareholders’ equity during 2021.
Total shareholders' equity at December 31, 2020
Dividends paid on common shares ($0.47 per share)
Dividends paid on restricted stock units
Net decrease in market value of securities available for sale, net of deferred taxes
Equity based compensation
Common stock repurchased pursuant to stock repurchase plan
Common stock repurchased - equity plans
Total shareholders' equity at June 30, 2021
In June 2019, our Board of Directors announced the authorization for the repurchase of up to an additional 2,000,000 shares of our common stock under our 2019 Repurchase Program. Through December 31, 2020 we had repurchased 1,485,000 of the shares authorized. In January 2021, the Board of Directors of the Company approved the authorization of a new 3,500,000 share Company stock repurchase plan (the “2021 Stock Repurchase Plan”), which replaced in its entirety the revised 2019 Repurchase Program. Our Board of Directors approved the new plan after considering, among other things, our liquidity needs and capital resources as well as the estimated current value of our net assets. The number of shares to be purchased and the timing of the purchases are based on a variety of factors, including, but not limited to, the level of cash balances, general business conditions, regulatory requirements, the market price of our common stock, and the availability of alternative investment opportunities. As of June 30, 2021, we have repurchased 700,000 shares, at an average price of $85.94 per share, excluding cost of commissions, for a total of $60.2 million, under the 2021 Stock Repurchase Plan and may repurchase up to an additional 2,800,000 shares of common stock under the program.
Specifically, we are required to maintain the following minimum capital ratios:
●a CET1, risk-based capital ratio of 4.5%;
●a Tier 1 risk-based capital ratio of 6%;
●a total risk-based capital ratio of 8%; and
●a leverage ratio of 4%.
Under the current capital rules, Tier 1 capital includes two components: CET1 capital and additional Tier 1 capital. The highest form of capital, CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, otherwise referred to as AOCI, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily comprised of noncumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities (as discussed below). Tier 2 capital generally includes the allowance for loan losses up to 1.25% of risk-weighted assets, qualifying preferred stock, subordinated debt and qualifying tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial institution. Cumulative perpetual preferred stock is included only in Tier 2 capital, except that the capital rules permit bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 Capital (but not in CET1 capital), subject to certain restrictions. With the merger with CSFL during the second quarter of 2020, the Company’s $115.0 million in trust preferred securities no longer qualifies for Tier 1 capital and is now only included in Tier 2 capital for regulatory capital calculations. AOCI is presumptively included in CET1 capital and often would operate to reduce this category of capital. When the current capital rules were first implemented, the Bank exercised its one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI, allowing us to retain our pre-existing treatment for AOCI.
In order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three risk-based measurements (CET1, Tier 1 capital and total capital), resulting in the following effective minimum capital plus capital conservation buffer ratios: (i) a CET1 capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%.
The federal banking agencies revised their regulatory capital rules to (i) address the implementation of CECL; (ii) provide an optional three-year phase-in period for the day 1 adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. CECL became effective for us on January 1, 2020 and the Company applied the provisions of the standard using the modified retrospective method as a cumulative-effect adjustment to retained earnings. Related to the implementation of ASU 2016-13, we recorded additional allowance for credit losses for loans of $54.4 million, deferred tax assets of $12.6 million, an additional reserve for unfunded commitments of $6.4 million and an adjustment to retained earnings of $44.8 million. Instead of recognizing the effects on regulatory capital from ASU 2016-13 at adoption, the Company initially elected the option for recognizing the adoption date effects on the Company’s regulatory capital calculations over a three-year phase-in.
