Sierra Bancorp — Q1 2019 Form 10-Q
Business context and reporting period. Sierra Bancorp is a California bank holding company whose principal subsidiary, Bank of the Sierra, provides retail and commercial banking services. This unaudited filing covers the quarter ended March 31, 2019; income and cash-flow comparisons are against Q1 2018, while balance-sheet changes are generally against December 31, 2018. Dollar amounts below are in millions unless stated otherwise.
Key financial results and position
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $23.97 | $21.76 in Q1 2018; up 10% |
| Net interest margin | 4.30% tax-equivalent | 4.20% in Q1 2018 |
| Provision for loan losses | $0.30 | $0.20 in Q1 2018 |
| Noninterest income | $5.91 | $5.13 in Q1 2018; up 15% |
| Noninterest expense | $17.85 | $17.89 in Q1 2018; essentially flat |
| Income before taxes / net income | $11.73 / $8.90 | $8.81 / $6.71 in Q1 2018 |
| Diluted EPS | $0.58 | $0.44 in Q1 2018 |
| Efficiency ratio | 58.74% tax-equivalent | 65.72% in Q1 2018 |
| Total assets / gross loans | $2,539 / $1,751 | $2,523 / $1,732 at December 31, 2018 |
| Deposits / shareholders’ equity | $2,161 / $284 | $2,116 / $273 at December 31, 2018 |
- Profitability: Net income rose 33%; annualized return on average assets was 1.44% and return on average equity was 12.99%, versus 1.16% and 10.61%, respectively, in Q1 2018.
- Cash flow: Operating activities provided $14.97; investing activities used $10.00; financing activities used $11.03. Cash and cash equivalents declined $6.07 during the quarter to $68.06.
- Credit and allowance: Nonperforming assets were $5.37, or 0.31% of gross loans plus foreclosed assets, down from $6.24 and 0.36% at year-end. The allowance was $9.44, or 0.54% of gross loans; net charge-offs were $0.61, compared with $0.25 in Q1 2018.
- Debt and liquidity: Short-term borrowings were zero at quarter-end, versus $56.10 at year-end; repurchase agreements were $19.36 and subordinated debentures $34.81. Management reported $596 in available correspondent/FHLB credit lines, a further $19 subject to collateral and stock requirements, and approximately $75 of Federal Reserve Discount Window capacity. Unpledged securities plus securities pledged in excess of current needs totaled $408.
- Capital: Consolidated regulatory ratios were 12.79% Common Equity Tier 1, 14.54% Tier 1 risk-based, 15.04% total risk-based, and 11.66% leverage. The Bank’s ratios also exceeded the stated “well capitalized” minimums.
Material changes and management commentary
- Net interest income increased primarily with organic loan growth: average interest-earning assets rose 7%, and loans’ average balance increased 12%. Higher loan yields and a 10-basis-point margin improvement also contributed.
- Interest expense increased to $3.51 from $1.72, largely as deposit costs rose; the average cost of interest-bearing deposits increased to 0.81% from 0.39%. Higher time-deposit costs and $50 million of brokered deposits contributed.
- Noninterest income growth was concentrated in bank-owned life insurance (BOLI), which generated $0.90 versus $0.20. The increase included $0.66 of gains on separate-account BOLI, which management said are generally associated with offsetting deferred-compensation accruals and can fluctuate.
- Loan growth was led by commercial real estate, farmland, and agricultural production lending. Management said it was seeing fewer lending opportunities that met its credit and yield criteria and noted uncertainty around future loan growth.
- Deposits increased $44.4, including nearly $23 of customer time deposits. Non-deposit borrowings declined as deposit growth outpaced loan growth.
- Accumulated other comprehensive loss improved by $4.34, mainly reflecting higher fair values of available-for-sale securities as long-term interest rates declined. Comprehensive income was $13.24.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management described liquidity as sufficient for current and anticipated short-term needs, but cautioned that liquidity may not remain at current levels.
- Interest-rate simulations projected that an immediate 100-basis-point increase would raise next-12-month net interest income by 1.06% ($1.07), while a 100-basis-point decline would reduce it by 4.25% ($4.28). Management identified deposit runoff and deposit-rate changes as key sensitivities.
- Credit risks include potential deterioration in economic conditions, agricultural and other local industries, higher nonperforming assets, and losses exceeding the allowance. Net charge-offs increased year over year; management stated the allowance reflected its estimate but gave no assurance that losses would remain within it.
- CECL, effective for the Company January 1, 2020, was expected to have a potentially material impact. Preliminary estimates indicated the allowance could increase by 100% or more under a discounted-cash-flow methodology with forecasting; the ultimate impact had not been determined.
- Lease accounting adoption brought approximately $9.4 of right-of-use assets and $10.1 of lease liabilities onto the balance sheet. The filing also identifies interest-rate, liquidity, regulatory, technology, staffing, and acquisition/branch-expansion risks.
- Management reported no material change in the risk factors from the 2018 Form 10-K, no significant first-quarter change in internal controls, and no legal proceedings expected to materially affect the Company.
Important facts for investors to verify
- Whether stronger earnings persist after accounting for the unusually high and potentially volatile BOLI contribution, and whether deposit-cost increases continue to pressure the margin.
- Loan quality trends, including charge-offs, nonperforming loans, performing troubled debt restructurings, and the adequacy of the 0.54% allowance-to-loans ratio.
- The eventual CECL adoption effect on reserves, retained earnings, and regulatory capital, given the preliminary estimate of a possible allowance increase of 100% or more.
- Whether deposit growth remains sufficient to fund loans and replace borrowings, and whether reported liquidity facilities and securities remain available under stress.
- Exposure to falling rates and deposit repricing/runoff assumptions underlying management’s interest-rate sensitivity models.