Sierra Bancorp — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Sierra Bancorp is the holding company for Bank of the Sierra, a California community bank serving the South San Joaquin Valley, Central Coast, and neighboring areas. Unless otherwise stated, amounts below are in millions of dollars.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $23.776 | $18.435 | $68.336 | $53.159 |
| Provision for loan losses | $2.450 | $0 | $2.950 | $0.300 |
| Non-interest income | $5.723 | $5.910 | $16.285 | $16.408 |
| Non-interest expense | $17.807 | $15.445 | $52.988 | $46.238 |
| Net income | $7.071 | $5.742 | $21.773 | $15.496 |
| Diluted EPS | $0.46 | $0.41 | $1.41 | $1.11 |
- Net interest margin, on a tax-equivalent basis, was 4.27% for Q3 versus 3.97% a year earlier, and 4.24% for the nine months versus 3.93%. Q3 return on average assets/equity was 1.15%/10.66%; nine-month figures were 1.22%/11.23%.
- At September 30, assets were $2.463 billion, up from $2.340 billion at year-end 2017. Gross loans were $1.695 billion, up 9% from year-end; deposits were $2.106 billion, up 6%. Shareholders’ equity was $263.2 million, versus $255.9 million at year-end.
- Cash and cash equivalents were $65.0 million. For the first nine months, operating cash flow was $25.1 million, investing cash flow was negative $143.8 million, and financing cash flow was positive $113.7 million.
- Period-end borrowings included $16.1 million of short-term borrowings, $16.5 million of repurchase agreements, and $34.7 million of subordinated debentures. The filing reports $519 million of available correspondent-bank and FHLB credit lines, plus potential additional FHLB and Federal Reserve borrowing capacity subject to collateral and other conditions.
- The consolidated total risk-based capital ratio was 14.86% (15.32% at year-end); the leverage ratio was 11.40%. Management said the Company and Bank remained well capitalized and above applicable “well capitalized” thresholds.
Changes versus comparable periods
- Net income increased 23% for Q3 and 41% for the first nine months. Growth in net interest income reflected larger average earning assets, including the Ojai acquisition, loan growth, and improved loan yields; net interest margin rose 30 basis points in Q3 and 31 basis points year to date.
- Q3 pre-tax income rose about 4%, while the effective tax rate fell to 23.5% from 35.5%, primarily reflecting the lower federal corporate tax rate. The nine-month tax rate was 24.1% versus 32.7%.
- Non-interest expense rose 15% in both comparisons, largely from acquired operations, branch expansion, staffing, and operating costs. Non-interest income declined slightly, partly because Q3 2017 included $918,000 of securities gains that did not recur.
- Loan growth was concentrated in real estate and agricultural production lending; mortgage warehouse balances declined $44 million, or 32%, from year-end. The loan portfolio was 82.9% real estate at September 30.
- The available-for-sale securities portfolio’s net unrealized loss widened to $15.0 million from $3.3 million at year-end, primarily due to rising interest rates. The resulting after-tax accumulated other comprehensive loss increased by $8.2 million.
Outlook, risks, and unusual items
- No formal earnings or financial guidance is provided. Management cited a record loan pipeline in recent periods but cautioned that prepayments and mortgage warehouse fluctuations make future aggregate loan growth uncertain.
- Credit quality weakened on reported measures: nonperforming assets were $13.2 million, or 0.78% of gross loans plus foreclosed assets, versus $9.4 million and 0.60% at year-end. Nonperforming loans included a $10 million commercial real estate participation placed on non-accrual; approximately $2 million was reserved and $2 million charged off in August.
- After quarter-end, the collateral property for that participation was conveyed to the lead bank. In mid-October, Sierra transferred its remaining approximately $8 million participation from loans to other real estate owned at approximate fair value. Management said the transfer did not change total nonperforming assets.
- The allowance for loan and lease losses was $9.463 million, 0.56% of gross loans; coverage of nonperforming loans was 86.34%, down from 228.19% at year-end. Management considers the allowance adequate but warns that losses could exceed it.
- CECL is scheduled for adoption January 1, 2020. Preliminary work indicates it may materially affect the allowance and equity; initial estimates suggest the allowance could increase by 100% or more under a discounted-cash-flow approach with forecasting. The amount remains undetermined.
- Interest-rate simulations show projected 12-month net interest income up 0.57% for an immediate +100 bp shock, but down 4.67% for −100 bp and 10.57% for −200 bp. Management noted that declines of 200 bp or more exceed internal policy guidelines; no corrective action was then planned. Sensitivity depends on assumptions, particularly deposit behavior and rates.
- Other risks identified include local economic conditions, credit losses, deposit competition and runoff, interest-rate changes, liquidity, securities valuation, acquisitions and branch expansion, staffing, technology, and regulation. Unused commitments to extend credit totaled $772 million; standby letters of credit totaled $10.4 million. The company stated that not all commitments are expected to be drawn.
- Management reported no material change in risk factors from its 2017 Form 10-K, no material adverse effect expected from ordinary-course legal proceedings, and no significant third-quarter change in internal controls. The filing does not provide a clear quantified forecast for future earnings or loan-loss provisions.
Important facts for investors to verify
- Track resolution, recovery, and any further charge-offs associated with the $10 million loan participation and the subsequent $8 million OREO transfer.
- Review subsequent nonperforming-loan trends, charge-offs, allowance coverage, and the concentration of lending in real estate.
- Monitor deposit retention, wholesale and brokered funding, funding costs, and the capacity and collateral conditions for available borrowing lines.
- Assess the impact of rate changes on net interest income, securities values, and deposit pricing, including the model assumptions behind sensitivity estimates.
- Follow CECL implementation estimates and the eventual effect on the allowance, retained earnings, and regulatory capital.
- Distinguish recurring earnings from acquisition and branch costs, OREO gains, securities gains, and tax-rate effects when assessing the reported profit increase.