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SFNC > SEC Filings for SFNC > Form 10-Q on 11-Aug-2014All Recent SEC Filings

Show all filings for SIMMONS FIRST NATIONAL CORP

Form 10-Q for SIMMONS FIRST NATIONAL CORP


11-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

OVERVIEW

Our net income for the three months ended June 30, 2014, was $9.9 million and diluted earnings per share were $0.60, compared to net income of $6.6 million and $0.40 diluted earnings per share for the same period of 2013. Net income for the six months ended June 30, 2014, was $14.3 million and diluted earnings per share were $0.87, compared to net income of $12.5 million and $0.76 diluted earnings per share for the same period of 2013.

Net income for the first and second quarters in both 2014 and 2013 included significant nonrecurring items that impacted net income. The majority of these items, which we will discuss later in this section, were related to our acquisitions. Excluding all nonrecurring items, core earnings for the three months ended June 30, 2014 were $9.2 million, or $0.56 diluted core earnings per share, compared to $6.4 million, or $0.39 diluted core earnings per share for the same period in 2013. Diluted core earnings per share increased by $0.17, or 43.6%. Core earnings for the six months ended June 30, 2014 were $16.6 million, or $1.02 diluted core earnings per share, compared to $12.5 million, or $0.76 diluted core earnings per share for the same period in 2013. Diluted core earnings per share increased by $0.26, or 34.2%. See Reconciliation of Non-GAAP Measures and Table 13 - Reconciliation of Core Earnings (non-GAAP) for additional discussion of non-GAAP measures.

On November 25, 2013, we closed the transaction to acquire Metropolitan National Bank ("Metropolitan" or "MNB"), headquartered in Little Rock, Arkansas. During the first quarter of 2014 we completed the system integration and branch consolidation associated with the Metropolitan acquisition. We also entered into a definitive agreement and plan of merger with Delta Trust & Banking Corporation ("Delta Trust"), also headquartered in Little Rock, including its wholly-owned bank subsidiary Delta Trust & Bank, with plans to complete the transaction in the third quarter of 2014.

During the second quarter of 2014, we entered into a definitive agreement and plan of merger with Community First Bancshares, Inc. ("Community First"), headquartered in Union City, Tennessee, including its wholly-owned bank subsidiary First State Bank ("First State"). During the second quarter we also entered into a definitive agreement and plan of merger with Liberty Bancshares, Inc. ("Liberty"), headquartered in Springfield, Missouri, including its wholly-owned bank subsidiary Liberty Bank. We plan to complete both of these transactions in the fourth quarter of 2014.

The second quarter of 2014 was a landmark quarter for Simmons. We announced two acquisitions totaling approximately $3 billion in assets and reported record core earnings and record core earnings per share for the quarter. As a result of acquisitions and efficiency initiatives in recent reporting periods, we have and will continue to recognize one-time revenue and expense items which may skew our short-term core business results but provide long-term performance benefits. Our focus continues to be improvement in core operating income.

We are also pleased with the positive trends in our balance sheet, as reflected in our organic loan growth as well as in our growth from acquisitions, which enabled us to produce a net interest margin of 4.34% for the quarter.

Stockholders' equity as of June 30, 2014 was $414.1 million, book value per share was $25.36 and tangible book value per share was $19.69. Our ratio of stockholders' equity to total assets was 9.6% and the ratio of tangible stockholders' equity to tangible assets was 7.6% at June 30, 2014. The Company's Tier I leverage ratio of 8.4%, as well as our other regulatory capital ratios, remain significantly above the "well capitalized" levels (see Table 12 in the Capital section of this Item).

Total assets were $4.33 billion at June 30, 2014, compared to $4.38 billion at December 31, 2013 and $3.42 billion at June 30, 2013. Total loans, including loans acquired, were $2.39 billion at June 30, 2014, compared to $2.40 billion at December 31, 2013 and $1.88 billion at June 30, 2013. We continue to have good asset quality.