In 2020, in response to the COVID-19 pandemic, the federal banking agencies issued a final rule for additional transitional relief to regulatory capital related to the impact of the adoption of CECL. The final rule provides banking organizations that adopt CECL in the 2020 calendar year with the option to delay for two years the estimated impact of CECL on regulatory capital, followed by the aforementioned three-year transition period to phase out the aggregate amount of benefit during the initial two-year delay for a total five-year transition. The estimated impact of CECL on regulatory capital (modified CECL transitional amount) is calculated as the sum of the day-one impact on retained earnings upon adoption of CECL (CECL transitional amount) and the calculated change in the ACL relative to the day-one ACL upon adoption of CECL multiplied by a scaling factor of 25%. The scaling factor is used to approximate the difference in the ACL under CECL relative to the incurred loss methodology. The modified CECL transitional amount will be calculated each quarter for the first two years of the five-year transition. The amount of the modified CECL transition amount will be fixed as of December 31, 2021, and that amount will be subject to the three-year phase out. The Company chose the five-year transition method and is deferring the recognition of the effects from day 1 and the CECL difference for the first two years of application.
The well-capitalized minimums and the Company’s and the Bank’s regulatory capital ratios for the following periods are reflected below:
Well-Capitalized
Minimums
South State Corporation:
Common equity Tier 1 risk-based capital
N/A
Tier 1 risk-based capital
6.00
Total risk-based capital
Tier 1 leverage
South State Bank:
The Company’s and Bank’s Common equity Tier 1 risk-based capital and Tier 1 risk-based capital ratios increased compared to December 31, 2020. These ratios increased as Tier 1 capital increased through net income during 2021 and growth in total risk-based assets remained flat at both the Company and Bank. The Tier 1 leverage ratio declined slightly both at the Company and Bank as the percentage increase in Tier 1 risk-based capital was less than the percentage increase in the average assets for regulatory capital purposes. The increase in average assets was mainly due to an increase in cash and cash equivalents and investments from December 31, 2020 with deposits growing as the federal government has pushed funds into the market through stimulus programs in addition to consumers remaining conservative in their spending habits. The total risk-based capital increased at the Bank and declined at the Company. The increase in the total risk-based capital ratio at the Bank was due to the percentage increase in total risk-based capital being greater than the percentage increase in total risk-based assets. The reason for the decline in the total risk-based capital ratio at the Company was due the redemption of $25.0 million in subordinated debt and $38.5 million in trust preferred securities during the second quarter of 2021 that was included in total risked-based capital. Our capital ratios are currently well in excess of the minimum standards and continue to be in the “well capitalized” regulatory classification.
Liquidity
Liquidity refers to our ability to generate sufficient cash to meet our financial obligations, which arise primarily from the withdrawal of deposits, extension of credit and payment of operating expenses. Our Asset/Liability Management Committee (“ALCO”) is charged with monitoring liquidity management policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management. We have employed our funds in a manner to provide liquidity from both assets and liabilities sufficient to meet our cash needs.
Asset liquidity is maintained by the maturity structure of loans, investment securities and other short-term investments. Management has policies and procedures governing the length of time to maturity on loans and investments. Normally, changes in the earning asset mix are of a longer-term nature and are not utilized for day-to-day corporate liquidity needs.
Our liabilities provide liquidity on a day-to-day basis. Daily liquidity needs are met from deposit levels or from our use of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings. We engage in routine activities to retain deposits intended to enhance our liquidity position. These routine activities include various measures, such as the following:
Our non-acquired loan portfolio increased by approximately $1.9 billion, or approximately 30.4% annualized, compared to the balance at December 31, 2020. The increase from December 31, 2020 was mainly related to organic growth and renewals on acquired loans along with a net increase in non-acquired PPP loans of $80.4 million. The acquired loan portfolio decreased by $2.5 billion from the balance at December 31, 2020 through principal paydowns, charge-offs, foreclosures and renewals of acquired loans. This included a reduction in acquired PPP loans of $695.2 million.
