Westamerica Bancorporation — Q2 2011 Form 10-Q
Business context and reporting period. The California-based bank holding company reported unaudited results for the quarter and six months ended June 30, 2011. It serves customers primarily in Northern and Central California. Figures below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
- Q2 earnings: Net income was $21.3 million and diluted EPS was $0.74, versus $23.6 million and $0.80 in Q2 2010. The quarter included a $2.1 million litigation settlement accrual, reducing net income by $1.2 million and diluted EPS by $0.04.
- First-half earnings: Net income was $43.7 million and diluted EPS was $1.50, versus $47.1 million and $1.59 in the first half of 2010. The 2011 period also included $0.4 million after tax of Sonoma integration costs.
- Revenue and margin: Q2 net interest income on a fully taxable equivalent (FTE) basis was $55.8 million; noninterest income was $15.3 million. FTE net interest margin was 5.38%, down from 5.62% a year earlier. First-half FTE net interest income was $110.8 million, down 2.4%; first-half margin was 5.37%, versus 5.61%.
- Profitability and efficiency: Q2 return on assets was 1.73% and return on common equity was 15.64%, compared with 2.00% and 18.24%, respectively, a year earlier. The Q2 efficiency ratio was 48.2%, up from 44.4%.
- Credit costs: Provision for loan losses was $2.8 million in Q2 and $5.6 million in the first half, unchanged from comparable 2010 periods. At June 30, the allowance for loan losses was $33.0 million, or 1.68% of originated loans; the broader allowance for credit losses, including off-balance-sheet exposure, was $35.7 million.
- Balance sheet and funding: Total assets were $4.88 billion, total loans net of the allowance were $2.72 billion, deposits were $4.09 billion, and shareholders’ equity was $549.3 million. Compared with December 31, 2010, assets declined $54.8 million, loans declined $168.2 million, and deposits declined $44.6 million.
- Debt and capital: Short-term borrowings were $106.7 million, FHLB advances $46.4 million, and parent-company debt financing and notes payable $25.9 million. Company regulatory capital ratios were 14.58% Tier 1, 15.88% total capital, and 8.57% leverage; all exceeded the stated well-capitalized thresholds.
- Cash flow and liquidity: Operating activities generated $61.8 million in the first half. Investing activities provided $28.2 million and financing activities used $108.8 million; cash and due from banks ended at $320.1 million. Management described liquidity as strong, citing more than $700 million in overnight borrowing lines with none outstanding, Federal Reserve access, and projected $44.5 million of securities paydowns and maturities in Q3.
- Shareholder returns: First-half dividends were $0.72 per share. The company repurchased 640,000 shares for $31.7 million during the first half; 401,000 shares were repurchased in Q2.
Material changes versus comparable periods
- Q2 net income declined 9.7% year over year; first-half net income declined 7.4%. Lower asset yields and loan balances, lower deposit service charges, and the settlement accrual were principal factors.
- Q2 FTE net interest income fell 1.3%; the first-half decrease was 2.4%. Lower earning-asset yields and reduced loan volumes were partly offset by investment growth and lower funding costs.
- Noninterest income declined 3.0% in Q2 and 3.9% in the first half, largely because overdraft-related service charges fell following regulatory changes. Noninterest expense rose 6.9% in Q2, mainly due to the settlement accrual; first-half expense rose 2.3% and included Sonoma pre-integration costs.
- Total loans and deposits contracted from year-end. The available-for-sale securities portfolio increased to $705.1 million from $671.5 million, while held-to-maturity securities rose to $669.5 million from $580.7 million.
Outlook, commentary, risks, and unusual items
- Management provided no specific earnings or revenue guidance. It anticipated maintaining cash levels through the rest of 2011; loan demand and deposit growth were described as dependent on economic conditions, competition, interest rates, and customer behavior. Continued dividends were expected subject to Board discretion and capital, earnings, and asset-quality considerations.
- Management characterized credit quality as reasonably stable but warned nonperforming assets could fluctuate and that further increases in nonaccrual or delinquent loans cannot be ruled out. Purchased covered loans were $622.7 million, about 23% of the loan portfolio, with FDIC loss-sharing generally covering 80% of eligible losses under the applicable agreements.
- Covered assets are concentrated in California’s Central Valley, which management described as having weak economic conditions and declining real estate values. Management estimated the bank’s after-tax exposure to under-estimated First Tier covered-asset losses at $12.5 million and considered the likelihood of Second Tier losses remote; maximum after-tax Second Tier exposure was stated as $16 million under an extreme no-future-cash-flow scenario.
- The Bank had one restructured construction loan of $3.2 million, on nonaccrual status. The allowance for credit losses was considered adequate by management; this is an estimate subject to economic, collateral, and borrower conditions.
- A lawsuit alleging improper overdraft-fee assessment and payment-processing order had a preliminary mediated settlement, subject to court approval; the company accrued $2.1 million. Other legal matters also arise from lending, deposit processing, and employment practices.
- The company intended to redeem its $10 million subordinated note in August 2011 at a call premium of approximately 5% of principal, using cash earnings. The note qualified as regulatory capital.
- Key stated risks include persistent weak national and California economic conditions, interest-rate and liquidity risks, competition and regulatory change, credit and collateral deterioration, operational failures or fraud, and securities-market movements. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the overdraft-fee settlement received court approval and whether its final cost differed from the accrued amount.
- Subsequent trends in nonaccrual loans, delinquency, charge-offs, foreclosed property, and the adequacy of loan-loss reserves—especially for construction, commercial real estate, and covered loans.
- Whether declining loan balances and asset yields continue to pressure net interest income and margin, and whether deposit mix or rates change materially.
- Actual liquidity from securities maturities and paydowns, deposit trends, and use or availability of borrowing facilities.
- Completion and cost of the planned subordinated-note redemption, and the resulting effect on regulatory capital ratios.
- FTE net interest income, margin, and efficiency ratio are non-GAAP or company-defined measures; compare them with reported GAAP results and the company’s stated calculation methods.