Banc of California, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. The company is a California-focused financial holding company operating through Banc of California, N.A. and 34 California banking offices. This filing covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are primarily with December 31, 2017. The company had previously sold its Banc Home Loans mortgage-banking division, which is reported as discontinued operations.
Financial performance and condition
- Q3 earnings: Net income was $11.1 million, down from $16.9 million in Q3 2017. Continuing-operations income was $10.4 million versus $18.1 million; diluted EPS from continuing operations was $0.06 versus $0.25. Net income available to common stockholders was $3.8 million versus $11.8 million, including a $2.3 million noncash impact from redeeming Series C preferred stock.
- Nine-month earnings: Net income was $34.4 million versus $46.4 million; continuing-operations income was $31.4 million versus $42.6 million. Diluted EPS from continuing operations was $0.26 versus $0.52, and net income available to common stockholders was $16.9 million versus $31.1 million.
- Interest income and margins: Q3 net interest income was $71.2 million, down 5.1% from $75.0 million; net interest margin narrowed to 2.93% from 3.15%. For nine months, net interest income was $215.4 million, down 6.8% from $231.0 million; margin was 2.97% versus 3.14%. Higher loan yields and loan growth were outweighed by higher deposit and FHLB funding costs and a smaller securities portfolio.
- Noninterest items and expenses: Q3 noninterest income fell to $4.8 million from $18.4 million, chiefly reflecting lower loan and securities sale gains. Nine-month noninterest income was $21.5 million versus $39.0 million. Noninterest expense declined to $60.9 million from $75.7 million in Q3 and to $183.2 million from $241.9 million for nine months, reflecting cost reductions and lower alternative-energy investment losses. Q3 professional fees rose to $12.0 million, including costs related to investigations and litigation.
- Assets, loans, deposits: Total assets were $10.26 billion, down $67.0 million from year-end 2017. Net loans and leases rose 8.9% to $7.20 billion; gross loans grew 8.9% to $7.25 billion, led by multifamily, commercial real estate, and single-family residential lending. Deposits increased 1.5% to $7.40 billion. Brokered deposits declined 18.4% to $1.19 billion as the company shifted toward core deposits.
- Cash flow: For nine months, operating cash flow was $96.5 million, investing cash outflow was $78.2 million, and financing cash outflow was $33.7 million. Cash and cash equivalents decreased $15.5 million to $372.2 million.
- Credit quality: The allowance for loan and lease losses was $57.8 million, or 0.80% of gross loans, versus $49.3 million, or 0.74%, at year-end. Nonperforming loans were $25.5 million versus $19.4 million; nonperforming assets were $26.0 million, or 0.25% of assets. Nine-month provision expense increased to $23.6 million from $8.6 million, and charge-offs were $16.0 million versus $4.2 million.
- Debt, liquidity, and capital: FHLB advances were $1.64 billion and long-term debt was $173.1 million; long-term debt consists principally of $175 million of 5.25% senior notes due 2025. The company reported $372.2 million in cash, $1.21 billion in additional FHLB borrowing capacity, $43.9 million of Federal Reserve discount-window capacity, and $210 million of unsecured federal-funds lines. Bank regulatory capital ratios remained above well-capitalized thresholds: total risk-based capital 15.94%, common equity tier 1 15.04%, and leverage 10.29%. Company total stockholders’ equity was $946.7 million, down 6.5% from year-end.
Material changes and unusual items
- Interest-bearing deposit costs and FHLB borrowing costs rose materially as rates increased. Average Q3 cost of interest-bearing deposits rose to 1.58% from 0.94%; average cost of FHLB advances rose to 2.33% from 1.38%.
- The company recorded a $13.9 million charge-off in Q1 on a $15 million line of credit after determining that borrower representations and supporting bank statements were fraudulent. The bank filed suit to pursue recovery; success is not assured. Management described the event as isolated external fraud.
- During the first half, the company sold mortgage servicing rights on approximately $3.55 billion of underlying loans for $30.1 million cash consideration; the sale generated a nine-month net loss of $2.4 million. Servicing rights on the balance sheet fell to $3.8 million from $33.7 million at year-end.
- The company redeemed all Series C preferred stock for $40.3 million in September. The associated $2.3 million reclassification of deferred issuance costs reduced income allocated to common stockholders.
- Available-for-sale securities declined 20.0% to $2.06 billion, while accumulated other comprehensive loss reached $21.9 million, largely reflecting market-rate-related unrealized losses. Management reported no other-than-temporary impairment and said it did not intend to sell securities in unrealized-loss positions.
- Alternative-energy partnership losses were $4.3 million for nine months, down from $26.8 million, while related investment tax credits fell to $9.6 million from $33.3 million. Results depend on investment performance, tax-credit generation, and estimates under the hypothetical-liquidation-at-book-value method.
Outlook, risks, and contingencies
- The filing provides no formal earnings or revenue guidance. Management expected the workforce reduction and planned reduction in third-party advisor use to be completed in Q4 2018 and estimated approximately $15 million of annual savings in 2019. It cautioned that savings may be lower and implementation costs higher than anticipated; 2018 severance expense through Q3 was $4.5 million.
- Key stated risks include the ongoing SEC investigation and related litigation, reputational harm and management distraction, credit and fraud losses, real-estate and economic deterioration, rising funding costs and net-interest-margin pressure, deposit retention, securities valuation, regulatory requirements, and execution of cost reductions.
- A consolidated shareholder securities class action remained pending, with trial set for October 21, 2019. Other disclosed matters include litigation by COR-affiliated entities, employment-related claims subject to arbitration, and a derivative action dismissed by the court. The company accrued $896,000 for various legal actions and said it intends to contest the pending claims.
- Management stated that disclosure controls and procedures were effective as of September 30, 2018, with no material change in internal control over financial reporting during the period. It also stated that the company and bank were no longer subject to Dodd-Frank stress-test requirements following regulatory relief.
Most important facts for investors to verify
- Whether loan growth can produce sufficient spread income to offset higher deposit and wholesale funding costs.
- Subsequent developments and recoveries on the $13.9 million fraud-related charge-off, and any implications for underwriting controls or other exposures.
- Trends in nonperforming loans, criticized commercial credits, charge-offs, and allowance adequacy as the portfolio expands.
- Actual delivery of the estimated $15 million in 2019 cost savings, including severance, advisor, and operational effects of the workforce reduction.
- Progress and potential financial exposure from the SEC investigation, shareholder litigation, and other legal matters.
- Deposit mix, liquidity capacity, regulatory capital, and the effects of securities valuation losses and alternative-energy tax-credit variability.