Our investment securities portfolio (excluding trading securities) increased $1.3 billion compared to the balance at December 31, 2020. The increase in investment securities from December 31, 2020 was a result of purchases of $1.8 billion. This increase was partially offset by maturities, calls, sales and paydowns of investment securities totaling $475.5 million as well as declines in the market value of the available for sale investment securities portfolio of $30.8 million. Net amortization of premiums were $19.7 million in the first six months of 2021. The increase in investment securities was due to the Company making the strategic decision to increase the size of the portfolio with the excess funds from deposit growth. Total cash and cash equivalents were $6.4 billion at June 30, 2021 as compared to $4.6 billion at December 31, 2020 as deposits grew $2.5 billion during the six months of 2021.
At June 30, 2021 and December 31, 2020, we had $475.0 million and $600.0 million of traditional, out–of-market brokered deposits. At June 30, 2021 and December 31, 2020, we had $748.8 million and $611.1 million, respectively, of reciprocal brokered deposits. Total deposits were $33.2 billion at June 30, 2021, an increase of $2.5 billion from $30.7 billion at December 31, 2020. Our deposit growth since December 31, 2020 included an increase in demand deposit accounts of $1.5 billion, an increase in savings and money market accounts of $797.0 million and an increase in interest-bearing transaction accounts of $695.9 million partially offset by a decline in time deposits of $409.4 million. Total borrowings at June 30, 2021 were $351.5 million and consisted of trust preferred securities and subordinated debentures of $326.5 million and an outstanding balance on our holding company line of credit of $25.0 million. During the second quarter of 2021, total trust preferred securities and subordinated debentures declined by $63.6 million as the Company redeemed $38.5 million in trust preferred securities and $25.0 million in subordinated debentures, in addition to the repayment of $11.0 million of subordinated notes that matured during the quarter. With the redemption of the trust preferred securities, the remaining fair value mark on these borrowings of $11.7 was written off as an extinguishment of debt cost. The holding company also borrowed $25.0 million on a line of credit in June 2021 to provide some short term liquidity. This balance was paid off in July of 2021. Total short-term borrowings at June 30, 2021 were $862.4 million, consisting of $486.1 million in federal funds purchased and $376.3 million in securities sold under agreements to repurchase. To the extent that we employ other types of non-deposit funding sources, typically to accommodate retail and correspondent customers, we continue to take in shorter maturities of such funds. Our current approach may provide an opportunity to sustain a low funding rate or possibly lower our cost of funds but could also increase our cost of funds if interest rates rise.
Our ongoing philosophy is to remain in a liquid position, taking into account our current composition of earning assets, asset quality, capital position, and operating results. Our liquid earning assets include federal funds sold, balances at the Federal Reserve Bank, reverse repurchase agreements, and/or other short-term investments. Cyclical and other economic trends and conditions can disrupt our Bank’s desired liquidity position at any time. We expect that these conditions would generally be of a short-term nature. Under such circumstances, our Bank’s federal funds sold position and any balances at the Federal Reserve Bank serve as the primary sources of immediate liquidity. At June 30, 2021, our Bank had total federal funds credit lines of $325.0 million with no balance outstanding. If additional liquidity were needed, the Bank would turn to short-term borrowings as an alternative immediate funding source and would consider other appropriate actions such as promotions to increase core deposits or the sale of a portion of our investment portfolio. At June 30, 2021, our Bank had $1.3 billion of credit available at the Federal Reserve Bank’s Discount Window and had no balance outstanding. In addition, we could draw on additional alternative immediate funding sources from lines of credit extended to us from our correspondent banks and/or the FHLB. At June 30, 2021, our Bank had a total FHLB credit facility of $2.6 billion with total outstanding FHLB letters of credit consuming $12.0 million leaving $2.6 billion in availability on the FHLB credit facility. The holding company has a $100.0 million unsecured line of credit with a $25.0 million outstanding balance leaving $75.0 million in availability at June 30, 2021. We believe that our liquidity position continues to be adequate and readily available.
Our contingency funding plans incorporate several potential stages based on liquidity levels. Also, we review on at least an annual basis our liquidity position and our contingency funding plans with our principal banking regulator. We maintain various wholesale sources of funding. If our deposit retention efforts were to be unsuccessful, we would utilize these alternative sources of funding. Under such circumstances, depending on the external source of funds, our
77
interest cost would vary based on the range of interest rates we are charged. This could increase our cost of funds, impacting net interest margins and net interest spreads.