Simmons First National Corporation is a $4.3 billion Arkansas based financial holding company conducting financial operations throughout Arkansas, Kansas and Missouri. Including the pending acquisitions, we project pro forma assets of $8.1 billion with an expansion of our operations within Arkansas, Missouri, and into Tennessee.

Subsidiary Bank Consolidation

We announced in March our plans to consolidate our seven subsidiary banks into a single banking organization, Simmons First National Bank ("Simmons Bank"), headquartered in Pine Bluff, Arkansas. We completed the first phase by consolidating three subsidiary banks into Simmons Bank in May, and will complete the final phase by consolidating the remaining three subsidiary banks into Simmons Bank in August. The elimination of the separate bank charters will increase the Company's efficiency and assist us in more effectively meeting the increased regulatory burden currently facing banking institutions. There are many operational functions that we currently perform separately for each of our seven banks; after the consolidation, these tasks will only need to be performed once.


We expect our customers to experience a positive impact from this change. All of our banking and financial services will continue to be available in the same locations as before the consolidation. Our local management and Community Boards of Directors are committed to maintaining our nearby and neighborly service and this change will allow them more opportunity to meet the needs of our customers and the communities we serve.

CRITICAL ACCOUNTING POLICIES

Overview

We follow accounting and reporting policies that conform, in all material respects, to generally accepted accounting principles and to general practices within the financial services industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

We consider accounting estimates to be critical to reported financial results if
(i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.

The accounting policies that we view as critical to us are those relating to estimates and judgments regarding (a) the determination of the adequacy of the allowance for loan losses, (b) acquisition accounting and valuation of covered loans and related indemnification asset, (c) the valuation of goodwill and the useful lives applied to intangible assets, (d) the valuation of employee benefit plans and (e) income taxes.

Allowance for Loan Losses on Loans Not Acquired

The allowance for loan losses is management's estimate of probable losses in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is calculated monthly based on management's assessment of several factors such as (1) historical loss experience based on volumes and types, (2) volume and trends in delinquencies and nonaccruals, (3) lending policies and procedures including those for loan losses, collections and recoveries, (4) national, state and local economic trends and conditions, (5) concentrations of credit within the loan portfolio, (6) the experience, ability and depth of lending management and staff and (7) other factors and trends that will affect specific loans and categories of loans. We establish general allocations for each major loan category. This category also includes allocations to loans which are collectively evaluated for loss such as credit cards, one-to-four family owner occupied residential real estate loans and other consumer loans. General reserves have been established, based upon the aforementioned factors and allocated to the individual loan categories. Allowances are accrued for probable losses on specific loans evaluated for impairment for which the basis of each loan, including accrued interest, exceeds the discounted amount of expected future collections of interest and principal or, alternatively, the fair value of loan collateral.

Our evaluation of the allowance for loan losses is inherently subjective as it requires material estimates. The actual amounts of loan losses realized in the near term could differ from the amounts estimated in arriving at the allowance for loan losses reported in the financial statements.

Acquisition Accounting, Acquired Loans

We account for our acquisitions under ASC Topic 805, Business Combinations, which requires the use of the purchase method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic 820, exclusive of the shared-loss agreements with the FDIC. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.


We evaluate loans acquired in accordance with the provisions of ASC Topic 310-20, Nonrefundable Fees and Other Costs. The fair value discount on these loans is accreted into interest income over the weighted average life of the loans using a constant yield method. These loans are not considered to be impaired loans. We evaluate purchased impaired loans accordance with the provisions of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased loans are considered impaired if there is evidence of credit deterioration since origination and if it is probable that not all contractually required payments will be collected.

We evaluate all of the loans purchased in conjunction with its FDIC-assisted transactions in accordance with the provisions of ASC Topic 310-30. All loans acquired in the FDIC transactions, both covered and not covered, were deemed to be impaired loans. All loans acquired, whether or not covered by FDIC loss share agreements, are considered impaired if there is evidence of credit deterioration since origination and if it is probable that not all contractually required payments will be collected.

