Westamerica Bancorporation — Q2 2017 Form 10-Q
Business context and period: Westamerica Bancorporation is a California bank holding company whose primary revenue comes from interest and fees on loans and investment securities, less funding costs. This unaudited filing covers the three and six months ended June 30, 2017; results are not necessarily indicative of full-year performance.
Financial performance and position
- Q2 earnings: Net income was $15.8 million, or $0.60 per diluted share, versus $14.5 million and $0.57 a year earlier. First-half net income was $30.8 million, or $1.17 per diluted share, versus $28.8 million and $1.13.
- Revenue and margin: Q2 net interest and loan fee income on a fully taxable-equivalent (FTE) basis was $35.8 million, down from $36.5 million; first-half income was $71.8 million, down from $72.9 million. FTE net interest margin fell to 3.12% for Q2 and 3.13% for the first half, from 3.27% and 3.30%, respectively. Noninterest income rose to $12.1 million in Q2 and $23.8 million for the first half.
- Expenses and profitability: Noninterest expense declined to $24.4 million in Q2 and $49.0 million for the first half, compared with $25.2 million and $51.1 million. The efficiency ratio improved to 50.9% for Q2 and 51.3% for the first half. Return on assets was 1.18% in Q2; first-half ROA was 1.15%.
- Credit costs: The company reversed $1.9 million of loan-loss provision in Q2, contributing approximately $0.04 to quarterly diluted EPS. It recorded $1.1 million of net loan recoveries in Q2. The allowance for loan losses was $24.1 million at June 30, down from $26.0 million at year-end.
- Cash flow: For the first half, operating cash flow was $40.4 million, investing cash flow was $34.7 million, and financing activities used $8.0 million. Cash and due from banks increased $67.1 million to $529.4 million.
- Balance sheet and liquidity: Total assets were $5.39 billion, compared with $5.37 billion at December 31, 2016. Deposits were $4.68 billion, down from $4.70 billion; loans were $1.32 billion, down from $1.35 billion. Investment securities totaled approximately $3.24 billion. Shareholders’ equity was $595.6 million, versus $561.4 million. Short-term borrowed funds were $75.8 million, up from $59.1 million; the parent company reported no debt.
- Capital and shareholder returns: At June 30, the company’s total risk-based capital ratio was 16.69% and the Bank’s was 13.41%; both exceeded the filing’s stated regulatory thresholds. The company paid $0.39 per share in Q2 dividends and $0.78 per share in the first half.
Material changes versus comparable periods
- Net income increased year over year in Q2 and the first half, primarily reflecting the $1.9 million provision reversal, higher noninterest income, and lower noninterest expense. Lower net interest and loan fee income and higher tax expense partly offset these benefits.
- Net interest income remained under pressure as average loan balances and loan yields declined. Higher average investment balances partly offset the loan-related decline; management cited low market rates and runoff of older, higher-yielding loans and municipal bonds.
- Nonperforming assets declined to $8.5 million from $12.0 million at year-end 2016 and $18.1 million at June 30, 2016. Total nonaccrual loans were $6.7 million, versus $8.4 million at year-end.
- At June 30, 2017, loans were $111.2 million below the June 30, 2016 balance, while deposits were $197.3 million higher. The company continued shifting its earning-asset mix toward securities and favoring lower-cost checking and savings deposits.
Outlook, commentary, and risks
- Management’s most likely 12-month earnings forecast assumed market rates would gradually rise, with short-term rates increasing more than long-term rates. Management described the company’s interest-rate position as neutral to slightly asset-sensitive, depending on model assumptions; the filing provides no numerical earnings guidance.
- Management said liquidity and capital stress-test results were satisfactory, but cautioned that liquidity could decline and unanticipated events could reduce earnings or capital. Deposits and securities are key funding and liquidity sources; approximately $795 million of securities were pledged as collateral at quarter-end.
- Management expects dividends to continue subject to Board discretion and ongoing review of capital, earnings, asset quality, and other factors. It projected capital ratios would remain above the highest effective regulatory standard, but gave no assurance that plans would not change.
- Key risks include interest-rate and asset/liability management exposure, liquidity and funding conditions, credit quality and collateral values, competition, regulatory changes, operational and cybersecurity risks, economic conditions, natural disasters, securities-market volatility, and legal contingencies.
- The company adopted share-based payment accounting guidance effective January 1, 2017. The first-half tax provision was $666,000 lower than it would have been under the prior accounting rules, principally following stock-option exercises. The company also reported a $1.9 million loan-loss provision reversal in Q2.
- Management was evaluating new accounting standards, including revenue recognition, financial-instrument measurement, leases, and expected credit losses. CECL adoption was required beginning January 1, 2020; management expected the transition adjustment to depend on economic conditions and portfolio composition at adoption and expected the company and Bank to meet capital requirements afterward.
- The filing reported no material pending legal proceeding and no material change in risk factors from the 2016 Form 10-K. Management stated routine legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- How sustainable earnings are without the Q2 provision reversal and with continued pressure on loan balances, loan yields, and net interest margin.
- Whether credit quality and recoveries remain favorable, and whether the $24.1 million allowance adequately reflects classified, nonaccrual, and other portfolio risks.
- How rising short-term rates, deposit competition, securities reinvestment yields, and the large securities portfolio affect margin and liquidity.
- The effect of share-based payment tax benefits on reported tax expense and whether future option exercises create tax-provision volatility.
- Progress and eventual financial and capital effects of adopting CECL and other pending accounting standards.