Asset-Liability Management and Market Risk Sensitivity
Our earnings and the economic value of equity vary in relation to the behavior of interest rates and the accompanying fluctuations in market prices of certain of our financial instruments. We define interest rate risk as the risk to earnings and equity arising from the behavior of interest rates. These behaviors include increases and decreases in interest rates as well as continuation of the current interest rate environment.
Our interest rate risk principally consists of reprice, option, basis, and yield curve risk. Reprice risk results from differences in the maturity or repricing characteristics of asset and liability portfolios. Option risk arises from embedded options in the investment and loan portfolios such as investment securities calls and loan prepayment options. Option risk also exists since deposit customers may withdraw funds at their discretion in response to general market conditions, competitive alternatives to existing accounts or other factors. The exercise of such options may result in higher costs or lower revenue. Basis risk refers to the potential for changes in the underlying relationship between market rates or indices, which subsequently result in narrowing spreads on interest-earning assets and interest-bearing liabilities. Basis risk also exists in administered rate liabilities, such as interest-bearing checking accounts, savings accounts, and money market accounts where the price sensitivity of such products may vary relative to general markets rates. Yield curve risk adverse consequences of nonparallel shifts in the yield curves of various market indices that impact our assets and liabilities.
We use simulation analysis as a primary method to assess earnings at risk and equity at risk due to assumed changes in interest rates. Management uses the results of its various simulation analyses in combination with other data and observations to formulate strategies designed to maintain interest rate risk within risk tolerances.
Simulation analysis involves the use of several assumptions including, but not limited to, the timing of cash flows such as the terms of contractual agreements, investment security calls, loan prepayment speeds, deposit attrition rates, the interest rate sensitivity of loans and deposits relative to general market rates, and the behavior of interest rates and spreads. Equity at risk simulation uses assumptions regarding discount rates that value cash flows. Simulation analysis is highly dependent on model assumptions that may vary from actual outcomes. Key simulation assumptions are subject to stress testing to assess the impact of assumption changes on earnings at risk and equity at risk. Model assumptions are reviewed by our Assumptions Committee.
Earnings at risk is defined as the percentage change in net interest income due to assumed changes in interest rates. Earnings at risk is generally used to assess interest rate risk over relatively short time horizons.
Equity at risk is defined as the percentage change in the net economic value of assets and liabilities due to changes in interest rates compared to a base net economic value. The discounted present value of all cash flows represents our economic value of equity. Equity at risk is generally considered a measure of the long-term interest rate exposures of the balance sheet at a point in time.
Mortgage banking derivatives used in the ordinary course of business consist of forward sales contracts and interest rate lock commitments on residential mortgage loans. These derivatives involve underlying items, such as interest rates, and are designed to mitigate risk. Derivatives are also used to hedge mortgage servicing rights.
From time to time, we execute interest rate swaps to hedge some of our interest rate risks. Under these arrangements, the Company enters into a variable rate loan with a client in addition to a swap agreement. The swap agreement effectively converts the client’s variable rate loan into a fixed rate loan. The Company then enters into a matching swap agreement with a third-party dealer to offset its exposure on the customer swap. The Company may also execute interest rate swap agreements that are not specific to client loans. As of the reporting date, the Company did not have such agreements.
The analysis provided below assumes the base case reflects interest rates as of the reporting date. Ramped and parallel interest rate shocks are applied over a one-year time horizon. This analysis is applied to a static balance sheet that assumes maturing or repricing assets and liabilities are replaced at current market prices and volumes consistent
78
with maintaining a stable balance sheet, with the exception of PPP loans that are not assumed to be replaced. The downward rate shock is subject to product floors and a zero-interest rate.
