Westamerica Bancorporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Unaudited consolidated results; comparisons are with the corresponding 2012 periods unless stated otherwise. Westamerica is a California banking company serving customers primarily in Northern and Central California.
Financial results and condition
- Q2 earnings: Net income was $17.1 million and diluted EPS was $0.64, down from $21.0 million and $0.75. For the first half, net income was $34.4 million and diluted EPS was $1.27, versus $42.0 million and $1.50.
- Revenue and margin: Net interest income on a fully taxable equivalent (FTE) basis was $42.6 million in Q2 and $86.5 million for the first half, down 15.3% in each comparison. FTE net interest margin fell to 4.12% in Q2 from 4.89%, and to 4.19% for the first half from 5.00%. Lower loan balances and lower earning-asset yields were the principal pressures.
- Credit costs and operating expenses: Loan-loss provision was $1.8 million in Q2 and $4.6 million for the first half, versus $2.8 million and $5.6 million. Noninterest expense declined 3.9% in Q2 to $28.2 million and 4.2% for the first half to $56.9 million. The efficiency ratio rose to 49.5% in Q2 from 46.0% and to 49.4% for the first half from 45.6%.
- Other income: Noninterest income was $14.3 million in Q2 and $28.6 million for the first half. Deposit service charges fell, while debit-card fees increased. The reported comparison also benefits from a $1.3 million securities-sale loss recorded in Q2 2012.
- Cash flow: First-half cash from operations was $48.9 million, investing activities provided $3.2 million, and financing activities used $159.2 million; cash and due from banks declined $107.1 million to $384.3 million. Financing outflows included a $130.9 million net deposit decline, $27.4 million of share repurchases, and $20.1 million of dividends.
- Balance sheet and liquidity: Total assets were $4.814 billion, down from $4.952 billion at December 31, 2012. Deposits were $4.101 billion, down $131.1 million; total loans before the allowance were $1.939 billion, down from $2.111 billion. Investment securities totaled about $2.140 billion. Management reported satisfactory results from its latest liquidity stress test, while noting liquidity could decline.
- Credit quality: Total nonperforming assets across originated, covered, and purchased non-covered portfolios were approximately $50.4 million at June 30, versus $59.3 million at year-end. Originated nonperforming assets declined, but nonperforming assets in purchased covered loans increased versus year-end. The total allowance for credit losses was $33.6 million, including $30.9 million for loan losses and $2.7 million for off-balance-sheet exposures.
- Debt and capital: Borrowings included $66.6 million of short-term secured funding, $25.7 million of FHLB advances, a $10.0 million term repurchase agreement, and $15.0 million of debt financing. The $15.0 million note matured October 31, 2013; the company said it intended to repay it with cash and reported covenant compliance. Company total risk-based capital was 15.98%; the Bank’s was 15.04%. Both exceeded the filing’s stated well-capitalized thresholds.
Material changes and management commentary
- Management attributed lower earnings chiefly to falling loan balances and earning-asset yields. Average loans fell about $381 million in Q2 year over year, while average earning-asset yield declined from 5.04% to 4.24%. Lower deposit costs and higher average investment balances partly offset this pressure.
- Management said it was not pursuing aggressive loan growth because competitive pricing did not provide adequate forward earnings potential, and it shifted a greater share of earning assets to lower-yielding investments.
- Management’s most likely earnings forecast for the 12 months ending June 30, 2014 assumed market rates remained relatively stable; newly originated or refinanced loans and new securities were expected to yield less than older assets. The company did not provide a numerical earnings forecast.
- Management expected to maintain capital above the highest applicable regulatory standard and continue quarterly dividends, subject to change. The filing reports a $0.37 Q2 dividend per common share.
Risks, contingencies, and unusual items
- Interest-rate and securities risk: The company described its position as slightly to modestly liability-sensitive, depending on model assumptions, and said results remain exposed to interest-rate changes. Rising rates between year-end and June reduced securities values: accumulated other comprehensive income fell to $4.5 million from $14.6 million. Management did not consider the securities other-than-temporarily impaired, stating it did not intend, and was not more likely than not required, to sell them before recovery of amortized cost.
- FDIC loss-sharing: FDIC indemnification on covered non-residential assets expires for losses on February 6, 2014 (with loss-recovery sharing continuing to February 6, 2017); residential coverage runs to February 6, 2019. Covered non-residential assets were $330.1 million at June 30. The end of loss protection could increase the company’s exposure to losses.
- Credit and concentration: Loan performance remains sensitive to economic conditions and collateral values, with significant real-estate-secured lending and covered assets concentrated in California’s Central Valley. Management cautioned that classified and nonperforming assets could rise. Four loans totaling $3.019 million were modified as troubled debt restructurings in the first half; a $3.954 million commercial real-estate loan defaulted during the period.
- Commitments and legal matters: Unfunded loan commitments were $334.1 million, standby letters of credit $32.3 million, and commercial letters of credit $0.3 million. The company was subject to threatened or filed legal cases and did not expect them to have a material adverse effect; covered-asset legal costs may be 80% indemnified if contractual conditions are met.
- Tax and regulatory changes: California enterprise-zone tax incentives are being phased out or changed effective January 1, 2014. Management was assessing the impact and did not expect a significant change in tax provision; first-half 2013 benefits under the existing program were $61,000, net of federal tax effects. New federal capital rules were scheduled to phase in beginning in 2015; management’s pro forma analysis showed capital above the stated requirements.
- Prior-period items: Q2 2012 included a securities-sale loss that reduced net income by about $750,000 and a tax refund that increased it by about $950,000. These items affect year-over-year comparisons.
Important facts for investors to verify
- Track whether net interest margin and loan yields stabilize, and whether management’s assumed stable-rate outlook remains reasonable.
- Review deposit trends, cash levels, funding mix, and the October 2013 repayment of the $15 million note.
- Monitor covered-loan credit quality and the effect of the February 2014 expiration of non-residential FDIC loss protection.
- Assess the change in unrealized securities losses, related accumulated other comprehensive income, and potential effects of further rate increases.
- Reconcile the reported earnings trend with the prior-year securities loss and tax refund, and assess the sustainability of dividends and repurchases against earnings and capital needs.