Sierra Bancorp — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; financial statements are unaudited. Sierra Bancorp is the holding company for Bank of the Sierra, a California community bank operating 34 full-service branches. Unless noted, dollar amounts below are in millions.
Financial performance
- Q2 earnings: Net income was $5.20 million, up 27% from $4.09 million in Q2 2016. Diluted EPS was $0.37 versus $0.31. Annualized return on average assets was 1.02% and return on average equity was 9.75%.
- First-half earnings: Net income was $9.75 million, up 20% from $8.12 million; diluted EPS was $0.70 versus $0.61. Annualized ROAA was 0.98% and ROAE was 9.31%.
- Revenue and margins: Q2 net interest income was $17.84 million, up 17%; non-interest income was $5.36 million, up 17%. Tax-equivalent net interest margin was 3.93%, compared with 3.89%. For the first half, net interest income rose 14% to $34.72 million and non-interest income rose 18% to $10.50 million; the tax-equivalent margin was 3.92%, unchanged year over year.
- Expenses and taxes: Q2 non-interest expense rose 10% to $15.09 million; the tax-equivalent efficiency ratio improved to 63.30% from 68.10%. First-half non-interest expense rose 13% to $30.79 million. The effective tax provision was 33% of pretax income in Q2 and 31% for the first half, versus 33% for the comparable first-half 2016 period.
- Cash flow: For the first half, operating cash flow was $10.82 million, investing cash outflow was $85.53 million, and financing cash inflow was $31.44 million. Cash and cash equivalents declined $43.27 million to $77.18 million.
Financial position, funding and credit
- Total assets were $2.078 billion at June 30, up from $2.033 billion at year-end 2016. Gross loans rose 3% to $1.299 billion; available-for-sale securities increased 9% to $579.58 million.
- Deposits increased 6% to $1.792 billion, including growth in core non-maturity deposits. Cash and cash equivalents fell 36% from year-end as funds were shifted in part into longer-term securities.
- Short-term borrowings were zero, down from $65 million at December 31, 2016, largely reflecting deposit growth. Repurchase agreements were $11.30 million and subordinated debentures were $34.50 million. Shareholders’ equity increased 5% to $216.12 million.
- Liquidity resources included $398 million of available correspondent-bank and FHLB lines, an additional $96 million of FHLB capacity subject to collateral and stock requirements, and approximately $79 million of Federal Reserve Discount Window capacity. Unpledged securities and securities pledged beyond current requirements totaled $431 million.
- Nonperforming assets declined 9% to $7.79 million; the ratio to gross loans plus foreclosed assets improved to 0.60% from 0.68% at year-end. Non-accrual loans were $5.65 million, and performing troubled debt restructurings were $13.64 million.
- The allowance for loan and lease losses was $9.23 million, or 0.71% of gross loans, down from $9.70 million, or 0.77%, at year-end. First-half net charge-offs were $771,000, including a $224,000 business-account overdraft charge-off; the company recorded a $300,000 loan-loss provision, its first since Q2 2014.
- Consolidated total risk-based capital was 17.18%; the company and bank regulatory capital ratios remained above stated “well capitalized” thresholds.
Material changes and notable items
- Q2 net interest income growth reflected a $260 million increase in average interest-earning assets, including the Coast Bancorp acquisition, and a four-basis-point increase in net interest margin. First-half growth in average earning assets was $232 million.
- Higher non-interest income included a $141,000 prepayment penalty on a large loan, higher deposit and debit-card fees, and higher bank-owned life insurance income. Expense growth reflected Coast-related costs, branch openings, technology and mobile-banking investment, and higher staffing and occupancy costs.
- Adoption of share-based compensation accounting guidance increased tax-provision variability: first-quarter disqualifying stock-option dispositions reduced the tax accrual by $284,000, versus $5,000 in Q2.
- The company entered agreements to acquire OCB Bancorp, parent of Ojai Community Bank, and the Citizens Business Bank Woodlake branch. Ojai’s merger was expected in October 2017 and the Woodlake transaction in Q4 2017; both were subject to approvals and other closing conditions. The Woodlake branch had approximately $27 million of deposits at May 31, 2017.
- The Coast acquisition closed in July 2016 and affects year-over-year comparisons of average balances, income and expenses. Management also cited an $85,000 Q2 legal-settlement expense.
Outlook, risks and contingencies
- No quantitative earnings or balance-sheet guidance was provided. Management reported a growing loan pipeline but cautioned that prepayments and mortgage-warehouse balances fluctuate, so future loan growth is uncertain.
- The company described itself as asset-sensitive: its model projected net interest income up 1.18% under an immediate 100-basis-point rate increase, but down 8.25% under a 100-basis-point decline. Management noted that modeled exposure in declining-rate scenarios exceeded internal policy limits and said it would continue monitoring the position.
- Key risks include credit losses and economic weakness in its markets, interest-rate and securities-value changes, liquidity, employee retention, technology execution, acquisitions and branch expansion, and regulatory requirements. Management cautioned that estimates for the loan-loss allowance may differ from actual losses.
- Unused commitments to extend credit were $583.56 million, up from $463.92 million at year-end; standby letters of credit were $8.43 million. These are potential funding exposures, although the company said not all commitments are expected to be drawn. A separate $344,000 allowance for losses on unused commitments was included in other liabilities.
- Management stated that routine legal proceedings were not expected to have a material adverse effect. It reported no material risk-factor changes from the 2016 Form 10-K and no material changes in internal controls.
Important facts for investors to verify
- Closing status, terms and integration outcomes for the proposed Ojai and Woodlake acquisitions, including the related regulatory and shareholder approvals.
- Whether loan growth, deposit growth and net interest margin persist as funding costs rise; in particular, monitor the cost of large time deposits and subordinated debt.
- Credit trends following the $771,000 in first-half net charge-offs and the new provision; track nonperforming loans, TDRs, loan concentrations and allowance adequacy.
- Liquidity and capital after the acquisitions, and the extent to which unused credit commitments become funded.
- Actual performance versus modeled sensitivity to falling interest rates, and any resulting management actions.