For impaired loans accounted for under ASC Topic 310-30, we continue to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques, and on purchased credit impaired loans. We evaluate at each balance sheet date whether the present value of our pools of loans and purchased credit impaired loans determined using the effective interest rates has decreased significantly and if so, recognize a provision for loan loss in our consolidated statement of income. For any significant increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the pool's remaining life or over the remaining life of the purchased credit impaired loans.

Covered Loans and Related Indemnification Asset

Because the FDIC will reimburse us for losses incurred on certain acquired loans, an indemnification asset is recorded at fair value at the acquisition date. The indemnification asset is recognized at the same time as the indemnified loans, and measured on the same basis, subject to collectability or contractual limitations. The shared-loss agreements on the acquisition date reflect the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflects counterparty credit risk and other uncertainties.

The shared-loss agreements continue to be measured on the same basis as the related indemnified loans, as prescribed by ASC Topic 805. Deterioration in the credit quality of the loans (immediately recorded as an adjustment to the allowance for loan losses) would immediately increase the basis of the shared-loss agreements, with the offset recorded through the consolidated statement of income. Increases in the credit quality or cash flows of loans (reflected as an adjustment to yield and accreted into income over the remaining life of the loans) decrease the basis of the shared-loss agreements, with such decrease being accreted into income over (1) the same period or (2) the life of the shared-loss agreements, whichever is shorter. Loss assumptions used in the basis of the indemnified loans are consistent with the loss assumptions used to measure the indemnification asset. Fair value accounting incorporates into the fair value of the indemnification asset an element of the time value of money, which is accreted back into income over the life of the shared-loss agreements.

Upon the determination of an incurred loss the indemnification asset will be reduced by the amount owed by the FDIC. A corresponding, claim receivable is recorded until cash is received from the FDIC. For further discussion of our acquisition and loan accounting, see Note 5, Loans Acquired, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report.

Goodwill and Intangible Assets

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that also lack physical substance but can be separately distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. We perform an annual goodwill impairment test, and more than annually if circumstances warrant, in accordance with ASC Topic 350, Intangibles - Goodwill and Other, as amended by ASU 2011-08 - Testing Goodwill for Impairment. ASC Topic 350 requires that goodwill and intangible assets that have indefinite lives be reviewed for impairment annually, or more frequently if certain conditions occur. Impairment losses, if any, will be recorded as operating expenses.


Employee Benefit Plans

We have adopted various stock-based compensation plans. The plans provide for the grant of incentive stock options, nonqualified stock options, stock appreciation rights and bonus stock awards. Pursuant to the plans, shares are reserved for future issuance by the Company upon exercise of stock options or awarding of bonus shares granted to directors, officers and other key employees.

In accordance with ASC Topic 718, Compensation - Stock Compensation, the fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model that uses various assumptions. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. For additional information, see Note 13, Stock Based Compensation, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report.

Income Taxes

We are subject to the federal income tax laws of the United States, and the tax laws of the states and other jurisdictions where we conduct business. Due to the complexity of these laws, taxpayers and the taxing authorities may subject these laws to different interpretations. Management must make conclusions and estimates about the application of these innately intricate laws, related regulations, and case law. When preparing the Company's income tax returns, management attempts to make reasonable interpretations of the tax laws. Taxing authorities have the ability to challenge management's analysis of the tax law or any reinterpretation management makes in its ongoing assessment of facts and the developing case law. Management assesses the reasonableness of its effective tax rate quarterly based on its current estimate of net income and the applicable taxes expected for the full year. On a quarterly basis, management also reviews circumstances and developments in tax law affecting the reasonableness of deferred tax assets and liabilities and reserves for contingent tax liabilities.

NET INTEREST INCOME

Overview

Net interest income, our principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets. Factors that determine the level of net interest income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, the level of non-performing loans and the amount of non-interest bearing liabilities supporting earning assets. Net interest income is analyzed in the discussion and tables below on a fully taxable equivalent basis. The adjustment to convert certain income to a fully taxable equivalent basis consists of dividing tax-exempt income by one minus the combined federal and state income tax rate of 39.225%.

