Banc of California, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The filing was signed and filed on March 1, 2017, after the company reported it had missed the filing deadline. Banc of California is a California-focused financial holding company whose principal businesses are commercial banking and mortgage banking.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $87.0 million | $55.6 million | $238.4 million | $161.7 million |
| Total revenue (net interest income plus noninterest income) | $161.6 million | $106.3 million | $430.6 million | $325.1 million |
| Net income | $35.9 million | $14.5 million | $82.2 million | $43.0 million |
| Net income available to common shareholders | $30.8 million | $11.5 million | $67.4 million | $36.2 million |
| Diluted EPS | $0.59 | $0.29 | $1.40 | $0.93 |
| Net interest margin | 3.32% | 3.42% | 3.36% | 3.57% |
- Net interest income growth reflected materially larger average loan and securities balances, partly offset by higher funding costs and lower average loan yields. Mortgage banking revenue also increased year over year in Q3.
- Noninterest expense rose 52% in Q3 to $124.3 million and 27.7% for the nine months to $313.4 million, mainly reflecting business expansion. Q3 included a $17.7 million loss on alternative-energy partnership investments.
- Year-to-date noninterest income included $30.1 million of securities-sale gains and a $3.7 million gain on the Palisades Group sale. Lower interest rates contributed to $22.9 million of mortgage-servicing-rights fair-value and runoff losses for the nine months.
- At September 30, total assets were $11.22 billion, up 36% from year-end 2015; net loans and leases were $6.53 billion, up 27%; deposits were $9.08 billion, up 44%. Stockholders’ equity was $971.4 million.
- Cash and cash equivalents were $372.6 million. For the first nine months, operating cash flow was negative $148.9 million, investing cash flow was negative $2.43 billion, and financing cash flow was positive $2.80 billion.
- Total borrowings were approximately $996.5 million, including $770 million of FHLB advances, $49.9 million of other borrowings, and $176.6 million of long-term debt. The company redeemed $84.8 million of 7.50% senior notes in April and recorded $2.7 million of debt-extinguishment costs.
- Regulatory capital ratios at September 30 included company common equity Tier 1 of 8.85% and bank common equity Tier 1 of 13.83%; the bank exceeded the stated “well-capitalized” thresholds. Nonperforming assets were $35.5 million, or 0.32% of assets; nonperforming loans declined from $45.1 million at year-end to $35.2 million.
Material changes, risks and unusual items
- Alternative-energy investment: The company recorded a $17.7 million investment loss in Q3 and recognized approximately $19.4 million of year-to-date tax credits, contributing to a 27.0% nine-month effective tax rate versus 41.3% in 2015. The investment had a $23.9 million carrying value and $58.4 million of unfunded commitments; disclosed maximum loss exposure was $82.3 million.
- Concentrated securities exposure: CLOs were approximately $1.74 billion, or 60.2% of securities at amortized cost, at September 30. Holdings were rated AAA or AA, but CLOs may be illiquid and exposed to underlying loan performance, market-value changes and Volcker Rule interpretation.
- Credit and mortgage risks: The allowance for loan and lease losses was $40.2 million, or 0.61% of loans. Nontraditional mortgages totaled $891.1 million, including interest-only and legacy Green Loan products. The mortgage repurchase reserve was $11.4 million; management cautioned that future repurchase demands could be material.
- Controls and reporting: Management concluded disclosure controls were ineffective and identified a material weakness in internal control over financial reporting, citing an inadequate control environment and related weaknesses in risk assessment, monitoring and resourcing. No material misstatement was identified, but the filing states that a material misstatement might not have been prevented or detected timely. Remediation steps were initiated.
- Investigation and leadership: After allegations concerning related-party relationships and governance, an independent Special Committee reported in February 2017 that its inquiry found no violation of law or evidence of undue control or impaired director independence; it also found that an October 2016 company press release contained inaccurate statements about the earlier inquiry. The SEC had issued a formal order of investigation, and the company said it was cooperating. CEO Steven Sugarman resigned in January 2017; interim leadership was appointed and a permanent CEO search was underway.
- Subsequent developments: The company disclosed later sales of seasoned mortgage pools, equipment-finance assets, and an agreement to sell mortgage-banking assets and about $3.8 billion of MSRs. The proposed mortgage-business transaction included a $25 million premium, possible additional consideration and an earn-out; the MSR sale price was $36 million and was expected to result in a $3.5 million loss. These events occurred after the reporting date and should not be treated as Q3 results.
- No specific earnings or revenue guidance is provided. Management described liquidity as adequate; however, the company had $1.72 billion of brokered deposits and later obtained extensions to deliver the September financial statements under its holding-company credit agreement.
Important facts for investors to verify
- Progress and independent validation of control-remediation measures, the delayed filing, and any subsequent reporting or audit developments.
- Status and consequences of the SEC investigation, related litigation, and management transition, including any effects on customers, deposits, funding costs or operations.
- CLO concentration, liquidity and valuation assumptions, along with the performance of the loan portfolio, nontraditional mortgages and acquired credit-impaired loans.
- Adequacy of mortgage repurchase reserves and the sensitivity of servicing-rights values to interest rates and prepayments.
- Post-quarter asset-sale closings, proceeds and earn-out terms, and resulting effects on capital, liquidity, recurring earnings and business mix.