Sierra Bancorp — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; comparisons are primarily with FY 2017. This is an annual filing, not a standalone fourth-quarter report. Sierra Bancorp is the holding company for Bank of the Sierra, a California community bank operating 40 full-service branches and serving the South San Joaquin Valley, Central Coast, Ventura County, and nearby markets.
Financial results and condition
| Metric | FY 2018 / Dec. 31, 2018 | FY 2017 / Dec. 31, 2017 |
|---|---|---|
| Net income | $29.7 million | $19.5 million |
| Diluted EPS | $1.92 | $1.36 |
| Net interest income | $92.4 million | $75.7 million |
| Tax-equivalent net interest margin | 4.24% | 4.04% |
| Noninterest income | $21.6 million | $21.8 million |
| Noninterest expense | $70.0 million | $65.4 million |
| Provision for loan losses | $4.35 million | Benefit of $1.14 million |
| Total assets | $2.523 billion | $2.340 billion |
| Gross loans | $1.732 billion | $1.558 billion |
| Deposits | $2.116 billion | $1.988 billion |
| Shareholders’ equity | $273.0 million | $255.9 million |
| Cash and cash equivalents | $74.1 million | $70.1 million |
- Net income rose 52%, supported by loan and earning-asset growth, improved net interest margin, and the lower federal corporate tax rate. The 2018 effective tax rate was 25.0%, versus 41.1% in 2017; 2017 included a $2.71 million deferred-tax remeasurement charge following the Tax Cuts and Jobs Act.
- Net interest income increased 22%. Average earning assets grew 14%, while the tax-equivalent margin expanded 20 basis points. Interest expense rose to $9.24 million from $5.22 million as deposit and borrowing costs increased.
- Operating expense rose 7%, reflecting acquisition-related operating costs, higher employee and health-insurance costs, and expansion. The efficiency ratio improved to 60.79% from 65.52%, partly aided by gains on foreclosed-asset sales.
- Gross loans increased 11%, mainly from commercial real estate and construction lending. Real estate represented 84% of gross loans. Mortgage warehouse balances fell 33% to $91.8 million.
- Deposits grew 6%. Growth included the Lompoc branch purchase, $50 million of brokered deposits, and a time-deposit promotion. Non-maturity deposits declined about $8 million overall, with money-market balances down $48 million.
- Credit costs increased: net charge-offs were $3.64 million, compared with $482,000 of net recoveries in 2017. The 2018 provision included $2.4 million associated with a purchased participation loan that was charged down, transferred to OREO, and sold.
- Nonperforming assets declined to $6.2 million, or 0.36% of loans and foreclosed assets, from $9.4 million, or 0.60%. Nonperforming loans nevertheless increased to $5.2 million from $4.0 million.
- Operating cash flow was $30.4 million, down from $40.7 million. Investing activities used $188.2 million, including net loan funding; financing activities provided $161.7 million, led by deposit growth and borrowings. Cash and cash equivalents increased $4.0 million during 2018.
Capital, debt, and liquidity
- Both Sierra Bancorp and Bank of the Sierra were classified as well capitalized. At year-end, the Company’s Common Equity Tier 1, Tier 1 risk-based, total risk-based, and leverage ratios were 12.61%, 14.38%, 14.89%, and 11.49%, respectively.
- Deposits were $2.116 billion. Other year-end funding included $56.1 million of short-term FHLB advances, $16.4 million of repurchase agreements, and $34.8 million of subordinated debentures. The debentures are long-dated, with stated maturities in 2034, 2036, and 2037.
- Management reported $524 million of available correspondent-bank and FHLB lines, plus approximately $64 million of Federal Reserve discount-window capacity, subject to collateral. Unpledged investments and securities pledged in excess of current requirements totaled about $352 million.
- The Company paid $0.64 per share in dividends in 2018, totaling $9.8 million, and did not repurchase shares during the fourth quarter. The holding company depends substantially on dividends from the Bank; regulatory or statutory limits could constrain distributions.
Material changes, outlook, and risks
- The May 2018 purchase of most Lompoc branch deposits added $38 million at acquisition and a $1.169 million deposit premium, amortized over eight years. The 2017 Ojai acquisition and Woodlake branch purchase continued to affect revenues, staffing, expenses, and acquired-intangible amortization.
- Management described local economies as stable or improving and cited strong loan pipelines, but provided no specific numerical earnings, loan-growth, or margin guidance. It cautioned that future loan growth and core-deposit growth are uncertain.
- Interest-rate modeling projected only a 0.19% increase in next-12-month net interest income under an immediate +100 basis-point shock, versus a 3.28% decline under a -100 basis-point shock. Deposit runoff and deposit-rate competition are additional sensitivities.
- Key exposures include commercial real estate and construction lending, geographic concentration in California, and borrower sensitivity to agriculture, water availability, trade tariffs, oil prices, real-estate values, and natural disasters. Dairy and hotel lending were each identified as notable industry concentrations.
- The company warned that adoption of the CECL credit-loss standard, scheduled for January 1, 2020, could materially affect reserves and equity. Preliminary analysis indicated the allowance could increase by 100% or more under one modeled approach; the impact was not yet determined.
- Available-for-sale securities had a $9.0 million net unrealized loss at year-end, versus $3.3 million a year earlier, primarily reflecting rising rates. Management said it did not consider the loss position other-than-temporary and did not expect to be forced to sell before recovery.
- Other noteworthy items included a $1.183 million gain from remeasuring the PCBB equity investment, a $915,000 accelerated amortization adjustment on tax-credit investments, and $1.423 million of gains on foreclosed-asset sales. The filing reports no legal proceedings expected to have a material adverse effect.
Most important facts to verify
- Whether loan growth and net interest income gains can continue as funding costs rise and mortgage warehouse balances fluctuate.
- The performance and collateral quality of the concentrated real-estate, construction, dairy, and hotel loan exposures, including the increase in nonperforming loans and 2018 charge-offs.
- The full CECL implementation estimate and its potential effects on the allowance, earnings, capital, and dividends.
- The sustainability and cost of deposit growth, including reliance on brokered and time deposits and the maturity profile of time deposits.
- Interest-rate exposure, securities valuation, and the availability of liquidity under stressed conditions; review assumptions concerning deposit repricing and runoff.
- The contribution of tax changes, acquisitions, investment remeasurement, tax-credit amortization, and OREO gains to reported earnings; compare these with recurring operating performance.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also reported effective controls as of December 31, 2018.