Our practice is to limit exposure to interest rate movements by maintaining a significant portion of earning assets and interest bearing liabilities in short-term repricing. Historically, approximately 70% of our loan portfolio and approximately 80% of our time deposits have repriced in one year or less. These historical percentages are fairly consistent with our current interest rate sensitivity.

Net Interest Income Quarter-to-Date Analysis

For the three month period ended June 30, 2014, net interest income on a fully taxable equivalent basis was $42.1 million, an increase of $11.5 million, or 37.3%, over the same period in 2013. The increase in net interest income was the result of an $11.9 million increase in interest income and a $0.4 million increase in interest expense.

The increase in interest income primarily resulted from a $9.5 million increase in interest income on loans and a $2.4 million increase in interest income on investment securities. The increase in interest income on investment securities was primarily due to volume increases resulting from the Metropolitan acquisition in late 2013. The increase in interest income from loans consisted of a $9.4 million increase in interest income on loans acquired and a $0.1 million increase in interest income on legacy loans. Although the increase in legacy loan volume generated $1.6 million of additional interest income, a 37 basis point decline in yield resulted in a $1.5 million decrease in interest income, netting the small $0.1 million increase from legacy loans.


The $9.4 million increase in interest income from acquired loans resulted from two sources. First, the average balance of acquired loans increased by $374.2 million from June 30, 2013 to June 30, 2014 because of the Metropolitan acquisition. Also, we recognized additional yield accretion in conjunction with the fair value of the loan pools acquired in the 2010 and 2012 FDIC-assisted transactions as discussed in Note 5, Loans Acquired, in the accompanying Condensed Notes to Consolidated Financial Statements included elsewhere in this report. Each quarter, we estimate the cash flows expected to be collected from the acquired loan pools. Beginning in the fourth quarter of 2011, the cash flows estimate has increased on the loans acquired in 2010 based on payment histories and reduced loss expectations of the loan pools. Beginning in the third quarter of 2013, the cash flows estimate has also increased on the loans acquired in 2012. This resulted in increased interest income that is spread on a level-yield basis over the remaining expected lives of the loan pools. The increases in expected cash flows also reduce the amount of expected reimbursements under the loss sharing agreements with the FDIC, which are recorded as indemnification assets. The estimated adjustments to the indemnification assets are amortized on a level-yield basis over the remainder of the loss sharing agreements or the remaining expected life of the loan pools, whichever is shorter, and are recorded in non-interest expense.

For the three months ended June 30, 2014, the adjustments increased interest income by an additional $2.7 million and decreased non-interest income by an additional $3.3 million compared to the same period in 2013. The net decrease to 2014 second quarter pre-tax income was $642,000 from 2013. Because these adjustments will be recognized over the estimated remaining lives of the loan pools and the remainder of the loss sharing agreements, respectively, they will impact future periods as well. The current estimate of the remaining accretable yield adjustment that will positively impact interest income is $25.1 million and the remaining adjustment to the indemnification assets that will reduce non-interest income is $18.6 million. Of the remaining adjustments, we expect to recognize $9.6 million of interest income and a $10.6 million reduction of non-interest income for a net reduction to pre-tax income of approximately $1.0 million during the remainder of 2014. The accretable yield adjustments recorded in future periods will change as we continue to evaluate expected cash flows from the acquired loan pools.

The $0.4 million increase in interest expense is primarily the result of $46.0 million in 3.25% floating rate notes payable secured as partial funding for our Metropolitan acquisition. The decrease in interest expense from lower interest rates on our deposit accounts offset the increased interest expense from the growth in deposits, primarily from Metropolitan.

Net Interest Income Year-to-Date Analysis

For the six month period ended June 30, 2014, net interest income on a fully taxable equivalent basis was $85.4 million, an increase of $23.5 million, or 38.1%, over the same period in 2013. The increase in net interest income was the result of a $24.3 million increase in interest income and a $0.8 million increase in interest expense.

