Sierra Bancorp — Q1 2018 Form 10-Q
Business context and period. Sierra Bancorp is the holding company for Bank of the Sierra, a California community bank serving the South San Joaquin Valley, Central Coast, Ventura County, and nearby markets. This unaudited report covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. The prior-year earnings comparison is Q1 2017.
Financial results and condition
| Metric | Q1 2018 / March 31, 2018 | Comparison |
|---|---|---|
| Net interest income | $21.76 million | Up 29% from $16.88 million in Q1 2017 |
| Net interest margin, tax-equivalent | 4.20% | 3.90% in Q1 2017 |
| Net income | $6.71 million | Up 47% from $4.55 million |
| Diluted earnings per share | $0.44 | $0.32 in Q1 2017 |
| Return on average assets / equity, annualized | 1.16% / 10.61% | 0.94% / 8.85% in Q1 2017 |
| Non-interest income / expense | $5.13 million / $17.89 million | Income unchanged; expense up 14% year over year |
| Efficiency ratio, tax-equivalent | 65.72% | 69.21% in Q1 2017 |
| Operating cash flow | $8.04 million | $7.99 million in Q1 2017 |
| Total assets | $2.374 billion | $2.340 billion at December 31, 2017 |
| Gross loans and leases | $1.592 billion | $1.558 billion at year-end |
| Total deposits | $2.037 billion | $1.988 billion at year-end |
| Shareholders’ equity | $255.3 million | $255.9 million at year-end |
| Allowance for loan and lease losses | $8.99 million; 0.56% of gross loans | $9.04 million; 0.58% at year-end |
- Net interest income growth reflected an 18% increase in average earning assets, including the effect of the 2017 Ojai Community Bank acquisition and organic growth, plus a 30-basis-point improvement in margin. Loan growth and higher asset yields contributed; interest expense also rose as deposit and borrowing costs increased.
- Pre-tax income increased 39% year over year. Net income grew faster in part because the effective tax provision fell to 24% of pre-tax income from 28%, primarily reflecting the lower federal corporate tax rate.
- Non-interest expense increased $2.19 million, including $286,000 of nonrecurring acquisition costs. Salaries and benefits rose 16%, reflecting acquired and new-branch staffing, pay and health-cost increases. Service-charge income rose, but lower bank-owned life insurance income and other income offset that growth.
- Q1 cash flows: operating activities provided $8.04 million; investing activities used $49.44 million, principally reflecting securities purchases and net loan funding; financing activities provided $34.77 million, mainly from deposit growth. Cash and cash equivalents ended at $63.51 million, down from $70.14 million at year-end.
- Deposits grew 2% in the quarter. Non-deposit interest-bearing liabilities declined by about $11 million; at March 31, short-term borrowings were $5.8 million, repurchase agreements $12.5 million, and subordinated debentures $34.6 million.
- Liquidity sources included $497 million of available correspondent-bank and FHLB lines, a further $77 million of potential FHLB capacity subject to collateral and stock requirements, and approximately $71 million of Federal Reserve Discount Window capacity. Management said available liquid assets and standby funding were sufficient for anticipated near-term needs.
- Regulatory capital remained strong: Sierra Bancorp’s total risk-based capital ratio was 15.32%; Bank of the Sierra’s was 15.18%. Both exceeded the stated 10.00% well-capitalized minimum.
Material changes and asset quality
- Gross loans increased $34 million, or 2%, from year-end. Real estate loans grew $63 million and agricultural loans $7 million; mortgage warehouse balances fell $29 million, or 21%.
- Nonperforming assets declined 10% to $8.46 million, and were 0.53% of gross loans plus foreclosed assets, versus 0.60% at year-end and 0.65% a year earlier. Nonperforming loans were $3.09 million; foreclosed assets were $5.37 million.
- Performing troubled debt restructurings totaled $11.19 million; total TDRs were $12.1 million, including $895,000 on non-accrual. Net loan charge-offs were $252,000 in Q1, compared with $113,000 in Q1 2017; the quarter included a $200,000 loan-loss provision.
- Accumulated other comprehensive loss widened to $7.68 million from $2.33 million at year-end, mainly as rising market rates reduced available-for-sale securities values. The portfolio’s net unrealized loss was approximately $11 million, versus $3 million at year-end. Management did not consider the losses other-than-temporary.
Outlook, risks and unusual items
- No formal earnings or financial guidance is provided. Management reported a record level in the loan pipeline in recent periods but cautioned that prepayments and mortgage-warehouse activity can make future loan growth variable.
- The bank planned to open a Fresno branch in mid-2018 and expected to complete the purchase of a Lompoc branch in May 2018, subject to customary conditions. Lompoc deposits were about $40 million at March 31; the contemplated property and equipment purchase price was $1.7 million.
- The company adopted several accounting standards in Q1 with no material financial-statement impact from the revenue-recognition standard. It adopted guidance permitting reclassification of certain tax effects from AOCI, recording a $413,000 increase to retained earnings and corresponding decrease to AOCI as of December 31, 2017.
- CECL, effective for the company in 2020, is a significant prospective uncertainty. A preliminary assessment indicated a potentially material impact; initial estimates suggested the allowance could increase by 100% or more under a discounted-cash-flow approach with forecasting. The ultimate effect had not been determined.
- Interest-rate simulations show an asset-sensitive position: a parallel 100-basis-point increase was estimated to raise 12-month net interest income by 0.95%, while a 100-basis-point decrease was estimated to reduce it by 5.72%. The modeled decline exceeded internal policy guidelines in falling-rate scenarios. Results depend on assumptions, including deposit behavior and repricing.
- Other stated risks include adverse local economic conditions, credit losses, interest-rate and liquidity exposure, securities-value declines, acquisition and branch-expansion execution, staffing and technology, and regulatory changes. Management reported no material change in previously disclosed risk factors. Ordinary-course legal proceedings were not expected to have a material adverse effect.
Most important facts for investors to verify
- Whether loan and deposit growth persists, and the effect of mortgage-warehouse contraction, competition, and rising funding costs on net interest margin.
- Credit performance, including charge-offs, TDRs, nonperforming assets, and the adequacy of the allowance as the loan book expands.
- The eventual CECL transition impact on reserves, retained earnings, and capital; the filing’s preliminary estimate is not a final forecast.
- Potential effects of further interest-rate changes on securities values and earnings, including sensitivity to deposit pricing and runoff assumptions.
- Completion and integration costs of the Lompoc branch purchase and other expansion plans, including whether acquisition-related costs remain elevated.