Banc of California, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The company is a California-focused commercial bank holding company with 34 banking offices. Following the March 2017 sale of Banc Home Loans, mortgage banking results are reported as discontinued operations; the filing identifies Commercial Banking as the company’s sole reportable segment. Comparisons with 2016 are affected by that sale.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income, continuing operations | $75.0 million | $82.8 million | $231.0 million | $227.4 million |
| Net interest margin, consolidated operations | 3.15% | 3.32% | 3.14% | 3.36% |
| Provision for loan and lease losses | $3.6 million | $2.6 million | $8.6 million | $4.7 million |
| Income from continuing operations | $18.1 million | $25.2 million | $42.6 million | $62.2 million |
| Net income, including discontinued operations | $16.9 million | $35.9 million | $46.4 million | $82.2 million |
| Net income available to common stockholders | $11.8 million | $30.8 million | $31.1 million | $67.4 million |
| Diluted EPS | $0.23 | $0.59 | $0.59 | $1.40 |
Continuing-operation noninterest income was $18.4 million in Q3 and $39.0 million for the nine-month period. Continuing-operation noninterest expense was $75.7 million and $241.9 million, respectively. The nine-month tax benefit was $23.2 million for continuing operations; consolidated tax benefits were driven substantially by alternative-energy investment credits.
Financial position, cash flow and capital
- At September 30, total assets were $10.28 billion, down 6.8% from December 31, 2016. Cash and cash equivalents were $611.8 million.
- Loans and leases held for investment totaled $6.23 billion gross and $6.18 billion net of the $45.1 million allowance. Deposits were $7.40 billion, down 19.0% from year-end 2016.
- Borrowings increased: FHLB advances were $1.47 billion and repurchase-agreement balances were $36.5 million. Long-term debt was $172.9 million net, principally 5.25% senior notes due 2025.
- Nine-month cash flows were $510.8 million provided by operations, $493.4 million provided by investing activities, and $831.9 million used in financing activities. Cash increased $172.3 million.
- Unpledged available-for-sale securities were $2.04 billion. Additional stated borrowing capacity included $918.2 million from the FHLB, $124.7 million from the Federal Reserve discount window, and $210.0 million in unsecured federal-funds lines.
- At the Bank, regulatory capital ratios were 16.39% total risk-based, 15.68% Tier 1 and CET1, and 10.88% Tier 1 leverage. The Bank exceeded the stated well-capitalized thresholds.
- Nonperforming loans and leases were $12.3 million; nonperforming assets were $16.0 million, or 0.16% of assets. The allowance equaled 0.72% of loans and leases.
Material changes and unusual items
- Q3 net income declined 52.8% year over year. Net interest income fell 12.7% in the quarter as higher funding costs and lower average loan balances outweighed improved securities income. For the nine months, net interest income was nearly flat, while margin declined.
- The sale of Banc Home Loans reduced mortgage-banking activity and drove substantial changes in loans held for sale and servicing rights. The company recorded a $13.7 million gain on disposal for the nine months; discontinued operations generated a $1.2 million loss in Q3 and $3.8 million income for the nine months.
- The company transferred $740.9 million of held-to-maturity securities to available-for-sale in Q2, citing strategic and liquidity considerations. It said the transfer would limit its ability to assert intent and ability to hold debt securities to maturity for the foreseeable future.
- Alternative-energy partnerships generated investment losses of $8.3 million in Q3 and $26.8 million for the nine months, alongside tax credits of $8.8 million and $33.3 million, respectively. The company had $96.7 million of unfunded commitments and stated maximum loss exposure of $140.6 million for these partnerships.
- Q3 included a $4.5 million legal settlement accrual and a $3.8 million loss related to CRA investments within other expense. Nine-month professional fees rose to $34.6 million, primarily reflecting investigations, litigation and audit costs; restructuring expense was $5.4 million in continuing operations.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management said liquidity sources were adequate for day-to-day needs and reported no known events or commitments reasonably likely to materially affect liquidity. Its stated strategy is to focus on core commercial banking, reduce reliance on brokered and other high-cost deposits, and manage balance-sheet risk and securities duration. The company expected about $10 million of restructuring expense during 2017 and had committed $100 million over 15 years for LAFC stadium naming and sponsorship rights; $10 million had been paid by September 30.
Key risks include a pending SEC investigation and related litigation, reputational and deposit-retention risks, senior-management transition, interest-rate and funding-cost sensitivity, credit and real-estate risks, and cybersecurity and third-party service-provider exposures. Several shareholder, former-employee and other lawsuits were pending; the company stated it intended to contest them. It had accrued $5.9 million for various litigation matters. A material weakness in internal control over financial reporting remained unremediated, and management concluded disclosure controls and procedures were ineffective as of September 30. The company expected to become subject to the Federal Reserve’s DFAST stress-test regime beginning January 1, 2018.
Important facts for investors to verify
- Whether deposit outflows and substitution toward FHLB funding affect funding costs, core deposits and net interest margin.
- Whether continuing-operation earnings can improve after the mortgage-banking sale, given lower loan-related income and elevated expenses.
- The performance, tax-credit realization and remaining funding obligations of alternative-energy partnerships.
- Developments and potential financial or regulatory effects of the SEC investigation and pending litigation.
- Progress in remediating the material weakness and whether disclosure and financial-reporting controls become effective.
- Credit trends, allowance adequacy and concentration exposure in commercial real estate, multifamily and residential lending.