Sierra Bancorp — FY2019 Form 10-K
Business context and reporting period. Sierra Bancorp is a California bank holding company whose principal subsidiary, Bank of the Sierra, operates 40 full-service branches and online and specialized lending services. The filing covers the fiscal year ended December 31, 2019; comparisons are primarily with FY2018. The company reported in March 2020, before the full economic effects of COVID-19 were known.
Financial performance and condition
- Profitability: Net income rose 21% to $36.0 million from $29.7 million; diluted EPS was $2.33 versus $1.92. Return on average assets improved to 1.40% from 1.23%, and return on average equity to 12.23% from 11.37%. Fourth-quarter 2019 net income was $9.3 million and diluted EPS was $0.60, compared with $7.9 million and $0.51 in Q4 2018.
- Revenue and margins: Net interest income increased 5% to $97.4 million. Noninterest income grew 9% to $23.5 million, including higher bank-owned life insurance income. Noninterest expense increased 1% to $70.6 million. Tax-equivalent net interest margin declined 5 basis points to 4.19%; the efficiency ratio improved to 57.46% from 60.79%.
- Credit costs and quality: The loan-loss provision was $2.55 million, down from $4.35 million; net charge-offs were $2.38 million versus $3.64 million. Nonperforming loans increased to $5.7 million (0.33% of loans) from $5.2 million (0.30%); nonperforming assets were $6.5 million, or 0.37% of loans and foreclosed assets, versus $6.2 million, or 0.36%. The allowance was $9.9 million, 0.56% of gross loans.
- Balance sheet and funding: Total assets increased 3% to $2.59 billion; gross loans increased 2% to $1.76 billion and deposits increased 2% to $2.17 billion. Real-estate loans were about 80% of the portfolio. Mortgage warehouse balances more than doubled to $189 million, while residential mortgage lending was reduced. Noninterest-bearing deposits were $691 million, about 32% of deposits.
- Cash flow: Operating activities provided $46.7 million, compared with $30.4 million in 2018. Investing activities used $53.3 million (versus $188.2 million); financing activities provided $12.5 million (versus $161.7 million). Cash and cash equivalents ended the year at $80.1 million.
- Debt and liquidity: Year-end subordinated debentures were $34.9 million, short-term FHLB borrowings $20.0 million, and repurchase agreements $25.7 million. Management reported $523 million of available correspondent-bank and FHLB credit lines, approximately $59 million of Federal Reserve discount-window borrowing capacity, and $437 million of unpledged or excess-pledged securities available for liquidity. The company and Bank met regulatory capital requirements and were classified as well capitalized; company total risk-based capital was 15.48% and leverage ratio 11.91%.
- Shareholder returns: Dividends totaled $0.74 per share, up from $0.64, with a 31.5% payout ratio. The company repurchased 98,603 shares during the year.
Material changes versus FY2018
- Net income rose by $6.3 million, supported by higher net interest income and noninterest income and a lower loan-loss provision. Net interest margin nevertheless edged down as the rate environment softened and deposit costs rose.
- Average earning assets grew, particularly in real-estate and mortgage warehouse loans. At year-end, mortgage warehouse loans were up $97 million, while total gross loans rose only $31 million, reflecting declines in other lending categories.
- Deposits grew $52 million, primarily from organic growth in noninterest-bearing and transaction accounts. Interest expense increased to $13.6 million from $9.2 million, largely due to higher time-deposit costs.
- Shareholders’ equity increased 13% to $309 million, reflecting net income and a $12.6 million improvement in accumulated other comprehensive income, partly offset by dividends and repurchases.
Outlook, commentary, risks and unusual items
- No specific earnings or growth guidance is provided. Management described local economic conditions as stable or improving and continued to emphasize organic lending growth; it opened a Sacramento-area loan production office in February 2020 and expanded its Southern California lending team.
- Management expected lower time-deposit rates in 2020 if short-term rates remained near their then-current levels. Its interest-rate model projected that a 100-basis-point rate decline could reduce next-12-month net interest income by about $4.5 million (4.4%) versus a stable-rate case; a 100-basis-point increase was projected to improve it by about $1.1 million (1.1%). These are model estimates, not guidance.
- The company adopted the current expected credit loss (CECL) standard on January 1, 2020. Preliminary estimates indicated an approximately $12 million increase in the allowance for credit losses; the final impact had not been determined in the filing.
- Key exposures include concentrations in commercial real estate and other real-estate-secured lending, including dairy loans (about 8% of total loans) and hotel loans (about 11%). Management also identified agricultural conditions, drought and water access, trade disputes, oil-price volatility, real-estate values, deposit competition, cybersecurity, regulatory costs and interest-rate changes as risks. The filing specifically cited the novel coronavirus as a potential source of economic disruption, but did not quantify its impact.
- Unusual or notable items included the $1.2 million partial charge-off on a loan placed on nonaccrual in 2019; $0.82 million of nonrecurring interest-related items; volatile BOLI and related deferred-compensation income and expense; and a $0.20 million realized securities loss from portfolio restructuring. The 2019 audit opinion was unqualified, and the auditor and management reported effective internal control over financial reporting.
Important facts for investors to verify
- Whether the CECL allowance increase matched or exceeded the preliminary $12 million estimate, and its effects on capital, earnings and lending.
- Subsequent performance of the large nonaccrual/impaired credits, including the loan charged down by $1.2 million, and trends in nonperforming loans, charge-offs and reserve coverage.
- Mortgage warehouse growth, borrower and lender concentrations, utilization and credit performance, alongside continued declines in residential and other loan categories.
- Deposit mix, time-deposit repricing and retention, brokered funding, and whether higher funding costs continue to pressure net interest margin.
- Actual effects of the coronavirus outbreak and other local economic risks on borrowers, collateral values, deposits and credit quality; the filing provides no quantified forecast.
- Capacity to sustain dividends and repurchases given reliance on Bank dividends, regulatory limits, and $34.9 million of subordinated debt.