Sierra Bancorp — 2020 Form 10-K
Business context and reporting period. Sierra Bancorp is a California bank holding company whose principal subsidiary, Bank of the Sierra, provides retail and commercial banking services across California. This filing covers the fiscal year ended December 31, 2020; quarterly figures below are unaudited. The company operated 40 full-service branches and reported $3.22 billion in assets.
Financial performance and condition
- Profitability: Net income was $35.4 million, down 1.4% from $36.0 million in 2019. Diluted EPS was $2.32 versus $2.33. Return on average assets declined to 1.22% from 1.40%; return on average equity fell to 10.80% from 12.23%.
- Revenue and margins: Net interest income rose 8% to $104.8 million as lower funding costs and asset growth more than offset lower asset yields. Net interest margin fell 24 basis points to 3.95%. Noninterest income increased 11% to $26.2 million. Interest income was $110.2 million, slightly below $110.9 million in 2019.
- Credit costs and expenses: Provision for loan and lease losses increased to $8.6 million from $2.6 million. Noninterest expense rose 8% to $75.9 million, including a $4.2 million increase in salaries and benefits. The efficiency ratio improved slightly to 57.18% from 57.46%.
- Loans and asset quality: Gross loans grew 40% to $2.46 billion, including substantial growth in non-owner-occupied real estate, mortgage warehouse lines and PPP loans. Real estate represented 77% of loans. Nonperforming assets were $8.6 million, or 0.35% of loans and foreclosed assets, versus $6.5 million and 0.37% a year earlier. The allowance was $17.7 million, 0.72% of gross loans, compared with $9.9 million and 0.56%.
- Deposits and liquidity: Deposits increased 21% to $2.62 billion, with growth concentrated in noninterest-bearing and other low-cost transaction accounts. Cash and cash equivalents were $71.4 million, down from $80.1 million. Management reported $1.20 billion in primary and secondary liquidity sources and stated they were sufficient for anticipated short-term needs. Net loans to deposits rose to 93.05% from 80.96%.
- Capital and debt: Shareholders’ equity increased 11% to $343.9 million. The company’s community bank leverage ratio was 10.50% and the Bank’s was 10.12%, above the 8% year-end 2020 requirement; both were classified as well capitalized. Year-end liabilities included $142.9 million in short-term borrowings, $39.1 million in repurchase agreements and $35.1 million in subordinated debentures.
- Cash flow: Operating cash flow was $40.0 million, down from $46.7 million. Investing activities used $627.3 million, primarily reflecting loan growth; financing activities provided $578.6 million, mainly from deposit growth and borrowings. Cash and cash equivalents decreased $8.7 million during the year.
- Shareholder returns: Cash dividends were $0.80 per share, totaling $12.2 million, or about 34% of net income. The company repurchased 112,050 shares for $2.6 million during 2020.
Material changes versus the prior comparable period
- Loan growth drove a 24% increase in total assets to $3.22 billion; deposits grew 21%. Gross loans rose by approximately $700 million, including $119.4 million of PPP loans and $118.6 million of mortgage warehouse growth.
- Net interest income increased despite a lower net interest margin, as deposit and borrowing costs declined sharply. The lower-rate environment also reduced yields on earning assets.
- The larger loan portfolio and uncertainty about COVID-19 impacts drove the higher provision. Net charge-offs, however, declined to $0.7 million from $2.4 million.
- Noninterest income benefited from a $1.5 million gain associated with the wind-up of low-income housing tax credit investments, lower related investment expenses, and securities gains. Salaries and benefits were the main driver of higher expenses.
- Equity benefited from a $12.5 million increase in accumulated other comprehensive income, largely reflecting higher available-for-sale securities values as interest rates fell; this value could decline if rates rise.
Outlook, commentary and risks
- Management said overall net income was expected to decline, with the low interest-rate environment a principal pressure. It anticipated slower organic loan growth than in 2020 and noted the loan pipeline had softened as it sought to diversify lending, particularly non-owner-occupied commercial real estate. The filing provides no formal numerical earnings or revenue guidance.
- COVID-19 created uncertainty around borrower repayment, collateral values, fee income, deposit flows and operating conditions. At year-end, $29.5 million of loans remained under qualifying payment modifications and continued accruing interest; $1.4 million of loans previously deferred were placed on nonaccrual. The company had previously processed short-term modifications on about $424.9 million of loans.
- Commercial real estate concentration is a key risk: regulatory-guideline CRE loans were 378% of Tier 1 capital plus allowance, and the CRE portfolio had grown more than 50% over three years. Management said its underwriting, credit administration and monitoring addressed the risk. Hotel loans were 9% of total loans; loans to lessors of non-residential buildings were 32%.
- The company deferred CECL implementation and expected to adopt it on January 1, 2022. Its December 2020 estimate indicated an approximately $8.9 million increase in the loan allowance and $0.8 million increase in the unfunded-commitment reserve at adoption; management cautioned estimates remained subject to refinement.
- Interest-rate modeling showed a 100-basis-point rate decline could reduce projected 12-month net interest income by about $8.6 million, or 7.67%, versus a stable-rate scenario. A 100-basis-point increase was projected to improve it by only about $0.6 million, or 0.51%.
- In February 2021, the board began considering permanent closure of up to five branches outside the bank’s primary market; any closures were expected, if pursued, in the third quarter of 2021. The estimated lease breakage fee was below $0.3 million, excluding accelerated leasehold-improvement amortization.
- The Bank received a “needs to improve” Community Reinvestment Act assessment rating in December 2020. The filing also identifies competition, agricultural and regional economic conditions, cybersecurity, interest-rate movements and real-estate values as risks. Management reported no material adverse effect from COVID-19 on capital or financial resources at year-end.
- Auditors issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective. The filing states ordinary-course legal claims were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether CRE and hotel-related borrowers remain current as COVID-related deferrals expire, and whether collateral values or credit classifications change.
- Whether the allowance remains adequate as loan growth, criticized assets and economic conditions evolve, and how the estimated CECL transition adjustment changes before adoption.
- Whether deposit growth is durable and funding needs remain manageable given the higher loan-to-deposit ratio and year-end short-term borrowings.
- Whether net interest margin and earnings respond as modeled to rates, deposit pricing and PPP loan forgiveness or fee recognition.
- Whether the CRA rating leads to remediation requirements or affects future expansion or acquisition plans, and whether any proposed branch closures proceed.
- Whether dividends and repurchases remain supportable by Bank earnings, capital and regulatory limits.