SIERRA BANCORP annual report, FY2013

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Sierra Bancorp — FY 2013 Form 10-K

Reporting period: Fiscal year ended December 31, 2013; filed March 13, 2014. Sierra Bancorp is the holding company for Bank of the Sierra, a community bank operating primarily in California’s San Joaquin Valley.

Business context and financial results

The Bank provides commercial, agricultural, real estate and consumer lending, deposit products, and related services through 25 full-service branches and digital channels. Its loan portfolio is concentrated in real estate and regional California borrowers.

  • Profitability: Net income was $13.369 million, up 63% from $8.185 million in 2012; diluted EPS was $0.94 versus $0.58. Return on average assets was 0.96% (0.59% in 2012), and return on average equity was 7.56% (4.74%).
  • Interest income and margins: Interest income was $51.785 million, down 6%; net interest income was $48.564 million, down 4%. Tax-equivalent net interest margin declined 20 basis points to 4.02%; the net interest spread was 3.90%, versus 4.08%.
  • Credit costs and expenses: Loan-loss provision fell 69% to $4.350 million from $14.210 million. Non-interest income declined 6% to $17.063 million; non-interest expense declined 4% to $44.815 million. The efficiency ratio improved slightly to 66.63% from 66.81%.
  • Balance sheet: Assets were $1.410 billion, down 2%; gross loans and leases were $803.2 million, down 9%; deposits were essentially unchanged at $1.174 billion. Shareholders’ equity increased to $181.7 million from $173.9 million.
  • Asset quality: Nonperforming assets declined 37% to $45.6 million, or 5.62% of loans plus foreclosed assets, from $72.8 million and 8.10%. Nonperforming loans were $37.4 million. The allowance was $11.7 million, 1.45% of gross loans and 31.21% of nonperforming loans. Net charge-offs fell to $6.5 million from $17.6 million.
  • Capital and debt: Consolidated total risk-based capital was 21.67%, Tier 1 risk-based capital 20.39%, and leverage capital 14.37%; both Company and Bank were classified as well capitalized. Subordinated debentures were $30.9 million, with no short- or long-term borrowings outstanding at year-end; repurchase agreements were $6.0 million.
  • Cash flow and liquidity: Operating cash flow was $34.5 million, investing cash flow was $20.6 million, and financing cash flow was negative $39.0 million. Cash and cash equivalents ended at $78.0 million, up from $61.8 million. Management reported $212 million available on credit lines, additional FHLB capacity subject to collateral, and approximately $51 million available at the Federal Reserve Discount Window.

Material changes versus 2012

  • Net income improved principally because the loan-loss provision and foreclosed-asset costs declined; net interest income continued to contract under margin pressure.
  • Gross loans fell $76.6 million, mainly as mortgage warehouse line utilization dropped. Mortgage warehouse balances declined $96.9 million; farmland loans rose $36.7 million and commercial real estate lending also grew.
  • Deposit balances were flat, but core non-maturity deposits rose $42 million and increased to 74% of deposits; customer time deposits and brokered deposits ran off. Non-deposit borrowings also declined substantially.
  • Investment securities increased to $425.0 million from $380.2 million. Their net unrealized gain fell to $0.7 million from $6.3 million amid rising longer-term rates; accumulated other comprehensive income declined $3.3 million.
  • 2013 net interest income included $233,000 of net interest recoveries and a $97,000 prepayment penalty; 2012 included $276,000 of net interest reversals. 2012 also benefited from $1.762 million of investment-security gains, compared with $6,000 in 2013.

Quarterly result, outlook, risks and unusual items

  • Fourth quarter: Net income was $3.869 million and diluted EPS was $0.27, compared with $2.098 million and $0.15 in fourth-quarter 2012.
  • Outlook: The filing provides no formal earnings or revenue guidance. Management described improving credit conditions and real estate values, while noting that the local recovery remained uneven and growth opportunities were not assured.
  • Key risks: Approximately 72% of loans were real-estate-related. Credit performance is exposed to commercial real estate, construction and land lending, regional economic conditions, and California’s severe drought and water availability. Management also highlighted competition, regulatory and compliance costs, cybersecurity and operational risks, and interest-rate risk.
  • Rate sensitivity: The Company characterized itself as asset-sensitive. Its model estimated net interest income would decline 11.41% under an immediate 100-basis-point rate decrease and rise 4.28% under a 100-basis-point increase. Management noted that modeled downside sensitivity exceeded internal policy guidelines in declining-rate scenarios.
  • Other items: Nonrecurring 2013 income included $397,000 of life-insurance proceeds and a $100,000 vendor signing incentive. California tax-law changes effective in 2014 were expected to increase the tax accrual rate; affordable-housing tax credits were expected to taper as they are used through 2018. The proposed expected-credit-loss accounting model could increase the allowance and reduce profitability if adopted as described.
  • Contingencies and controls: Management stated ordinary-course legal matters were not expected to materially affect financial condition or results. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also reported effective disclosure controls and financial reporting controls.

Investor verification priorities

  1. Track nonperforming loans, foreclosed assets, troubled debt restructurings, charge-offs, and allowance coverage to assess whether credit improvement is durable.
  2. Verify the quality and concentration of real estate, farmland, and commercial exposures, particularly given drought, water-supply, and local economic risks.
  3. Monitor net interest margin, deposit pricing and mix, and actual results against the disclosed sensitivity to falling rates.
  4. Assess liquidity and funding needs against the $296.9 million of time deposits scheduled to mature in 2014 and the $420.7 million of unused credit commitments.
  5. Review investment-security valuations and accumulated other comprehensive income as rates change, and confirm the effect of tax-credit runoff and California tax changes.