Percentage Change in Net Interest Income over One Year
Shock
Up 100 basis points
6.90%
Up 200 basis points
13.80%
Down 100 basis points
(1.50)%
Percentage Change in Economic Value of Equity
5.30%
9.50%
(4.00)%
LIBOR Transition
In July 2017, the Financial Conduct Authority (FCA), which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR at the end of 2021. On March 5, 2021, the FCA confirmed that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021 for the one-week and two-month US dollar settings and immediately after June 30, 2023 for all remaining US dollar settings.
The Alternative Reference Rates Committee has proposed SOFR as its preferred rate as an alternative to LIBOR and has proposed a paced market transition plan to SOFR from LIBOR. Organizations are currently working on industry-wide and company-specific transition plans related to derivatives and cash markets exposed to LIBOR. As noted within Part I - Item 1A. Risk Factors of the Company’s Annual Report on Form 10-K for the year ended 2020, we hold instruments that may be impacted by the discontinuance of LIBOR including floating rate obligations, loans, deposits, derivatives and hedges, and other financial instruments but is not able to currently predict the associated financial impact of the transition to an alternative reference rate. We have established a cross-functional LIBOR transition working group that has 1) assessed the Company's current exposure to LIBOR indexed instruments and the data, systems and processes that will be impacted; 2) established a detailed implementation plan; and 3) developed a formal governance structure for the transition.
Deposit and Loan Concentrations
We have no material concentration of deposits from any single customer or group of customers. We have no significant portion of our loans concentrated within a single industry or group of related industries. Furthermore, we attempt to avoid making loans that, in an aggregate amount, exceed 10% of total loans to a multiple number of borrowers engaged in similar business activities. As of June 30, 2021, there were no aggregated loan concentrations of this type. We do not believe there are any material seasonal factors that would have a material adverse effect on us. We do not have any foreign loans or deposits.
Concentration of Credit Risk
We consider concentrations of credit to exist when, pursuant to regulatory guidelines, the amounts loaned to a multiple number of borrowers engaged in similar business activities which would cause them to be similarly impacted by general economic conditions represents 25% of total Tier 1 capital plus regulatory adjusted allowance for loan losses of the Company, or $845.0 million at June 30, 2021. Based on this criteria, we had seven such credit concentrations at June 30, 2021, including loans on hotels and motels of $948.4 million, loans to lessors of nonresidential buildings (except mini-warehouses) of $4.0 billion, loans secured by owner occupied office buildings (including medical office buildings) of $1.7 billion, loans secured by owner occupied nonresidential buildings (excluding office buildings) of $1.4 billion, loans to lessors of residential buildings (investment properties and multi-family) of $1.3 billion, loans secured by 1st mortgage 1-4 family owner occupied residential property (including condos and home equity lines) of $4.0 billion and loans secured by jumbo (original loans greater than $548,250) 1st mortgage 1-4 family owner occupied residential property of $1.4 billion. The risk for these loans and for all loans is managed collectively through the use of credit
underwriting practices developed and updated over time. The loss estimate for these loans is determined using our standard ACL methodology.
With some financial institutions adopting CECL in the first quarter of 2020, banking regulators established new guidelines for calculating credit concentrations. Banking regulators set the guidelines for construction, land development and other land loans to total less than 100% of total Tier 1 capital less modified CECL transitional amount plus ACL (CDL concentration ratio) and for total commercial real estate loans (construction, land development and other land loans along with other non-owner occupied commercial real estate and multifamily loans) to total less than 300% of total Tier 1 capital less modified CECL transitional amount plus ACL (CRE concentration ratio). Both ratios are calculated by dividing certain types of loan balances for each of the two categories by the Bank’s total Tier 1 capital less modified CECL transitional amount plus ACL. At June 30, 2021 and December 31, 2020, the Bank’s CDL concentration ratio was 54.3% and 54.1%, respectively, and its CRE concentration ratio was 229.4% and 229.5%, respectively. As of June 30, 2021, the Bank was below the established regulatory guidelines. When a bank’s ratios are in excess of one or both of these loan concentration ratios guidelines, banking regulators generally require an increased level of monitoring in these lending areas by bank Management. Therefore, we monitor these two ratios as part of our concentration management processes.
