Sierra Bancorp — Q1 2020 Form 10-Q
Business context and reporting period. Sierra Bancorp is the bank holding company for Bank of the Sierra, a California community bank serving the South San Joaquin Valley, Central Coast, Ventura County and nearby markets. This unaudited filing covers the three months ended March 31, 2020; comparisons are with Q1 2019 unless otherwise noted. Balance-sheet comparisons are with December 31, 2019. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q1 2020 / Mar. 31, 2020 | Comparable period / Dec. 31, 2019 |
|---|---|---|
| Net income | $7.8 million; diluted EPS $0.51 | $8.9 million; diluted EPS $0.58 |
| Net interest income | $23.8 million; tax-equivalent net interest margin 4.13% | $24.0 million; margin 4.30% |
| Provision for loan losses | $1.8 million | $0.3 million |
| Noninterest income / expense | $6.1 million / $17.8 million | $5.9 million / $17.9 million |
| Profitability | Annualized ROE 9.97%; ROA 1.05%; efficiency ratio 58.88% | ROE 12.99%; ROA 1.44%; efficiency ratio 58.74% |
| Total assets | $2.670 billion | $2.594 billion |
| Gross loans and leases | $1.798 billion; net loans $1.789 billion | $1.763 billion gross; $1.756 billion net |
| Total deposits | $2.179 billion | $2.168 billion |
| Cash and cash equivalents | $107.0 million | $80.1 million |
| Allowance for loan and lease losses | $11.5 million; 0.64% of gross loans | $9.9 million; 0.56% of gross loans |
| Shareholders’ equity | $319.5 million | $309.3 million |
- Net cash provided by operating activities was $10.3 million, versus $15.0 million in Q1 2019. Investing activities used $46.7 million, largely reflecting net loan growth and securities purchases; financing activities provided $63.3 million, including $54.1 million of increased borrowings. Cash and cash equivalents increased $26.9 million during the quarter.
- Short-term borrowings were $74.1 million, up from $20.0 million at year-end, primarily due to FHLB advances. Repurchase agreements were $29.4 million and subordinated debentures were $35.0 million. Total liabilities were $2.351 billion.
- Reported primary and secondary liquidity sources totaled $1.056 billion, including $107.0 million cash, $379.4 million unpledged securities, $347.3 million FHLB borrowing availability, $80.0 million unsecured lines and $69.5 million available through the Federal Reserve discount window. Management said liquidity remained adequate and was not adversely affected by COVID-19.
- The Bank reported a 12.06% community bank leverage ratio at March 31, 2020, above the temporarily reduced 8% minimum. The filing notes adoption of the community bank leverage ratio framework in Q1.
Material changes versus comparable periods
- Net income declined about 12% year over year, with diluted EPS falling from $0.58 to $0.51. Management attributed the decline chiefly to the $1.5 million increase in loan-loss provision, reflecting greater economic uncertainty from COVID-19.
- Net interest income decreased 1%. Lower asset yields reduced interest income, partly offset by lower deposit and borrowing costs. Average cost of interest-bearing deposits fell to 0.50% from 0.81%; average yield on interest-earning assets declined to 4.52% from 4.93%.
- Gross loans grew 2% from year-end, driven mainly by a $39.5 million increase in mortgage warehouse lines. Total deposits rose 1%; noninterest-bearing deposits increased to 32.3% of deposits from 31.9%.
- Nonperforming assets increased to $8.1 million from $6.5 million at year-end. Nonperforming loans rose to $7.4 million from $5.7 million, and the nonperforming-loan ratio increased to 0.41% from 0.33%. Management said the new nonaccrual loans were not COVID-related and largely arose early in the quarter.
- Accumulated other comprehensive income increased by $7.7 million, principally from higher fair values of available-for-sale securities as interest rates fell. The securities portfolio’s net unrealized gain rose to $19.3 million from $8.4 million at year-end.
Outlook, management commentary and risks
- COVID-19 and credit outlook: Management said future provisions could be at or above Q1 levels if economic conditions do not improve. The company had not identified COVID-related increases in classified or nonperforming assets or COVID-related charge-offs as of the filing, but warned that borrower repayment capacity, collateral values, unemployment and the duration of restrictions create substantial uncertainty.
- Deferrals and assistance: As of April 15, 2020, 104 commercial customer modifications totaling $149.1 million had been executed or approved for execution. Hospitality borrowers accounted for $50.8 million and restaurant borrowers for $5.8 million. These modifications generally deferred principal and interest for 180 days; interest continued to accrue. The company said worsening conditions could lead to higher classified or nonperforming assets, interest reversals or charge-offs.
- PPP: The Bank began funding Paycheck Protection Program loans in April. By April 30, SBA approval had been obtained for approximately 800 customers and $94.2 million of PPP loans. These are post-quarter-end developments.
- Interest rates and revenue: Management expected March’s 150-basis-point Federal Reserve rate cuts to pressure net interest income and margin, since loan yields could fall more than deposit costs. Lower consumer spending and fee waivers were also expected to reduce interchange and deposit-service-charge income. The filing’s interest-rate model estimated a 7.4% decline in 12-month net interest income under an immediate 100-basis-point rate decrease, versus a 2.4% increase under a 100-basis-point increase; larger downward shocks exceeded internal policy limits.
- Credit concentrations and commitments: Hospitality loans totaled $216.0 million across fewer than 70 relationships; retail loans were $86.2 million, including $21 million in restaurants, and energy loans were approximately $13 million. Unused commitments to extend credit were $453.8 million and standby letters of credit were $9.1 million at quarter-end. A separate $105 million FHLB letter of credit supported certain deposits and customer credit arrangements.
- Accounting and capital: The company elected under the CARES Act to defer CECL implementation until the earlier of the end of the COVID-19 national emergency or December 31, 2020. It said CECL would materially affect the financial statements, particularly the allowance and equity; an estimated one-time allowance adjustment of approximately $12 million had been anticipated, but the Q1 impact remained uncertain. The company suspended its share-repurchase program on March 16 after repurchasing 112,050 shares during Q1 at a weighted-average $22.86 per share. It declared a $0.20-per-share dividend payable May 13, 2020.
- Operations and other matters: Nine of 40 branches without drive-up or walk-up facilities were closed except by appointment; other branches continued modified service. Management reported no material business-continuity resource constraints. Goodwill of $27.4 million was not considered impaired following a qualitative assessment. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. No formal earnings guidance was provided.
Most important facts for investors to verify
- Subsequent-quarter loan performance, including the repayment behavior of customers receiving deferrals and the concentration of those modifications in hospitality and restaurants.
- Whether the larger Q1 provision adequately reflects COVID-related expected losses, and the timing, assumptions and equity impact of CECL adoption.
- Trends in nonperforming loans, criticized assets, charge-offs and collateral values, particularly in commercial real estate and other exposed industries.
- Actual net interest margin, funding costs and liquidity as rate cuts, deposit flows, warehouse lending and PPP funding affect the balance sheet.
- Regulatory capital and dividend capacity under worsening credit conditions, and whether the share-repurchase suspension continues.