Sierra Bancorp (NASDAQ: BSRR) — Q3 2019 Form 10-Q
Business context and reporting period
Sierra Bancorp is the holding company for Bank of the Sierra, a California community bank serving the South San Joaquin Valley, Central Coast, Ventura County and nearby areas. This unaudited report covers the quarter and nine months ended September 30, 2019. Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $24.4 | $23.8 | $72.5 | $68.3 |
| Provision for loan losses | $1.4 | $2.5 | $2.1 | $3.0 |
| Noninterest income | $5.9 | $5.7 | $17.6 | $16.3 |
| Noninterest expense | $17.1 | $17.8 | $52.6 | $53.0 |
| Net income | $9.0 | $7.1 | $26.7 | $21.8 |
| Diluted EPS | $0.58 | $0.46 | $1.73 | $1.41 |
| Tax-equivalent net interest margin | 4.09% | 4.27% | 4.20% | 4.24% |
- Q3 net income increased 27%; nine-month net income increased 23%. Q3 annualized return on average assets/equity was 1.36%/11.78%; the nine-month figures were 1.40%/12.33%.
- At September 30, total assets were $2,636 million, up from $2,523 million at year-end 2018. Gross loans were $1,798 million, up 4%; deposits were $2,196 million, up 4%. Shareholders’ equity was $303 million versus $273 million.
- Cash and cash equivalents were $80.7 million. Available-for-sale securities were $599.9 million. The loan-loss allowance was $11.2 million, or 0.62% of gross loans.
- Deposits were the principal funding source. Other reported funding included $25.2 million in repurchase agreements, $42.2 million in short-term borrowings and $34.9 million in subordinated debentures.
- For the nine months, operating cash flow was $25.5 million, investing cash flow was negative $84.4 million and financing cash flow was positive $65.5 million; cash and equivalents increased $6.6 million.
- Regulatory capital ratios remained well above “well capitalized” minimums: Sierra Bancorp’s CET1 ratio was 13.07% and total capital ratio 15.35%; Bank of the Sierra’s were 14.36% and 14.93%, respectively.
Material changes versus comparable periods
- Net interest income rose with growth in average earning assets, but the tax-equivalent margin narrowed 18 basis points year over year in Q3 and 4 basis points year to date. Management cited lower-yielding asset mix, competitive mortgage-warehouse pricing, and higher-cost time and brokered deposits.
- Q3 loan-loss provision fell year over year, partly because the 2018 quarter included a $1.9 million reserve on a loan participation. The 2019 quarter included nearly $0.9 million of reserves for a $2.8 million commercial real estate loan newly placed on nonaccrual.
- Q3 noninterest expense declined 4%, aided by lower occupancy and other costs and an FDIC assessment credit. The efficiency ratio improved to 55.64% from 59.59%.
- Mortgage warehouse balances increased $125 million from year-end, while real estate loans declined $46 million and commercial and industrial loans declined $12 million. Warehouse utilization rose to 64% from 23%.
- Nonperforming assets increased to $7.5 million from $6.2 million at year-end; the ratio rose to 0.42% from 0.36%. Nonperforming loans were $6.7 million, including the newly nonaccrual commercial real estate loan. Performing troubled debt restructurings were $9.1 million.
- Available-for-sale securities increased $39 million. Their net unrealized position swung to an $8 million gain from a $9 million loss at year-end, primarily reflecting lower market interest rates.
Outlook, commentary, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management emphasized quality loan growth but noted fewer qualifying lending opportunities, stronger competition, prepayments and volatile mortgage-warehouse balances; future loan growth is not assured.
- Management said liquidity resources were sufficient for current and anticipated short-term needs. Available lines of credit totaled $500 million, with additional potential FHLB and Federal Reserve borrowing subject to collateral and requirements. The company also reported $437 million of unpledged or excess-pledged investment securities.
- Interest-rate modeling projected a 1.10% increase in 12-month net interest income under an immediate 100-basis-point increase, but a 4.55% decline under a 100-basis-point decrease. Modeled declines under 200- and 300-basis-point decreases exceeded internal policy guidelines. Results depend on assumptions, including deposit behavior.
- CECL was scheduled for adoption January 1, 2020. Management’s preliminary assessment suggested a potentially material effect on the allowance and equity; it estimated the allowance could increase by 100% or more under a discounted-cash-flow methodology with forecasting. The ultimate impact was not yet determined.
- Other notable items included a $278,000 Q3 valuation reduction on a limited partnership investment, $232,000 of restricted-stock gains and a $100,000 LIHTC fund-related gain in Q2, and higher BOLI income. The company resumed repurchases in August and bought back 54,579 shares in Q3 at a weighted-average $25.16 per share.
- Forward-looking risks include local economic weakness, interest-rate and liquidity risk, credit deterioration, securities valuation changes, competition for deposits and loans, staffing and technology execution, and acquisition or regulatory risks. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. Disclosure controls were assessed as effective, with no significant Q3 change in internal controls reported.
Important facts for investors to verify
- Whether the $2.8 million nonaccrual commercial real estate exposure is resolved and how nonperforming loans and the allowance evolve.
- The eventual CECL adoption adjustment, especially its effect on reserves, retained earnings and regulatory capital.
- Whether deposit costs and funding mix continue to pressure margin, and whether mortgage-warehouse growth is sustainable and adequately priced.
- Actual liquidity and interest-rate sensitivity compared with modeled assumptions, including deposit runoff and rate floors.
- Whether reported earnings benefited materially from market-sensitive BOLI, investment valuation changes, tax credits or other nonrecurring items.