Reconciliation of GAAP to Non-GAAP
The return on average tangible equity is a non-GAAP financial measure that excludes the effect of the average balance of intangible assets and adds back the after-tax amortization of intangibles to GAAP basis net income. Management believes these non-GAAP financial measures provide additional information that is useful to investors in evaluating our performance and capital and may facilitate comparisons with other institutions in the banking industry as well as period-to-period comparisons. Non-GAAP measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider South State’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of South State. Non-GAAP measures have limitations as analytical tools, are not audited, and may not be comparable to other similarly titled financial measures used by other companies. Investors should not consider non-GAAP measures in isolation or as a substitute for analysis of South State’s results or financial condition as reported under GAAP.
Return on average equity (GAAP)
Effect to adjust for intangible assets
5.74
(7.93)
7.07
(2.85)
Return on average tangible equity (non-GAAP)
Average shareholders’ equity (GAAP)
Average intangible assets
(1,730,572)
(1,240,650)
(1,732,039)
(1,146,070)
Adjusted average shareholders’ equity (non-GAAP)
3,008,669
1,659,793
2,981,300
1,472,325
Net income (loss) (GAAP)
(2,011)
(1,052)
(4,002)
(1,933)
Net income (loss) excluding the after-tax effect of amortization of intangibles (non-GAAP)
105,917
(81,322)
260,039
(55,086)
Cautionary Note Regarding Any Forward-Looking Statements
Statements included in this report, which are not historical in nature are intended to be, and are hereby identified as, forward-looking statements for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward looking statements are based on, among other things, Management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, South State, the merger with CSFL and the proposed acquisition of Atlantic Capital. Words and phrases such as “may,” “approximately,” “continue,” “should,” “expects,” “projects,” “anticipates,” “is likely,” “look ahead,” “look forward,” “believes,” “will,” “intends,” “estimates,” “strategy,” “plan,” “could,” “potential,” “possible” and variations of such words and similar expressions are intended to identify such forward-looking statements. We caution readers that forward-looking statements are subject to certain risks, uncertainties and assumptions that are difficult to predict with regard to, among other things, timing, extent, likelihood and degree of occurrence, which could cause actual results to differ materially from anticipated results. Such risks, uncertainties and assumptions, include, among others, the following:
For any forward-looking statements made in this report or in any documents incorporated by reference into this Report, we claim the protection of the safe harbor for forward looking statements contained in the Private Securities Litigation Reform Act of 1995. All forward-looking statements speak only as of the date they are made and are based on information available at that time. We do not undertake any obligation to update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by federal securities laws. As forward-looking statements involve significant risks and uncertainties, caution should be exercised against placing undue reliance on such statements. All subsequent written and oral forward-looking statements by us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Report.
Additional information with respect to factors that may cause actual results to differ materially from those contemplated by our forward-looking statements may also be included in other reports that we file with the SEC. We caution that the foregoing list of risk factors is not exclusive and not to place undue reliance on forward-looking statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in our quantitative and qualitative disclosures about market risk as of June 30, 2021 from those disclosures presented in our Annual Report on Form 10-K for the year ended 2020.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
South State’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of South State’s disclosure controls and procedures as of June 30, 2021, in accordance with Rule 13a-15 of the Securities Exchange Act of 1934. We applied our judgment in the process of reviewing these controls and procedures, which, by their nature, can provide only reasonable assurance regarding our control objectives. Based upon that evaluation, our Chief Executive Officer and the Chief Financial Officer concluded that South State’s disclosure controls and procedures as of June 30, 2021, were effective to provide reasonable assurance regarding our control objectives.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the three months ended June 30, 2021, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 1. LEGAL PROCEEDINGS
As of June 30, 2021 and the date of this Quarterly Report on Form 10-Q, we believe that we are not party to, nor is any or our property the subject of, any pending material legal proceeding other than those that may occur in the ordinary course of our business.
