Sierra Bancorp — Q2 2014 Form 10-Q
Business and period: Sierra Bancorp is a California bank holding company whose Bank of the Sierra provides retail and commercial banking services in California’s San Joaquin Valley. This unaudited report covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. Amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $12.950 | $12.275 | $25.165 | $24.117 |
| Net interest margin (tax-equivalent) | 4.00% | 4.04% | 4.00% | 4.00% |
| Provision for loan losses | $0.200 | $0.450 | $0.350 | $2.050 |
| Non-interest income | $4.018 | $4.022 | $7.725 | $8.138 |
| Non-interest expense | $11.008 | $10.717 | $21.736 | $22.538 |
| Net income | $4.237 | $3.799 | $8.036 | $6.132 |
| Diluted EPS | $0.30 | $0.27 | $0.56 | $0.43 |
Q2 pre-tax income was $5.760 million and income tax expense was $1.523 million; first-half figures were $10.804 million and $2.768 million. The effective tax rate was 26% for Q2 2014 and 26% for Q2 2013; for the first half it was 26% versus 20%. Return on average assets and equity were 1.16% and 9.13% for Q2, and 1.12% and 8.75% for the first half. The efficiency ratio was 64.06% for Q2 and 66.96% year to date.
Balance sheet at June 30: Total assets were $1.498 billion, up $88 million (6%) from year-end. Gross loans were $893.0 million, up $89.8 million (11%); available-for-sale securities were $459.7 million, up $34.7 million. Deposits totaled $1.246 billion, up $71.9 million (6%). Cash and cash equivalents were $48.8 million, down $29.2 million. Shareholders’ equity was $186.9 million, up $5.2 million. The allowance for loan and lease losses was $11.6 million, or 1.30% of gross loans.
Debt and liquidity: Reported liabilities included $30.9 million of junior subordinated debentures, $7.75 million of short-term borrowings, and $6.1 million of federal funds purchased and repurchase agreements. First-half operating cash flow was $16.8 million; investing activities used $119.9 million, financing provided $73.9 million, and cash declined by $29.2 million. Management reported $206 million available on existing credit lines, a further $212 million of potential FHLB capacity subject to collateral and stock requirements, and approximately $55 million of Federal Reserve Discount Window capacity. Unpledged securities and securities pledged in excess of requirements totaled $353 million.
Changes and management commentary
- Net income rose 12% year over year in Q2 and 31% for the first half. Management attributed improvement to higher net interest income and substantially lower loan-loss provisions; first-half non-interest expense also declined.
- Average earning assets increased, supporting net interest income, while margin was flat year to date and down four basis points in Q2. Competitive loan pricing and growth in lower-yielding investments pressured yields. Management also cited $280,000 of non-recurring interest recoveries and prepayment penalties in Q2.
- First-half net charge-offs fell to $0.393 million from $3.743 million; the Q2 provision was $0.200 million. Nonperforming assets declined to $33.7 million from $45.6 million at year-end, and represented 3.76% of gross loans plus foreclosed assets, versus 5.62%. However, $34.6 million of loans were classified as TDRs, including $21.4 million on non-accrual; $13.2 million of performing TDRs were also reported.
- Loan growth included $33 million of purchased residential mortgages, increased commercial real estate and farmland lending, and higher mortgage warehouse balances. Management noted mortgage warehouse activity is sensitive to interest rates and refinancing volume.
- Core banking software conversion costs raised Q2 expenses, particularly data processing; rebranding also increased marketing and supply costs. First-half expenses benefited from lower foreclosed-asset costs and gains on foreclosed-property sales. Deposit service-charge income declined.
- Capital remained above regulatory “well capitalized” thresholds, although ratios declined with asset and commitment growth. The company’s total risk-based capital ratio was 20.10%, Tier 1 risk-based ratio 18.94%, and Tier 1 leverage ratio 13.87%. It repurchased 270,100 shares in the first half for approximately $4.3 million and paid $2.3 million in dividends.
Outlook, risks and unusual items
The filing gives no specific earnings or revenue guidance. On July 17, 2014, after quarter-end, Sierra Bancorp agreed to acquire Santa Clara Valley Bank, which had approximately $125 million in assets. Consideration includes $12.3 million for common shareholders, including $0.7 million to cash out warrants, and $3.0 million for preferred shareholders and associated warrants. Closing was expected in Q4 2014, subject to regulatory and shareholder approvals.
The company described itself as asset-sensitive: its model projected next-12-month net interest income decreasing 8.22% (about $4.287 million) with an immediate 100-basis-point rate decline, exceeding its stated internal guideline; a 100-basis-point increase was projected to raise income 2.26%. Management cautioned that model results depend on assumptions and do not include possible competitive or credit-quality effects. Other stated risks include economic weakness in its markets, credit losses and foreclosed-asset resolution, interest-rate and liquidity changes, securities valuation, regulation, technology implementation, and employee retention. Management said pending legal proceedings were not expected to have a material adverse effect and reported no material change in previously disclosed risk factors.
Most important facts to verify
- Whether the Santa Clara Valley Bank acquisition received required approvals, closed as expected, and produced the anticipated costs and benefits.
- Subsequent trends in nonperforming loans, TDR performance, charge-offs, foreclosed assets, and allowance adequacy as loan balances expand.
- Whether deposit growth—some of which management described as potentially seasonal—and mortgage warehouse lending remain stable.
- Actual net interest margin and earnings sensitivity as rates change, given the disclosed downside exposure beyond internal policy guidelines.
- Whether core-conversion and rebranding expenses persist, and whether declining service charges and other non-interest income continue.
- Capital and liquidity after the acquisition, dividends, repurchases, and further balance-sheet growth.