Sierra Bancorp (NASDAQ: BSRR) — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022; unaudited. Sierra Bancorp is the holding company for Bank of the Sierra, a California community bank with 35 full-service branches and an online branch. Its lending includes real estate, agriculture, commercial and industrial, and mortgage warehouse loans.
Financial performance and condition
| Metric | Q2 2022 | Q2 2021 | First half 2022 | First half 2021 |
|---|---|---|---|---|
| Net interest income | $26.6m | $27.2m | $51.3m | $55.7m |
| Net interest margin | 3.40% | 3.60% | 3.31% | 3.76% |
| Provision (benefit) for loan and lease credit losses | $2.5m | $(2.1)m | $3.1m | $(1.9)m |
| Noninterest income | $10.4m | $6.6m | $16.5m | $13.4m |
| Noninterest expense | $22.1m | $20.2m | $42.3m | $40.5m |
| Net income | $9.2m | $11.7m | $16.6m | $22.8m |
| Diluted earnings per share | $0.61 | $0.76 | $1.10 | $1.48 |
At June 30, assets were $3.397bn, compared with $3.371bn at year-end 2021. Gross loans and leases were $2.023bn, up $32.9m from year-end; deposits were $2.851bn, up $69.4m. Cash and cash equivalents fell $95.7m to $161.9m as funds were deployed into securities and loans. Shareholders’ equity declined $63.4m to $299.0m, including accumulated other comprehensive loss of $50.4m, mainly reflecting falling securities values.
First-half operating cash flow was $14.4m; investing activities used $178.7m and financing activities provided $68.7m. Cash and cash equivalents decreased $95.7m during the half. Period-end debt included $49.2m of long-term debt and $35.4m of subordinated debentures; repurchase agreements were $118.0m. The Bank’s leverage ratio was 11.72%, and the holding company’s was 10.45%. Management reported a 36.56% primary liquidity ratio and net loans to deposits of 70.11%.
Material changes and unusual items
- Earnings fell year over year: lower net interest income and higher credit-loss provision outweighed increased noninterest income. For the first half, net interest income fell $4.4m; loan balances and yields were lower, while higher interest rates increased funding costs.
- Noninterest income included unusual gains and recoveries, including a $2.6m gain on Visa B stock, a $0.6m gain on a small-business investment, $0.4m of life-insurance proceeds, a $1.0m recovery of prior-year legal expenses, and a $0.2m acquired-loan recovery. The first half also included a $1.0m securities-sale gain. Volatile life-insurance income tied to deferred compensation reduced income versus 2021.
- The company adopted CECL on January 1, 2022. The adoption increased the loan allowance by $9.5m and the unfunded-commitment allowance by $0.9m before deferred taxes, with a $7.3m reduction to retained earnings. This affects comparability with 2021, which used the prior incurred-loss method.
- On April 1, the company transferred $162.1m of securities from available-for-sale to held-to-maturity to reduce future mark-to-market effects on equity. At June 30, available-for-sale securities had $60.6m of gross unrealized losses; held-to-maturity securities had $14.3m of unrecognized losses. Management attributed these declines primarily to interest rates, not credit deterioration, and recorded no available-for-sale credit-loss allowance.
- Nonperforming assets rose to $29.7m from $4.6m at year-end; nonperforming loans were 1.47% of gross loans. The increase principally reflected four loans in one dairy relationship. A separate commercial real estate office-building loan relationship resulted in $1.9m of second-quarter charge-offs; first-half net loan charge-offs were $4.1m. The allowance for loan losses was $22.8m, or 1.13% of gross loans.
- Noninterest expense included a $0.7m accrual for customer restitution related to nonsufficient-funds fee representments, after an FDIC position change. Beginning in Q3, the company planned to stop charging NSF fees and to change overdraft-fee practices; management did not expect a material effect on deposit-fee income.
Outlook, risks and contingencies
No formal earnings or financial guidance is provided. Management expects to deploy excess liquidity into organic lending and investments, while noting that pandemic-era deposits could run off and mortgage-warehouse activity is not expected to return to 2020–2021 levels. Management says liquidity sources are sufficient for current and anticipated needs, but does not guarantee that liquidity will remain at current levels.
The company describes itself as asset-sensitive in its interest-rate model: a 100-basis-point increase was projected to raise one-year net interest income 3.3%, while a 100-basis-point decrease was projected to reduce it 6.9%; a 200-basis-point decrease was projected to reduce it 15.9%. The downside sensitivities exceeded internal policy guidelines. Results depend on assumptions, including deposit pricing and deposit runoff, and are not forecasts.
Risks include inflation and rate changes, weaker local economic conditions, deposit outflows, credit deterioration and further securities-value declines. Management said current legal proceedings were not considered likely to have a material adverse outcome, while noting an unfavorable outcome could be material. The filing reported no material change in previously disclosed risk factors and no significant change in internal controls.
Key facts for investors to verify
- How much of reported noninterest income and earnings relied on nonrecurring gains, recoveries, and volatile life-insurance results.
- Developments in the dairy and commercial real estate credits, other nonperforming loans, charge-offs, and CECL allowance assumptions.
- The effect of rising rates on deposit costs, net interest margin, securities marks, and the company’s downside interest-rate sensitivities.
- The scale and potential cash impact of the NSF-fee restitution accrual and changes to overdraft and NSF fee practices.
- Deposit stability, liquidity availability, and capital after securities losses, share repurchases, and dividends.