Item 1A. RISK FACTORS
Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Note Regarding Any Forward-Looking Statements” set forth in Part I, Item 2. of this Quarterly Report on Form 10-Q, risks and matters described elsewhere in this Quarterly Report on Form 10-Q and in our other filings with the SEC.
The Company is providing this additional risk factor to supplement the risk factors contained in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2020.
We may face risks with respect to future expansion, including our proposed acquisition of Atlantic Capital.
Our business growth, profitability and market share have been enhanced by us engaging in strategic mergers and acquisitions and de novo branching either within or contiguous to our existing footprint. We have entered into an Agreement and Plan of Merger with Atlantic Capital, and we may acquire other financial institutions or parts of those institutions in the future and engage in additional de novo branching. We may also consider and enter into or acquire new lines of business or offer new products or services. As part of our acquisition strategy, we seek companies that are culturally similar to us, have experienced management and are in markets in which we operate or close to those markets so we can achieve economies of scale. We also may receive future inquiries and have discussions with potential
acquirers of us or potential companies in which we may engage in a so-called “merger of equals.” Acquisitions and mergers, including our proposed acquisition of Atlantic Capital, involve a number of risks, including:
We also face litigation risks with respect to potential mergers and acquisitions, and such litigation is common.
We expect to continue to evaluate merger and acquisition opportunities that are presented to us in our current and expected markets and conduct due diligence related to those opportunities, as well as negotiate to acquire or merge with other institutions. If we announce a transaction, we may issue equity securities, including common stock and securities convertible into shares of our common stock in connection with future acquisitions. We also may issue debt to finance one or more transactions, including subordinated debt issuances. Generally, acquisitions of financial institution involve the payment of a premium over book and market values, resulting in dilution of our book value and fully diluted earnings per share, as well as dilution to our existing shareholders. We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. There is no assurance that, following any future mergers or acquisitions, including our proposed acquisition of Atlantic Capital, that our integration efforts will be successful or our company, after giving effect to the acquisition, will achieve increased revenues comparable to or better than our historical experience, and failure to realize such expected revenue increases, cost savings, increases in market presence or other benefits could have a material adverse effect on our financial conditions and results of operations.
We may not be able to successfully integrate our latest mergers or to realize the anticipated benefits of them.
On June 7, 2020, the Company and CSFL combined in a merger of equals, and we successfully completed the systems and operational conversion in May 2021. In addition, we entered into an Agreement and Plan of Merger with Atlantic Capital on July 23, 2021. If the proposed acquisition of Atlantic Capital is completed, we will also integrate the systems and operations of Atlantic Capital.
A successful integration of these banks’ operations with our operations so that the Company operates as one entity depends substantially on our ability to successfully consolidate operations, management teams, corporate cultures, systems and procedures and to eliminate redundancies and costs. While we have substantial experience in successfully integrating institutions we have acquired, we may encounter difficulties during integration, such as:
84
Integration activities could divert resources from regular operations. In addition, general market and economic conditions or governmental actions affecting the financial industry generally may inhibit the Company’s successful integration of these entities.
In addition, we merged with CSFL and have proposed to acquire Atlantic Capital with the expectation that these mergers will result in various benefits including, among other things, benefits relating to enhanced revenues, a strengthened and expanded market position for the combined company, technology efficiencies, cost savings and operating efficiencies. Achieving the anticipated benefits of these mergers is subject to a number of uncertainties, including whether we integrate these institutions in an efficient and effective manner, and general competitive factors in the marketplace. Failure to achieve these anticipated benefits could result in a reduction in the price of our shares as well as in increased costs, decreases in the amount of expected revenues and diversion of management's time and energy and could materially and adversely affect the Company’s financial condition, results of operations, business and prospects.
