Sierra Bancorp — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; comparisons are primarily with 2015. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and reporting period
Sierra Bancorp is a California bank holding company whose principal subsidiary, Bank of the Sierra, provides commercial and retail banking across California’s South Central Valley, Central Coast, and selected Southern California markets. At year-end, the Bank operated 33 full-service branches and a loan production office. The loan portfolio is concentrated in real estate, including commercial real estate, and mortgage warehouse lending.
The company completed its acquisition of Coast Bancorp on July 8, 2016. Coast contributed $94.3 million of loans and $129.0 million of deposits at acquisition and expanded the company’s coastal California presence. The results include Coast from July 9 onward.
Financial results and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Net interest income | $65.2 million | $60.1 million |
| Non-interest income | $19.2 million | $17.7 million |
| Non-interest expense | $58.1 million | $50.7 million |
| Net income | $17.6 million | $18.1 million |
| Diluted earnings per share | $1.29 | $1.33 |
| Return on average assets / equity | 0.95% / 8.71% | 1.07% / 9.59% |
| Net interest margin, tax-equivalent | 3.95% | 3.99% |
| Efficiency ratio, tax-equivalent | 67.23% | 63.98% |
- Net income declined 3%, despite 8% growth in net interest income. Higher expenses, including $2.4 million of Coast acquisition costs and ongoing costs to support acquired operations and a new branch, contributed to the decline. The company recorded no loan-loss provision in either 2016 or 2015.
- Total assets rose 13% to $2.033 billion. Gross loans increased 11% to $1.263 billion, and deposits grew 16% to $1.695 billion; acquisition effects contributed materially to both increases. Shareholders’ equity was $205.9 million, up from $190.3 million.
- Cash and cash equivalents increased to $120.4 million from $48.6 million. Operating cash flow was $17.5 million; investing activities used $23.3 million, and financing activities provided $77.6 million. Cash increased $71.8 million during the year.
- Credit quality improved: nonperforming assets were $8.6 million, or 0.68% of loans plus foreclosed assets, versus $12.8 million and 1.13% a year earlier. Net charge-offs were $722,000. The allowance was $9.7 million, 0.77% of gross loans, compared with $10.4 million, 0.92%, in 2015.
- Deposits were the principal funding source. Year-end borrowings included $65.0 million of short-term borrowings, $8.1 million of repurchase agreements, and $34.4 million of subordinated debentures. The company reported $287 million of available correspondent-bank and FHLB credit, with additional borrowing capacity subject to collateral, plus approximately $69 million available at the Federal Reserve Discount Window.
- Regulatory capital remained strong: the company’s Common Equity Tier 1, Tier 1 risk-based, total risk-based, and leverage ratios were 14.09%, 16.53%, 17.25%, and 11.92%, respectively. The company and Bank were classified as well capitalized.
Material changes versus 2015
- Coast’s acquisition, organic commercial real estate and construction lending, and purchased loan participations supported loan growth. Mortgage warehouse balances fell $17 million, with line utilization declining to 48% from 60%.
- Net interest income benefited from higher average earning assets, while margin slipped four basis points as investment and loan yields declined and funding costs rose modestly.
- Non-interest income rose 9%, supported by deposit fees, debit-card interchange, and $489,000 of life-insurance proceeds. It also included $223,000 of securities gains and $276,000 in special FHLB dividends.
- Non-interest expense rose 14%, reflecting acquisition and integration expenses, higher staffing and occupancy costs, and acquired-branch operating costs. The efficiency ratio consequently worsened.
- Unrealized losses on available-for-sale securities reduced accumulated other comprehensive income by $4.3 million during 2016; the portfolio moved from a $4.4 million unrealized gain at 2015 year-end to a $3.0 million unrealized loss at 2016 year-end, primarily reflecting higher interest rates.
- The company paid $0.48 per share in dividends, up from $0.42, and repurchased $2.3 million of stock. Coast acquisition consideration included 599,226 newly issued shares.
Outlook, commentary, risks, and unusual items
- The filing provides no specific earnings or revenue guidance. Management cited opportunities from Coast’s expanded footprint and potential growth, but cautioned that future loan and core-deposit growth is not assured.
- Management described liquidity and capital as strong. Interest-rate simulations showed estimated 12-month net interest income falling 9.24% under an immediate 100-basis-point rate decline, while rising 100 basis points was estimated to increase it 2.39%. These are model estimates, not forecasts.
- Key exposures include California real estate and commercial real estate, agricultural conditions and water availability, local economic conditions, and interest-rate changes. Mortgage warehouse loans were approximately 13% of loans; dairy-industry lending was approximately 10%. Energy-related credits were $23 million, down from $43 million.
- Other risks include acquisition integration and expense execution, competition, cyber and operational threats, regulatory and compliance costs, and potential credit losses exceeding the allowance. Unused commitments to extend credit totaled $463.9 million and standby letters of credit $8.6 million; not all commitments are expected to be drawn.
- The 10-K reports no material legal-proceeding exposure in management’s view. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal control.
- Future accounting changes include CECL, which the company expected to affect credit-loss reserves; the amount of impact was not yet determined. The company also expected the new lease standard to bring some operating lease obligations onto the balance sheet.
Important facts for investors to verify
- How much of 2016 growth and earnings reflects Coast versus ongoing organic performance, and how integration costs and expected synergies develop.
- Whether the allowance and zero-provision approach remain appropriate as loans grow, particularly given real estate concentrations and the $14.2 million of performing troubled debt restructurings.
- The sustainability of net interest income and deposit growth, including the impact of rate changes, competition for deposits, and mortgage warehouse utilization.
- The sensitivity of capital and reported equity to further securities valuation declines, and the potential reserve impact and implementation costs of CECL.
- The Bank’s capacity to upstream dividends and support the parent’s dividends, repurchases, and debt service; the filing reports an approximately $8.9 million statutory dividend limit available from the Bank at year-end.