The increase in interest income resulted from a $19.8 million increase in interest income on loans and a $4.6 million increase in interest income on investment securities. The increase in interest income on investment securities was primarily due to volume increases resulting from the Metropolitan acquisition in late 2013. The increase in interest income from loans consisted of a $21.8 million increase in interest income on loans acquired and a $2.0 million decrease in interest income on legacy loans. Although the increase in legacy loan volume generated $2.4 million of additional interest income, a 51 basis point decline in yield resulted in a $4.4 million decrease in interest income, netting the $2.0 million decrease from legacy loans.

The $21.8 million increase in interest income from acquired loans resulted from two sources. First, the average balance of acquired loans increased by $412.3 million because of the Metropolitan acquisition. Also, we recognized additional yield accretion from the accretable yield adjustments related to the loan pools acquired in the FDIC-assisted transactions. For the six months ended June 30, 2014, the adjustments increased interest income by an additional $7.1 million and decreased non-interest income by an additional $7.9 million compared to the same period in 2013. The net decrease to 2014 year-to-date pre-tax income was $810,000 from 2013.

The $0.8 million increase in interest expense is primarily the result of the $46.0 million in 3.25% floating rate notes payable issued as partial funding for our Metropolitan acquisition. The decrease in interest expense from lower interest rates on our deposit accounts offset the increased interest expense from the growth in deposits, primarily from Metropolitan.

Net Interest Margin

Our net interest margin increased 38 basis points to 4.34% for the three month period ended June 30, 2014, when compared to 3.96% for the same period in 2013. For the six month period ended June 30, 2014, net interest margin increased 46 basis points to 4.44% when compared to 3.98% for the same period in 2013. The margin has been strengthened from the impact of the accretable yield adjustments discussed above. Also, the acquisition of loans, along with our ability to stabilize the size of our legacy loan portfolio, has allowed us to increase our level of higher yielding assets. Conversely, while keeping us prepared to benefit from rising interest rates, our high levels of liquidity continue to compress our margin.


Although interest income from our accretable yield adjustments has increased from 2013, the total accretable yield is declining as our FDIC-assisted acquired loan portfolios begin to mature. This reduction in total accretable yield also acts to compress our margin.

Net Interest Income Tables

Tables 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the three month and six month periods ended June 30, 2014 and 2013, respectively, as well as changes in fully taxable equivalent net interest margin for the three month and six month periods ended June 30, 2014, versus June 30, 2013.

Table 1: Analysis of Net Interest Margin
(FTE =Fully Taxable Equivalent)

                                         Three Months Ended          Six Months Ended
                                              June 30,                   June 30,
(In thousands)                            2014          2013         2014         2013

Interest income                        $   43,842     $ 32,571     $ 88,876     $ 65,803
FTE adjustment                              1,695        1,095        3,387        2,168
Interest income - FTE                      45,537       33,666       92,263       67,971
Interest expense                            3,414        2,989        6,904        6,146
Net interest income - FTE              $   42,123     $ 30,677     $ 85,359     $ 61,825

Yield on earning assets - FTE                4.69 %       4.35 %       4.80 %       4.38 %
Cost of interest bearing liabilities         0.44 %       0.48 %       0.44 %       0.49 %
Net interest spread - FTE                    4.25 %       3.87 %       4.36 %       3.89 %
Net interest margin - FTE                    4.34 %       3.96 %       4.44 %       3.98 %

Table 2: Changes in Fully Taxable Equivalent Net Interest Margin

                                                                    Three Months Ended       Six Months Ended
                                                                         June 30,                June 30,
(In thousands)                                                        2014 vs. 2013           2014 vs. 2013

Increase due to change in earning assets                           $             15,000     $           30,492
Decrease due to change in earning asset yields                                   (3,129 )               (6,200 )
Increase due to change in interest bearing liabilities                             (795 )               (1,627 )
. . .
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