Changes to or the application of incorrect assumptions, estimates, or judgements in our financial statements could cause significant unexpected losses or impacts in the future.
For example, the CECL standard, as of January 1, 2020, requires that we provide reserves for a current estimate of lifetime expected credit losses for our loan portfolios and other financial assets, if applicable, at the time those assets are acquired or originated. This estimate is adjusted each period for changes in expected lifetime credit losses. Our allowance for credit losses estimate depends upon the CECL models and assumptions and forecasted macroeconomic conditions, including, among other things, the South Atlantic unemployment rate, and the credit indicators, composition, and other characteristics of our loan and other applicable portfolios. These model assumptions and forecasted macroeconomic conditions will change over time, whether due to the COVID-19 pandemic or other factors, resulting in greater variability in our ACL compared to its provision for loan losses under the previous GAAP methodology, and thus, will impact operations, as well as regulatory capital, including as the CECL phase-in begins as of January 1, 2022.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In June 2019, our Board of Directors announced the authorization for the repurchase of up to an additional 2,000,000 shares of our common stock under our 2019 Repurchase Program. Through December 31, 2020 we had repurchased 1,485,000 of the shares authorized. In January 2021, the Board of Directors of the Company approved the authorization of a new 3,500,000 share Company stock repurchase plan (the “2021 Stock Repurchase Plan”), which replaced in its entirety the revised 2019 Repurchase Program. As of June 30, 2021, we have repurchased 700,000 shares, at an average price of $85.94 per share (excluding cost of commissions) for a total of $60.2 million, of the 3,500,000 shares authorized for repurchase under the 2021 Stock Repurchase Plan and may repurchase up to an additional 2,800,000 shares of common stock under the program.
The following table reflects share repurchase activity during the second quarter of 2021:
(d) Maximum
(c) Total
Number (or
Number of
Approximate
Shares (or
Dollar Value) of
Units)
(a) Total
Purchased as
Units) that May
Part of Publicly
Yet Be
(b) Average
Announced
Purchased
Price Paid per
Plans or
Under the Plans
Period
Share (or Unit)
Programs
or Programs
April 1 ‑ April 30
1,745
*
81.47
3,500,000
May 1 - May 31
350,000
88.19
3,150,000
June 1 - June 30
350,221
83.70
2,800,000
701,966
700,000
For the months ended April 30, 2021 and June 30, 2021, totals include 1,745 shares and 221 shares, respectively, that were repurchased under arrangements, authorized by our stock-based compensation plans and Board of Directors, whereby officers or directors may sell previously owned shares to the Company in order to pay for the exercises of stock options or for income taxes owed on vesting shares of restricted stock. These shares were not purchased under the 2021 Stock Repurchase Plan to repurchase shares.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. MINE SAFETY DISCLOSURES
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS
The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated by reference.
Exhibit Index
Exhibit No.
Description
Exhibit 31.1
Rule 13a-14(a) Certification of Principal Executive Officer
Exhibit 31.2
Rule 13a-14(a) Certification of Principal Financial Officer
Exhibit 32
Section 1350 Certifications of Principal Executive Officer and Principal Financial Officer
Exhibit 101
The following financial statements from the Quarterly Report on Form 10-Q of South State Corporation for the quarter ended June 30, 2021, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Income, (iii) Condensed Consolidated Statements of Comprehensive Income, (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) Condensed Consolidated Statement of Cash Flows and (vi) Notes to Condensed Consolidated Financial Statements.
Exhibit 104
Cover Page Interactive Data File (the cover page XBRL tags are embedded within the Inline XBRL document).
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: August 6, 2021
/s/ John C. Corbett
John C. Corbett
President and Chief Executive Officer
(Principal Executive Officer)
/s/ William E. Matthews, V
William E. Matthews, V
Senior Executive Vice President,
Chief Financial Officer
(Principal Financial Officer)
/s/ Sara G. Arana
Sara G. Arana
Senior Vice President and
Principal Accounting Officer
87