Banc of California, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2018. Banc of California is a California-focused commercial bank operating 34 branches. Results include continuing operations and the residual activity of Banc Home Loans, sold in 2017 and reported as discontinued operations.
Financial performance and condition
- Q2 earnings: Continuing-operations net income was $13.9 million, versus $15.1 million in Q2 2017. Diluted continuing-operations EPS was $0.16, versus $0.20. Including discontinued operations, net income was $14.8 million, compared with $12.3 million; diluted EPS was $0.18 versus $0.14.
- First-half earnings: Continuing-operations net income was $20.9 million, versus $24.5 million in 2017. Consolidated net income was $23.3 million, versus $29.5 million; diluted EPS was $0.25 versus $0.37.
- Net interest income and margins: Q2 net interest income was $72.8 million (consolidated basis: $73.0 million), down 6.8% from the prior-year quarter; first-half consolidated net interest income was $144.6 million, down 10.8%. Net interest margin was 3.01% in Q2 versus 3.09%, and 3.00% for the first half versus 3.14%. Higher funding costs and lower average securities balances weighed on results.
- Other income and expenses: Q2 noninterest income was $8.1 million, up from $5.7 million, including $2.1 million in legal-settlement proceeds. First-half noninterest income was $16.6 million, down from $20.6 million, including a $2.5 million loss on MSR sales. Noninterest expense fell to $62.5 million in Q2 from $76.3 million and to $122.3 million for the half from $166.2 million; Q2 included $4.0 million in restructuring costs.
- Credit costs and asset quality: Provision for loan and lease losses was $2.7 million in Q2 versus $2.5 million; first-half provision rose to $22.2 million from $5.1 million. The allowance was $56.7 million, or 0.81% of loans, at June 30. Nonperforming loans were $22.3 million (0.32% of loans), versus $19.4 million at year-end.
- Balance sheet and funding: Total assets were $10.32 billion, broadly unchanged from year-end. Net loans were $6.98 billion, up 5.6%; available-for-sale securities were $2.30 billion, down 10.8%. Deposits were $7.14 billion, down 2.2%; FHLB advances were $1.81 billion, up from $1.70 billion. Long-term debt, net, was $173.0 million. Cash and cash equivalents were $385.7 million.
- Cash flow: First-half operating cash flow was $50.9 million, investing cash flow was $20.1 million, and financing cash flow was negative $72.9 million. Cash declined $2.0 million to $385.7 million.
- Capital and liquidity: The Bank’s total risk-based capital ratio was 16.63%, CET1 ratio 15.74%, and leverage ratio 10.58%; each exceeded the stated well-capitalized thresholds. The company reported $804 million of additional FHLB borrowing capacity, a $61.7 million Federal Reserve discount-window line, $210 million of unused unsecured federal funds lines, and $1.77 billion of unpledged securities.
Material changes versus comparable periods
- Loan growth and higher loan yields lifted loan interest income, but rising deposit and FHLB funding costs and a smaller securities portfolio reduced net interest income and margin.
- First-half credit provision increased substantially, largely due to a $13.9 million charge-off tied to a fraudulent $15 million line of credit, plus a downgrade of a $28.5 million commercial-and-industrial loan.
- Expense reductions, including lower staffing, professional fees, and alternative-energy investment losses, improved reported efficiency; Q2 results also included restructuring charges and legal-settlement proceeds.
- The securities portfolio was repositioned to reduce duration, with proceeds directed largely toward loan originations. Accumulated other comprehensive loss was $19.4 million at quarter-end, compared with income of $5.2 million at year-end.
Outlook, risks, and unusual items
- No earnings or revenue guidance is provided. The company expected its workforce reduction and reduced use of outside advisors to be substantially complete by Q3 and fully complete in Q4 2018; it estimated annual savings of approximately $15 million. Additional severance costs could occur, and actual savings may be lower than expected.
- The filing identifies an ongoing SEC investigation, related litigation and reputational risk, management-transition risk, credit and fraud exposure, interest-rate and funding risks, and uncertainty around regulatory requirements and economic conditions. The company says it intends to contest the securities class action; trial was scheduled for October 2019. Other matters include litigation and arbitration proceedings. A shareholder derivative case was dismissed in June 2018.
- The Bank is pursuing recovery related to the fraudulent credit line but states there is no assurance it will succeed. Management characterized the event as isolated external fraud.
- The company has a $100 million stadium naming-rights and sponsorship commitment payable over 15 years through 2032; $12.7 million had been paid by June 30, 2018.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The company stated it believed available liquidity was adequate for day-to-day requirements.
Important facts for investors to verify
- Progress and recoveries, if any, relating to the fraudulent $15 million line of credit and the adequacy of the loan-loss allowance.
- Whether the targeted $15 million annual cost savings are achieved, and the total restructuring costs required.
- Developments in the SEC investigation and outstanding securities, employment, and other litigation, including possible financial or reputational consequences.
- Deposit trends, reliance on FHLB advances, funding costs, and the effect of further rate changes on net interest margin.
- Credit quality trends, particularly nonperforming loans, commercial-and-industrial exposures, and the nontraditional mortgage portfolio.
- Execution and economic value of the securities repositioning and the long-term stadium sponsorship commitment.