BANC OF CALIFORNIA, INC. annual report, FY2017

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Banc of California, Inc. — 2017 Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended December 31, 2017. Banc of California is a California-focused financial holding company operating through 34 branches in Southern California. In March 2017, it sold Banc Home Loans, largely its mortgage banking business, and reported the division as discontinued operations. The company said its strategy is to focus on core commercial banking in California.

Financial performance and condition

  • Profit: Net income was $57.7 million, down from $115.4 million in 2016. Continuing-operations income was $53.5 million, versus $86.7 million; diluted EPS was $0.63 from continuing operations and $0.71 overall, compared with $1.34 and $1.94, respectively, in 2016. Net income available to common stockholders was $37.3 million.
  • Revenue and margins: Continuing-operations net interest income was $304.2 million, down 2.0%; noninterest income was $44.7 million, down 54.7%. Net interest margin declined to 3.11% from 3.30%, as interest expense rose and loan interest income fell. The efficiency ratio increased to 88.52% from 74.11%; management’s adjusted, non-GAAP ratio was 77.18% versus 67.13%.
  • Expenses and credit costs: Continuing-operations noninterest expense was $308.3 million, up 1.7%, and provision for loan and lease losses rose to $13.7 million from $5.3 million. Year-end allowance for loan and lease losses was $49.3 million, or 0.74% of loans; nonperforming loans were $19.4 million, and nonperforming assets were 0.21% of total assets.
  • Cash flow: Consolidated operating cash flow was $563.0 million, investing cash flow was $151.9 million, and financing cash flow was negative $766.7 million. Cash and cash equivalents decreased $51.8 million to $387.7 million. Discontinued operations contributed $421.2 million of net cash during 2017, so operating cash flow includes significant mortgage-business runoff and should not be read as a recurring run rate.
  • Balance sheet and liquidity: Total assets fell 6.4% to $10.33 billion. Net loans and leases rose 10.3% to $6.61 billion, while deposits declined 20.2% to $7.29 billion. Core deposits were $5.28 billion, 72.3% of deposits, and brokered deposits were $1.46 billion, 20.0%. The company increased FHLB advances to $1.70 billion; year-end cash was $387.7 million. Management said liquidity sources were adequate and reported $873.1 million of additional FHLB capacity, $63.2 million at the Federal Reserve discount window, and $210.0 million in unsecured federal funds lines.
  • Debt and capital: Total borrowings were $1.87 billion, including $1.70 billion of FHLB advances and $172.9 million of senior notes. The company’s total risk-based capital ratio was 14.56% and CET1 ratio 9.92%; the Bank’s respective ratios were 16.56% and 15.78%. Tangible common equity to tangible assets, a non-GAAP measure, was 6.78%.

Material changes versus 2016

  • The Banc Home Loans sale reduced mortgage banking activity; discontinued-operations income fell to $4.2 million from $28.7 million. The transaction generated a $13.8 million net disposal gain. The company received a $25.0 million cash premium, in addition to certain assets’ net book value, and could receive future earn-out payments.
  • Noninterest income declined substantially, including lower gains on securities and loan sales and the absence of 2016 gains from the Palisades Group and Commercial Equipment Finance sales. Meanwhile, the provision for loan losses increased and funding costs rose.
  • Deposits decreased by $1.85 billion as the company reduced brokered and other higher-cost, volatile funding, replacing some of it with FHLB advances. Securities declined on an amortized-cost basis by 21.8%; management said it sold longer-duration and fixed-rate securities to reduce duration and support lending.
  • All $740.9 million of held-to-maturity securities were transferred to available-for-sale in June 2017. The transfer increased pretax accumulated other comprehensive income by $22.0 million and limits the company’s ability to assert it intends and is able to hold debt securities to maturity for the foreseeable future.
  • Effective tax results were unusually favorable: continuing-operations income tax benefit was $26.6 million, producing a reported effective tax rate of negative 98.8%. Tax credits from alternative-energy partnerships, stock-compensation tax benefits, and the Tax Cuts and Jobs Act affected the result.

Outlook, commentary, risks and unusual items

  • No numerical earnings or revenue guidance is provided. Management expects an approximately 29% combined statutory tax rate for 2018 and said the company became subject to additional requirements, including Dodd-Frank stress testing, beginning January 1, 2018 after exceeding $10 billion in assets for four consecutive quarters.
  • Key risks include the pending SEC investigation, related securities and derivative litigation, reputational damage, management transition, deposit outflows and rising funding costs, California real estate and borrower credit exposure, adjustable-rate and interest-only mortgage risk, interest-rate sensitivity, and regulatory and compliance costs. The company disclosed that certain public statements in October 2016 about an earlier inquiry were not fully accurate; it said it was cooperating with the SEC investigation.
  • At year-end, the company had accrued $4.7 million for various litigation. A former officer’s suit was settled after year-end for $4.3 million in cash payments plus $650,000 of attorneys’ fees; the company stated the settlement would not materially affect its financial condition, results, or liquidity. Other proceedings remained pending, including a securities class action in which the court denied dismissal as to a claim concerning the 2016 proxy statement.
  • Alternative-energy partnership investments produced a $30.8 million accounting loss in 2017 and $38.2 million of tax credits; the company also had $50.1 million in unfunded commitments to those partnerships. Their maximum disclosed loss exposure was $98.9 million.
  • The Bank agreed to pay $100 million over 15 years for Los Angeles Football Club stadium naming and sponsorship rights; $10 million was paid in 2017 and recorded as a prepaid asset. The company also recorded $9.1 million of total restructuring expense related principally to the mortgage-business sale and operating realignment.
  • The company said a material weakness in internal control identified in 2016 was remediated by December 31, 2017. Management and KPMG reported effective internal control over financial reporting, and KPMG issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

  • How much of 2017 earnings and operating cash flow is attributable to nonrecurring tax benefits, mortgage-business wind-down, disposal gains, or other unusual items?
  • What are the status, potential costs, and insurance or indemnification coverage for the SEC investigation and pending litigation, including the securities class action?
  • Can the company stabilize core deposits and reduce brokered funding without materially increasing deposit costs or reliance on FHLB borrowings?
  • How are loan quality, delinquencies, and allowance adequacy trending, particularly in California commercial real estate, multifamily, and interest-only residential loans?
  • What are the realized returns, remaining commitments, and tax-credit utilization timeline for alternative-energy partnerships, and how will the stadium commitment affect expenses and cash flows?