Southside Bancshares: Rising Interest Rates Destroyed Book Value (NASDAQ:SBSI)
Back in January, I wasn’t sure what to make of Southside Bancshares (NASDAQ:NASDAQ: SBSI). I could see that the bank offered good balance sheet and investment quality, but the the sharp rise in interest rates also weighed on the value of securities for sale, which must be valued at market price.
Strong net interest income helped net income
During the second quarter of the year, the bank saw its net interest income increase as total interest income increased from $54m to $57m compared to the first quarter of the year, while that total interest expense increased from $5 million to $6 million. The result is an increase in net interest income from $49 million to $51 million. A decent result and the bank was able to maintain the extra loan loss provisions pretty. They were effectively non-existent on a net basis, with the bank writing off about $0.6 million of previously recorded provisions. Net interest income after taking into account these provisions for loan losses amounts to $51.7 million.
Net non-interest expense in the second quarter was approximately $23 million, which includes a loss of $2.2 million on available-for-sale securities that were actually sold (I will explain later that AFS securities that have not been sold weigh on the book value per share, but are not included in the income statement). Higher net non-interest expense offset the positive performance in net interest income, and the bank reported total pre-tax income of $28.7 million. Strong increase from $24.2m in Q2 2021 due to $23m difference in loan loss provisions and $5.5m improvement in net interest income partially offset by higher net non-interest expense.
Net income was approximately $25.4 million, resulting in EPS of $0.79. That brings first-half 2022 EPS to $1.56. A decrease from the $1.69 recorded in the first half of last year, but that result included an $8.5m provision reversal that added about $0.25 per share to pretax earnings.
As Southside currently pays a quarterly dividend of $0.34, this dividend is very well covered as the payout ratio is less than 50% based on past quarters earnings.
The loan portfolio remains satisfactory, but the book value has fallen
In my January article, I was actually quite charmed by the bank’s high exposure to cash and securities, but unfortunately it didn’t work out as well as I had expected or hoped. While the balance sheet is certain to be safer when about half of assets are invested in liquid assets such as cash and securities, the bank held nearly $2.8 billion in available-for-sale securities. at the end of last year.
And as interest rates started to rise, the value of those securities went down, and precisely because they were accounted for as an available-for-sale security, Southside has to use market values for those securities.
As you can see above, the bank’s management team executed some very significant changes. The total amount of AFS securities fell by almost 40%, while the proceeds from these disposals were used to constitute the portfolio of securities held until maturity. These do not need to be marked down based on market prices and this should result in a more stable book value.
It is important to see that the bank still sticks to its exposure to liquid assets. At the end of 2021, the bank had approximately $3.06 billion in cash and securities, and by the end of June this had decreased slightly to $2.99 billion. This still means that nearly 40% of the total amount of assets on the balance sheet was invested in liquid securities and cash. And around 30% of municipal securities in the portfolio available for sale are now hedged.
Looking at liabilities on the balance sheet, the only reason total equity dropped by $180 million is available-for-sale securities.
On a pre-tax basis, the bank actually had to take a discount of almost $300 million on securities held for sale. This is very unfortunate as it will be a few years before the bank can bring its book value back to the level of two quarters ago.
Fortunately, SBSI’s problems remain isolated from the interest rate issue that hits the value of available-for-sale securities. Looking at the bank’s loan portfolio, the total amount of unearned loans and delinquent loans remains very low. At the end of June, only $3.1 million of loans were in non-recognition status, while just under $5.8 million of loans were in default, as you can see below -below.
Since the total provision for loan losses still exceeds $35 million, the bank has a very healthy cushion even in the (unlikely) event that no dollar can be recovered on these loans.
Given that the bank has decided to add more held-to-maturity securities to the portfolio and has also invested in higher yielding mortgage-backed securities, we should see a substantial increase interest income and net interest income in the third quarter.
While the bank appears to be reasonably priced from an earnings perspective at around 11 times earnings, which isn’t too bad considering the local bank runs a safe balance sheet, the premium to book value tangible has increased considerably.
At the end of 2021, SBSI had net equity (defined as equity less goodwill) of $711 million or approximately $22/share, but due to value destruction in the securities portfolio, the value equity had fallen to just under $732 million by the end of June. After deducting $201 million of goodwill, tangible equity fell to just $531 million, or just $16.5 per share. This means the bank is now trading at more than 2x tangible book value, and while that makes SBSI very attractive if you’re speculating on sudden interest rate cuts, that valuation is just a tad too high for my liking. .
A very well run bank, but I’m not interested in the current valuation.