Sierra Bancorp — FY 2017 Form 10-K
Business context and period. Sierra Bancorp is a California bank holding company whose principal subsidiary, Bank of the Sierra, operates in California’s San Joaquin Valley, Central Coast and neighboring markets. This annual report covers the year ended December 31, 2017; balance-sheet comparisons are to December 31, 2016. The filing was signed March 13, 2018.
Financial results and position
| Metric | FY 2017 / year-end 2017 | Prior comparable period |
|---|---|---|
| Interest income | $80.9 million | $68.5 million in 2016 |
| Net interest income | $75.7 million | $65.2 million in 2016 |
| Net interest margin, tax-equivalent | 4.04% | 3.95% in 2016 |
| Non-interest income | $21.8 million | $19.2 million in 2016 |
| Non-interest expense | $65.4 million | $58.1 million in 2016 |
| Net income | $19.5 million | $17.6 million in 2016 |
| Diluted earnings per share | $1.36 | $1.29 in 2016 |
| Return on average assets / equity | 0.93% / 8.82% | 0.95% / 8.71% in 2016 |
| Total assets | $2.340 billion | $2.033 billion |
| Gross loans / net loans | $1.558 billion / $1.552 billion | $1.263 billion / $1.256 billion |
| Total deposits | $1.988 billion | $1.695 billion |
| Shareholders’ equity | $255.9 million | $205.9 million |
| Cash and cash equivalents | $70.1 million | $120.4 million |
Cash flow. Net cash provided by operating activities was $41.3 million; investing activities used $52.3 million and financing activities used $39.3 million. Cash and cash equivalents decreased $50.3 million during the year to $70.1 million.
Credit quality and reserves. The company recorded a $1.14 million benefit from loan-loss provisions, compared with no provision in 2016. Net recoveries were $482,000. The allowance was $9.0 million, or 0.58% of gross loans, down from $9.7 million, or 0.77%. Nonperforming assets were $9.4 million, 0.60% of loans and foreclosed assets, versus $8.6 million, or 0.68%, in 2016. Foreclosed assets rose to $5.5 million from $2.2 million.
Debt and liquidity. Year-end liabilities included $34.6 million of subordinated debentures, $21.9 million of short-term borrowings and $8.2 million of repurchase agreements. Short-term borrowings fell from $65.0 million in 2016. Management reported $394 million of available correspondent-bank and FHLB credit lines, a further $96 million of potential FHLB capacity subject to collateral, and approximately $68 million of Federal Reserve discount-window borrowing capacity. Unpledged securities and pledged securities exceeding current requirements totaled $415 million. The company and Bank were classified as well capitalized; consolidated Common Equity Tier 1, total risk-based capital and leverage ratios were 12.84%, 15.32% and 11.32%, respectively.
Material changes versus 2016
- Net income increased 11%, while diluted EPS rose from $1.29 to $1.36. Net interest income increased 16%, driven mainly by higher average earning assets from acquisitions and organic loan growth, with margin expansion contributing as well.
- Assets increased 15%, gross loans 23% and deposits 17%. The October 2017 Ojai Community Bank acquisition added approximately $218 million of loans and $231 million of deposits at acquisition; the Woodlake branch acquisition added $27 million of deposits. The company also issued 1.38 million shares as Ojai consideration.
- Non-interest expense rose 13%, including $2.2 million in acquisition costs. Staffing, occupancy, data processing and deposit-service costs also grew with acquisitions and branch expansion.
- Credit indicators improved on the nonperforming-loan measure, but foreclosed assets increased, largely due to property acquired with Ojai.
- Reported net income included a $2.71 million tax expense from remeasuring deferred tax assets following the Tax Cuts and Jobs Act. Net deferred tax assets declined to $6.5 million from $9.5 million.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific earnings or revenue guidance. Management expects the reduced federal corporate tax rate to benefit tax expense beginning in 2018 and estimated a blended marginal tax rate of 29.56% for 2018, compared with 42.05% in 2017. These are management expectations, not a formal earnings forecast.
- Management cited loan growth, core deposits and lower nonperforming assets as supports to recent core performance. It also noted a record loan pipeline, while cautioning that prepayments and mortgage-warehouse balances can be volatile.
- Interest-rate sensitivity modeling showed projected 12-month net interest income rising 1.33% under an immediate 100-basis-point increase, but declining 6.55% under a 100-basis-point decrease; the downside exceeded internal policy guidelines. Results depend on assumptions and exclude potential competitive or credit-quality pressures.
- Key risks include concentration in real estate lending (79% of loans), California agricultural and local economic conditions, borrower and collateral deterioration, competition and deposit pricing, interest-rate exposure, cyber and operational risks, acquisition integration and potential goodwill impairment. Dairy lending was 8% of loans and mortgage-warehouse lending 9%.
- Unused credit commitments totaled approximately $692 million, with $9.2 million of standby letters of credit. The company had a $334,000 reserve for potential losses on unfunded commitments. Management stated that legal proceedings were not expected to have a material adverse effect.
- Other notable items: $500,000 in securities gains, $503,000 in life-insurance proceeds and a $323,000 gain related to dissolution of a tax-credit fund were included in 2017 income. The company’s auditor gave an unqualified opinion and reported effective internal control over financial reporting.
Important facts for investors to verify
- Review the Ojai and Woodlake acquisition accounting, integration progress, acquired-loan performance, goodwill balance and contribution to ongoing earnings.
- Reconcile the $2.71 million deferred-tax remeasurement charge and assess the durability of the expected 2018 tax benefit and tax-credit utilization.
- Assess credit-risk concentrations, including commercial real estate, dairy and mortgage warehouse; monitor foreclosed assets, criticized loans, recoveries and the allowance as loan balances grow.
- Evaluate deposit retention and funding costs after acquisition-related deposit runoff, and confirm the availability and collateral requirements of stated liquidity sources.
- Consider the modeled sensitivity to falling interest rates, the effect of higher deposit betas, and unrealized losses in the available-for-sale securities portfolio.
- Assess acquisition-related expense and share dilution against earnings growth; FY 2017 dividends were $0.56 per share, with the filing noting that future dividends are not assured.
- Track implementation of the expected-credit-loss (CECL) standard, which the company said could affect reserves and shareholders’ equity; the magnitude was not yet clear.