Banc of California, Inc. — Q2 2014 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2014. Banc of California is a financial holding company operating a California-focused bank, with 17 branches and 60 loan production offices. Results reflect significant expansion, including the 2013 Private Bank of California acquisition and growth in mortgage banking; comparisons with 2013 are therefore affected by changes in scale and business mix.
Financial performance and condition
- Q2 earnings: Net income was $8.1 million versus $4.4 million a year earlier; net income available to common shareholders was $7.2 million after $0.9 million of preferred dividends. Basic and diluted EPS were $0.27, compared with $0.35 in Q2 2013.
- First-half earnings: Net income was $8.9 million versus $5.3 million; common-shareholder income was $7.1 million after $1.8 million of preferred dividends. EPS was $0.30 versus $0.41.
- Revenue and margin: Q2 interest and dividend income was $43.6 million, up 63%; net interest income was $35.6 million, up 65%. Noninterest income was $35.4 million, up 36%, including $26.1 million in mortgage banking gains. Net interest margin declined to 3.70% from 3.93% in Q2 2013. For the first half, net interest income was $70.8 million, noninterest income $60.7 million, and net interest margin 3.84%, unchanged from the prior-year period.
- Expenses and returns: Q2 noninterest expense increased 53% to $60.5 million, led by salaries, commissions, occupancy and acquisition-related growth. The efficiency ratio was 85.23% versus 83.01%; Q2 return on average assets was 0.81% versus 0.76%. First-half efficiency ratio was 89.97% versus 85.39%, and return on average assets was 0.46% versus 0.53%.
- Balance sheet: At June 30, total assets were $4.39 billion, up 20.9% from year-end 2013. Net loans and leases were $2.58 billion, deposits $3.35 billion, and shareholders’ equity $439.3 million. Loans held for sale totaled $1.10 billion, including $851.0 million carried at the lower of cost or fair value.
- Credit quality: Nonaccrual loans rose to $41.6 million from $31.6 million at year-end; nonperforming assets were $42.2 million. The allowance for loan and lease losses was $22.6 million, or 0.87% of gross loans, versus 0.77% at year-end; coverage of nonperforming loans fell to 54.38% from 59.42%. The company extended its historical loss lookback from 12 to 15 quarters, adding $1.8 million to the allowance relative to the prior method.
- Cash flow and liquidity: First-half operating cash flow was negative $460.4 million, largely reflecting mortgage-loan originations held for sale; financing activities provided $743.2 million, including deposit growth, FHLB advances and capital issuance. Cash and cash equivalents ended at $258.1 million. Deposits increased $428.7 million from year-end; FHLB advances were $450 million. The Bank reported additional FHLB borrowing capacity of $554.9 million and Federal Reserve lines of $106.6 million.
- Debt and capital: Total borrowings were $546.5 million, including $450 million of FHLB advances and $96.5 million of notes payable. The company issued $57.9 million gross common stock and $69 million gross tangible equity units in May. The Bank’s regulatory capital ratios were 14.88% total risk-based, 13.79% Tier 1 risk-based and 9.72% Tier 1 leverage; each exceeded the stated “well-capitalized” thresholds.
Material changes and notable items
- Growth in average loans and acquired balances drove much of the increase in interest income and net interest income. Mortgage originations and sales also expanded: first-half conforming mortgage originations were $1.23 billion, with $1.18 billion sold.
- Mortgage banking gains increased, but mortgage banking margin on conforming production declined to 3.13% for the first half from 3.70% in 2013. Expenses rose substantially alongside acquisitions, expanded staffing and mortgage operations.
- On April 22, 2014, the Bank agreed to acquire 20 Banco Popular North America California branches. Based on March 31 balances, the deal contemplated about $1.1 billion each of loans and deposits and approximately $5.4 million of consideration, an effective 0.5% deposit premium. Closing depended on regulatory approvals, other conditions and financing; certain termination circumstances could trigger a $2 million fee.
- The company reported cumulative prior-period adjustments that increased loan-loss provision by $758,000, stock compensation expense by $483,000 and other expense by $160,000; management said these corrections were not material to prior or current periods.
- Management disclosed a material weakness in internal control over financial reporting, tied to insufficient account-level review procedures in 2013. It stated the weakness had not caused a material misstatement, described remediation efforts, and said controls must operate and be tested for a sufficient period before remediation can be concluded. Disclosure controls were deemed ineffective as of June 30, 2014.
Outlook, risks and contingencies
- The filing provides no specific earnings or financial guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Risks include completing and integrating the Banco Popular branch acquisition, obtaining financing and approvals, deposit or loan runoff, integration expense, and realizing expected growth or savings.
- Credit risks include real-estate market and borrower deterioration, allowance adequacy, and geographic concentration. Single-family residential mortgages were approximately 41.5% of the loan portfolio; the company also highlighted higher-risk nontraditional mortgage features. Green Loan nonperformers increased to $15.1 million from $5.7 million at year-end.
- Interest-rate exposure is significant: the company reported that an immediate +100 basis-point shock would reduce economic value of equity by 4.8% while increasing modeled net interest income by 2.2%; a -100 basis-point shock would increase economic value of equity by 1.3% but reduce modeled net interest income by 4.5%.
- Other risks include mortgage repurchase claims (reserve $6.2 million), ongoing tax examinations and $2.2 million of unrecognized tax benefits, acquisition and related-party risks, and the disclosed material weakness. A patent lawsuit concerning Green Loans remained pending; the company believed it lacked merit and did not expect a material impact, while noting no assurance.
Most important facts for investors to verify
- Whether the Banco Popular transaction closed, how it was financed, and the acquired branches’ actual deposit retention, loan performance and integration costs.
- Whether the internal-control material weakness was fully remediated and whether later filings report further corrections or control deficiencies.
- Whether nonperforming loans, especially Green Loans and residential mortgages, continue to rise and whether allowance coverage remains adequate.
- How sustainable mortgage banking income and margins are relative to rising operating expenses and the company’s expanded balance sheet.
- Funding mix, deposit pricing and runoff, use of FHLB and other borrowing capacity, and capital effects from the tangible equity units and potential share issuance.