Banc of California, Inc. — Q2 2016 Form 10-Q
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2016, compared with the same 2015 periods. Banc of California is a California-focused financial holding company, with commercial banking and mortgage banking operations. It sold The Palisades Group, its financial advisory subsidiary, on May 5, 2016, and recognized a $3.7 million gain.
Financial performance and position
- Q2 earnings: Net income was $26.5 million, up 66.6% from $15.9 million; income available to common stockholders was $21.4 million and diluted EPS was $0.43, versus $13.1 million and $0.32, respectively.
- First-half earnings: Net income was $46.2 million, up 62.2%; common income was $36.5 million and diluted EPS was $0.79, versus $24.7 million and $0.62.
- Revenue and margins: Q2 net interest income increased 49.8% to $81.0 million, while net interest margin declined to 3.39% from 3.64%. Noninterest income was $65.6 million, down 1.6%. The efficiency ratio improved to 68.24% from 72.78%. First-half net interest income rose 42.7% to $151.5 million; margin was 3.39%, down from 3.66%, and noninterest income rose 4.3% to $117.6 million.
- Expenses and credit provision: Q2 noninterest expense rose 13.8% to $100.1 million, primarily with business expansion. The provision for loan and lease losses was $1.8 million, down from $5.5 million. First-half expense rose 15.5% to $189.2 million; provision was $2.1 million versus $5.5 million.
- Balance sheet at June 30: Assets were $10.16 billion, up 23.3% from year-end 2015; net loans and leases were $6.20 billion, up 20.4%; loans held for sale were $893.8 million. Deposits were $7.93 billion, up 25.8%, and stockholders’ equity was $939.9 million.
- Debt and liquidity: Borrowings totaled $1.11 billion, including $930 million of FHLB advances and $177.7 million of long-term debt. Cash and cash equivalents were $271.7 million. Management reported $3.48 billion of available borrowing capacity, including $2.17 billion from FHLB and up to $1.00 billion through unused repurchase agreements. The company reported no material liquidity uncertainty at quarter-end.
- Cash flow, first half: Operating cash flow was negative $236.0 million and investing cash flow negative $1.42 billion; financing provided $1.77 billion. Cash increased $115.6 million to $271.7 million. Funding included deposit growth and common and preferred stock issuance.
- Capital and credit: The bank’s total risk-based capital ratio was 14.96%, CET1 was 14.38%, and leverage was 9.70%; each exceeded the filing’s well-capitalized thresholds. Nonperforming loans were $45.0 million, and the allowance was $37.5 million, or 0.60% of loans and leases.
Material changes and unusual items
- Common and preferred stock offerings and stronger deposits supported balance-sheet growth. The company also redeemed $84.8 million of 7.50% senior notes in April, recording $2.7 million of debt-extinguishment expense, and redeemed Series A and B preferred stock.
- First-half noninterest income included $29.6 million in realized gains on available-for-sale securities. Management said it repositioned the portfolio to address rate volatility and improve earnings consistency; gains helped offset negative fair-value changes in mortgage servicing rights and interest-rate swaps.
- Mortgage servicing income was negative $3.3 million in Q2 and negative $8.6 million for the first half, including $8.6 million and $18.7 million of servicing-rights fair-value/runoff losses, respectively. Management attributed the valuation declines mainly to lower interest rates.
- Mortgage banking revenue was $43.8 million in Q2, up 11.1%, but first-half segment pretax results shifted to a $4.3 million loss from $10.8 million income in 2015. The filing attributes the deterioration mainly to fair-value-related effects and higher expansion costs.
- Operating cash flow was negative, in part reflecting the scale and timing of mortgage-loan originations and sales. This should be considered alongside the bank’s substantial financing inflows and investing activity.
Outlook, risks, and contingencies
The filing provides no specific earnings or revenue guidance. Management identified interest-rate changes, funding costs, credit performance, loan demand, securities valuation, operating-cost control, regulatory examinations, and execution of acquisitions or other strategic transactions as risks. The company’s consolidated assets and the bank’s assets exceeded $10 billion at June 30; if they remain above the relevant thresholds, additional regulatory requirements, compliance costs and potentially higher deposit-insurance assessments may apply, and debit interchange income may decline. The filing also notes that future mortgage repurchase demands could be material, although management considered known or probable estimable demands adequately reserved. Nontraditional mortgage loans were $842.6 million, or 13.5% of loans; the filing identifies their interest-only and potential negative-amortization features as credit risks. The company reported no material expected liability from pending litigation.
Interest-rate sensitivity analysis estimated that an immediate 200-basis-point increase would reduce economic value of equity by 8.4% and net interest income by 3.0%; the filing cautions that model assumptions and borrower prepayments can affect these estimates.
As a post-quarter event, on August 3, 2016, the company sold 2.5 million common shares to an employee compensation and liquidity trust for $53.6 million, financed primarily by a promissory note. The filing says the trust is intended to fund future employee-plan obligations and may affect future compensation expense as shares are released.
Investor verification priorities
- Assess how sustainable earnings are excluding the $29.6 million securities gains and the $3.7 million subsidiary-sale gain, and whether servicing-rights losses continue.
- Review deposit composition, funding costs, brokered-deposit use, and the availability and terms of reported borrowing capacity.
- Track credit quality, allowance coverage, purchased-credit-impaired loan performance, nontraditional mortgage exposure, and repurchase claims.
- Confirm the impact and timing of regulatory requirements associated with crossing the $10 billion asset threshold, including deposit-insurance and compliance costs.
- Evaluate the employee trust’s financing, share-release terms, capital treatment, voting arrangements, and potential compensation expense.