Sierra Bancorp — Q2 2018 Form 10-Q
Business and period: California bank holding company for Bank of the Sierra, serving communities across California. This unaudited report covers the quarter and six months ended June 30, 2018; balance-sheet comparisons are against December 31, 2017. The company acquired a Lompoc branch in May and planned to open a Fresno branch in Q3 2018.
Financial performance and condition
Amounts below are in millions except per-share data and ratios.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $22.8 | $17.8 | $44.6 | $34.7 |
| Provision for loan losses | $0.3 | $0.3 | $0.5 | $0.3 |
| Non-interest income | $5.4 | $5.4 | $10.6 | $10.5 |
| Non-interest expense | $17.3 | $15.1 | $35.2 | $30.8 |
| Income before taxes | $10.6 | $7.8 | $19.4 | $14.1 |
| Net income | $8.0 | $5.2 | $14.7 | $9.8 |
| Diluted EPS | $0.52 | $0.37 | $0.95 | $0.70 |
| Net interest margin, tax-equivalent | 4.24% | 3.93% | 4.22% | 3.92% |
- Q2 net income rose 54% year over year; first-half net income rose 51%. Management attributed the gains chiefly to higher net interest income from asset growth and improved margin, with a lower tax rate also lifting net income.
- Q2 annualized return on average assets was 1.34% and return on average equity was 12.44%, versus 1.02% and 9.75%, respectively, a year earlier. Efficiency ratio improved to 60.44% from 63.30% for Q2.
- At June 30, total assets were $2.425 billion, gross loans $1.624 billion, deposits $2.088 billion, and shareholders’ equity $260.2 million. Since year-end, assets grew $85 million, loans $67 million, and deposits $100 million.
- Cash and cash equivalents were $85.1 million, up from $70.1 million at year-end. For the first half, operating cash flow was $11.1 million, investing cash outflow $78.5 million, and financing cash inflow $82.3 million.
- Total liabilities were $2.165 billion. Short-term borrowings fell from $21.9 million at year-end to zero; subordinated debentures were $34.7 million and repurchase agreements $17.2 million. The filing reports total risk-based capital of 15.20% for Sierra Bancorp and 15.09% for Bank of the Sierra; both exceeded stated well-capitalized thresholds.
- The allowance for loan and lease losses was $9.1 million, or 0.56% of gross loans, versus 0.58% at year-end. First-half net charge-offs were $0.4 million. Nonperforming assets fell to $5.2 million from $9.4 million; the ratio to loans plus foreclosed assets declined to 0.32% from 0.60%.
Changes, outlook and risks
- Net interest income increased 28% in both Q2 and the first half. Management cited loan growth, acquisition effects—particularly the 2017 Ojai acquisition—and loan yields rising faster than deposit costs. The Q2 margin benefited by about 11 basis points from acquired-loan discount accretion.
- Operating expense rose 15% in Q2 and 14% in the first half, reflecting acquired operations, branch expansion, staffing and higher deposit costs. The first-half effective tax provision fell to 24% from 31%, largely following the federal corporate tax-rate reduction.
- A $713,000 gain from selling an OREO property in Q2 was unusual and reduced reported expense. The securities portfolio’s net unrealized loss widened to $12 million from $3 million at year-end, primarily due to rising interest rates; management did not consider the losses other-than-temporary.
- Management reported a record loan pipeline in recent periods but cautioned that prepayments and mortgage-warehouse balances can fluctuate, so future net loan growth is uncertain. No earnings or financial guidance was provided.
- Interest-rate simulations show asset sensitivity: a 100-basis-point upward shock was projected to increase 12-month net interest income 1.50%; a 100-basis-point decline was projected to reduce it 5.95%, beyond the company’s stated policy limit. Further rate declines produced larger modeled reductions. Results depend on assumptions, including deposit behavior.
- The company is preparing for CECL, effective January 1, 2020. Preliminary estimates indicate the allowance could increase by 100% or more under a discounted-cash-flow approach with forecasting; management said the ultimate impact was not yet determined and could materially affect the allowance and equity.
- Liquidity sources included $520 million of available correspondent-bank and FHLB lines, plus additional conditional FHLB and Federal Reserve borrowing capacity. Unused credit commitments were $728 million, with $10 million in standby letters of credit; these are potential funding needs, not certain drawdowns.
- Other disclosed risks include economic and credit conditions, interest-rate and securities-value changes, liquidity, deposit retention, acquisition and branch execution, technology, staffing and regulatory requirements. Management said legal proceedings were not expected to have a material adverse effect, and reported no material change in risk factors or internal financial-reporting controls.
Important facts for investors to verify
- How much of earnings growth persists after acquisition-related growth, acquired-loan accretion, lower taxes and the one-time OREO gain?
- Whether deposit costs continue to rise faster than asset yields, and how actual rate sensitivity compares with the model’s assumptions.
- Credit performance, including commercial and real-estate exposures, TDRs, nonperforming assets, charge-offs and allowance adequacy.
- The eventual CECL transition adjustment and its effects on reserves, equity and regulatory capital.
- Execution and funding implications of branch expansion, loan commitments and continued deposit growth.
- Whether the widening unrealized securities loss affects liquidity, capital or portfolio-management decisions.